Federal Regulations Drive Up Gasoline Prices

Lately an argument has broken out over the Renewable Fuel Standard (RFS) and whether it drives up gasoline prices. The recent controversy was sparked by a WSJ article discussing the shocking fact that Renewable Identification Number (RIN) credits—which are one way of complying with the federal standard—had shot up in prices from about 7 cents in January to more than $1 in March. The WSJ article argued that—duh!—massively increasing a cost component would drive up gas prices.

In response, the Renewable Fuels Association (RFA) commissioned a quantitative study by “informa economics,” which concluded (surprise?) that the impact of the skyrocketing price of RIN credits had virtually no measureable impact on pump prices. In fact, the study said that the RFS mandate made it cheaper for American motorists to drive their vehicles.

Here at American Products. American Power. an earlier blog post has already documented the numerous flaws in the study. For example, the study ignores the fact that ethanol has less energy content per volume than conventional gasoline, making the RFA study’s price comparisons misleading. But more fundamentally, our blog post argued that even taking the RFA study at face value, it would mean that there is no need for a federal Renewable Fuel Standard. To repeat our point: If the people at RFA actually believe that using ethanol instead of conventional gasoline is good for the refining industry and will lower prices at the pump, then why do we need a federal mandate? Why wouldn’t natural market forces give us this outcome?

In the present post, we want to supplement our earlier critique with one additional point. One of the ways that the RFA-commissioned study tries to exonerate RIN prices from the spike in gas prices, is to say that the seasonal pattern in early 2013 was not noticeably different from that in 2011 and 2012. Looking at the “crack spread,” for example, doesn’t show us anything unusual in early 2013. Here’s how they put it:

There is a distinct seasonal pattern to gasoline prices and crack spreads, slumping during the last quarter of the calendar year and then strengthening considerably through the first quarter of the following year.  The increase in gasoline prices and crack spreads during the first quarter of 2013 has been generally consistent with increases experienced in 2011 and 2012, despite the fact that conventional ethanol RIN prices averaged $0.03 during the first quarter of 2011 and $0.02 during the first quarter of 2012.

Now, they actually don’t come right out and explicitly finish their argument here—probably because even their own readers would raise an eyebrow. To finish the train of thought they should add, “So the fact that RIN prices shot up to more than $1 in the first quarter of 2013, shouldn’t make us blame the spike in gas prices—over and above changes in crude oil prices—on the Renewable Fuel Standard.”

Such analysis shows the danger of naïve statistical analysis in economic matters. It’s true, there are always a million factors changing in the real world. On top of that, producers don’t mechanically set prices based on their “costs” plus some margin for “profit.” Everything is always embedded in a context of consumer demand, as well as expectations of the future. Finally, even demonstrably obvious factors might be muted in their apparent effects, because we don’t know what the path of the economy would be in the alternate timeline. For example, eating a Snickers bar is generally not a good way to lose weight, but if we just looked at a guy stranded on a desert island, we might see a correlation between him eating the candy bar in his pocket, and losing 5 pounds.

Yet let’s put aside all of these commonsense observations, and focus just on the raw numbers. Remember, the defenders of the Renewable Fuel Standard are saying that the big jump in RIN prices in early 2013 didn’t cause a spike in gas prices (relative to crude oil prices), any more than happened in 2011 or 2012. But look at a long-term chart of crude oil vs. gasoline prices to see why that “defense” is rather misleading:

As the chart above shows, gasoline prices have been much higher, relative to crude oil prices, precisely in the period the RFA-commissioned study analyzes. We can be even fancier and look at a single measure, where we take the average price of a gallon of gas, and subtract out the price of a barrel of crude divided by 42 (since that’s how many gallons of gas are produced by a barrel of oil):

Intuitively, the second chart shows that the average U.S. retail price of gasoline, relative to the adjusted crude oil cost, was much higher in the mid-2000s and then again from 2011 through today, compared to the long-term trend. For some reason, it seems as if some additional force has been pushing up prices at the pump, that was particularly pronounced in the mid-2000s and then again in the last three years. What could it be?

As we said before, it’s impossible to point to one specific factor, because market prices are based on many different elements. But on these pages we have discussed the costly mandates embedded in the Energy Policy Act of 2005, and the Tier 2 standards that insisted on a 90 percent reduction in sulfur contact by 2006, and how the recently codified Tier 3 standards will begin rising pump prices.

In short, we have been warning on these pages that the various, bipartisan interventions into the refining sector—starting under President George W. Bush and ramping up under President Obama—have been making gasoline artificially more expensive for American motorists. The world price of crude oil alone cannot explain the annual surges in gasoline prices since 2005, with the only (relative) respite occurring during the massive economic slump of 2008.

It’s true, in economics we usually can’t have a smoking gun and point to “the” reason a market price moved in a certain way. Yet economic theory—as well as common sense—tells us that increasing refiner costs will make gasoline prices higher for motorists. Further, the historical data most certain do show a strong correlation between the Bush and Obama regulations on refining, and an extra margin in gas prices.