CARD analyses discuss E85 and the RFS

By Erin Voegele | November 08, 2013

Two new papers published by Iowa State University economists Bruce Babcock and Sebastien Pouliot discuss E85 investment and consumption. Both papers were published under the ISU’s Center for Agricultural and Rural Development.

The first CARD Policy Brief, titled “RFS Compliance: Death Spiral or Investment in E85,” addresses the NERA Economic Consulting study commissioned by the American Petroleum Institute last year. The report found that ethanol and biodiesel blend walls create insurmountable barriers to the volume of biofuels that can be consumed in the U.S., and that once the blend walls are hit the only way obligated parties can comply with the renewable fuel standard (RFS) is to reduce domestic sales of gasoline and diesel, leading to an upward “death spiral” in fuel prices that will harm the U.S. economy.

However, Babcock and Pouliot said that NERA finding rely on the assumption that obligated parties no available options to meet RFS obligations other than reducing sales. However, the blend wall can be overcome with E85 sales.

In the paper, the economists estimate that in order to consume 2.8 billion gallons of E85 in 2015, there would have to be 5,000 more fueling stations selling E85 located in regions where flex fuel vehicles are. The E85 would also have to be priced low enough to save drivers money. “The question becomes, is it more reasonable to assume, as NERA does, that obligated parties will choose a compliance path that leads to a death spiral in fuel prices or that they will choose to finance investments in E85 infrastructure?” asked Babcock and Pouliot in the paper.

The economists note that under a theoretical death spiral, higher domestic prices for gasoline and diesel would increase profits for oil companies. While this would create a win-win scenario for oil companies, Babcock and Pouliot said the outcome would be unstable, and as such will not materialize.

“Some may think it is not realistic to expect obligated parties to invest in E85 retail infrastructures when they do not own the stations,” they wrote in the paper. “However, if the alternative is a cut in gasoline sales that can only be maintained if oil companies act together and form a cartel, then perhaps this investment is not so far-fetched. Of course, from the oil company perspective, the best situation would be if EPA reduces mandates to easily-achievable levels that would provide them with cheap ethanol and no compliance costs.”

The second paper, titled “How Much E85 Can Be Consumed in the United States?” notes that there three key factors currently limit the consumption of E85. First, there are 14.6 million flex fuel vehicles on the road, concentrated primarily in Texas, the Midwest, and the East Coast. The second limiting factor is that he number and location of gas stations that sell the fuel blend. Third, E85 has, until recently, been priced at a level that increases fuel costs. 

“If consumption of ethanol in the United States is to move significantly beyond the E10 blend wall then consumption of E85 must increase,” write the economists in the paper. “There were enough flex vehicles on the road at the end of 2012 to consume about three billion gallons of ethanol if E85 were priced at parity with E10 on a fuel cost per mile basis. However, because of a limited number of stations, this fuel price ratio would result in 500 million gallons of ethanol sold as E85. An additional fuel cost discount of 10 percent would increase ethanol consumption by about 250 million gallons. Consumption beyond these levels will require a substantial increase in the number of stations that offer E85. Whether investment in E85 fueling infrastructure actually occurs depends on whether EPA sets biofuel mandates at levels that can be met only by increasing the amount of ethanol that is sold in E85.”