UI economists: Ethanol/CBOB ratio at breakeven, unlikely to last

By Susanne Retka Schill | November 13, 2014

The recent drop in gasoline prices raises the question whether ethanol’s competitiveness in blends is being threatened. University of Illinois economists Scott Irwin and Darrel Good examined the prices relationship and conclude the conventional breakeven price ratio of 1.0 is the most accurate measure. “Which, interestingly, is substantially higher than average ratio (0.83) based on what blenders have actually paid for ethanol relative to gasoline in recent years.”

Even though the current drop in oil prices and increase in ethanol has narrowed the ratio to just under 1.0, the economists argue that any negative margin is likely to be shortlived. Looking at the two previous periods of negative margins in the past few years, they conclude, “the ethanol/CBOB price ratio is not likely to move above 1.0 for any length of time and that market adjustments to maintain the competitive position of ethanol likely will be rapid. Higher ethanol production and lower ethanol prices have proven quite effective in the past at maintaining ethanol's place in gasoline blends and are likely to continue to do so in the future.” 

The economists wrote about their analysis in their most recent posting with FarmDocDail, “Do Falling Gasoline Prices Threaten the Competitiveness of Ethanol?” In the analysis, they look at the historical price relationships for wholesale CBOB gasoline in Chicago, compared to wholesale ethanol.  While the spread indicated by the ratio of ethanol to gasoline average 0.92 between 2007 and 2011, the year the tax credit ended, it has averaged 0.83 since the beginning of 2012. In discussing whether the breakeven ratio would be 1, the authors note, “it is interesting to observe how infrequently negative blending margins have occurred since 2011—only a total of seven weeks.” 

In looking at the ratios pre- and post-tax credit, they found a drop in marginal valuation of ethanol relative to CBOB. “The 2007-2011 average ratio is 0.92, the same as the overall sample average, but the 2012-2014 average ratio falls to 0.83. The difference between the two means is not only statistically significant (t-statistic = 7.25), but also economically significant. Given that the average CBOB price over 2012-2014 was $2.68 per gallon, the nine percentage point drop in the mean ratio translates into a $0.24 drop in the average ethanol price.” The authors note another implication, “This also implies there was less than full pass through of the tax credit from blenders to producers when the credit was in place.”