Ethanol continues to reduce gas prices significantly

By Kris Bevill | May 03, 2011

Updated analysis conducted by economists at Iowa State University and the University of Wisconsin shows that the domestic ethanol industry has become an integral part of the U.S. transportation fuels sector. Ethanol production has reduced wholesale gas prices by 25 cents per gallon on average over the past decade, the paper’s authors concluded. Previous analysis showed a 14-cent-reduction in gas prices on average. Perhaps more importantly, they also noted that ethanol is now vital to the nation’s fuel supply and any disruption to ethanol supply could cause a dramatic increase in gas prices.

The paper,  authored by Xiaodong Du, assistant professor of agricultural and applied economics at the University of Wisconsin-Madison, and Dermot Hayes, professor of economics and finance at ISU, was released by ISU’s Center for Agricultural and Rural Development and sponsored by the Renewable Fuels Association. It is an update on analysis conducted by the authors in May 2009 to examine ethanol’s impact on wholesale gas prices. 

The new paper includes two additional years of data—2009 and 2010. The authors present average economic impacts of ethanol on gas prices over the last decade as well as just during 2010. They found that last year, ethanol production reduced gas prices by an average of 89 cents per gallon. Separating the data for each Petroleum Administration for Defense District region shows that the Midwest region has received the greatest benefit from ethanol production. Last year, ethanol reduced gas prices there by $1.37 per gallon, according to the paper’s authors. Ethanol has had the least impact on gas prices on the East Coast. Ethanol production reduced prices in that region by 58 cents per gallon in 2010. In the past decade, the average price reduction on the East Coast has been just 16 cents per gallon. 

Du said he was not surprised that the impact of ethanol production on gas prices has become more apparent in the past two years. He credits substantial growth within the ethanol industry combined with higher crude oil prices for most of the increase in economic impact. Likewise, however, the growing dependence on ethanol as a fuel source means that losing it would significantly increase gas prices, the authors stated. “The ethanol industry now provides approximately 10 percent of the gasoline used in automobiles, an amount that exceeds the spare capacity of U.S. oil refineries,” the authors stated in the paper. “This ‘missing’ fuel would have to be imported in the short run, and the required volume would be large relative to available import supplies. The only way to solve this short-term supply problem would be to use high gasoline prices to ration demand.” The authors stated that while it is difficult to calculate with any certainty the exact increase in gas prices that would occur as a result of ethanol shortages, they estimate it would be of historic proportions, ranging from 41 percent to 92 percent.

Hayes said that examining the impact of an immediate halt of ethanol production is topical, and used drought as an example of why it is important to evaluate this scenario. “We have come to rely on ethanol to run our gasoline fleet,” Hayes said. “The ethanol industry needs corn and if we get a drought in the Corn Belt, we may not have enough corn. This could potentially cause a dramatic increase in gasoline prices.”

Bob Dinneen, president of the RFA, said the warning from the paper’s authors regarding ethanol’s impact on gas prices should serve as “a wake-up call” to those seeking to remove it from the nation’s fuel supply. “At a time when the economic recovery is fragile and oil markets are increasingly volatile, policymakers should be embracing—not shunning—ethanol’s ability to add to domestic fuel supplies and hold prices in check,” he said. “While it isn’t realistic to assume that all ethanol production would ever come to an immediate halt, this analysis shows just how important ethanol is to our fuel supply.”