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Ethanol and Gasoline Prices

October 26, 2010

           

Ethanol prices have strengthened over the past several months in response to higher corn prices and growing ethanol demand. Some have attempted to single out the escalation in ethanol prices as a primary driver of the slight increase in retail gasoline prices. Yet, a quick look at the data shows retail gasoline prices and ethanol spot prices are not well correlated, even when lagged to account for the fact that it may take some time for ethanol price increases to work through to the retail level. Further, an examination of recent pricing data reveals that gasoline prices would be higher if not for the fact that ethanol is blended with nearly every gallon of gasoline consumed in the U.S. today. Current market dynamics also demonstrate the importance of the ethanol blender's tax credit. Despite the fact that the market price for ethanol has been above the price of gasoline in recent weeks, the ethanol blender's tax credit has kept the effective price of ethanol below the price of gasoline. Gasoline blenders and refiners who mix ethanol with their gasoline are able to claim a $0.45/gallon tax credit (known officially as the Volumetric Ethanol Excise Tax Credit, or VEETC) on every gallon of ethanol blended. This tax credit effectively lowers the price a blender or refiner pays for ethanol. When the value of the tax credit is passed through to the consumer, it translates to a 4.5 cent/gallon savings at the retail level for gasoline containing 10% ethanol (E10) compared to gasoline without ethanol. As of last week, Chicago spot prices showed ethanol selling for $0.15 less than the blend-ready gasoline (called Reformulated Blendstock for Oxygenated Blending, or RBOB), when VEETC is accounted for.  This differential translates to a gallon of E10 being 1.5 cents/gallon cheaper at the retail level than unleaded gasoline without ethanol. Data sources: Jim Jordan & Associates (Ethanol & RBOB); Energy Information Administration (Gasoline Retail) This simple example demonstrates the importance and effectiveness of the VEETC. In essence, VEETC is enhancing the ability of ethanol producers to manage sharply higher corn prices, while at the same time ensuring ethanol is priced competitively with gasoline and ultimately saving consumers money. It is also important to remember that ethanol's ability to significantly expand overall motor fuel supplies contributes to lower gasoline prices. The addition of nearly 13 billion gallons of ethanol to the U.S. gasoline supply in 2010 is taking significant pressure off of gasoline stocks, which has the effect of putting downward or moderating pressure on gas prices. Economists from entities as diverse as the Department of Energy, White House Council of Economic Advisors, Merrill Lynch, and several universities have estimated that gasoline prices could be $0.20-0.50/gallon higher if not for the incremental supply provided by ethanol.