There is currently a debate about whether to permit more ethanol use—a liquid fuel derived from corn—at greater percentages during the summer months. Normally, ethanol is blended into gasoline at no higher a rate than 10 percent (E10). But there is an effort to permit more sales beyond the so-called “blend wall” of 10 percent, and go to 15 percent (E15). At a surface level it would seem that regulation is precluding industry from selling a product that customers demand, but that is not true. The narrow issue of E15 sales obscures the fact that the only reason so much ethanol is consumed is because government requires it. If Washington stepped back and let the market determine the optimal mixture of liquid fuels for customer sales, this debate wouldn’t be occurring, and Americans would be spending less on energy.
A bit of context is in order. The federal government requires that U.S. refiners blend 15 billion gallons of conventional biofuel (mostly ethanol) into the fuel supply each year as part of the Renewable Fuel Standard (RFS). Given that Americans consume about 137 billion gallons of gasoline per year, a blend wall of 10 percent presents a challenge because the government may require more ethanol to be consumed than there are available gallons of gasoline to blend ethanol into. Proponents of raising the blend wall to 15 percent note that reduced limitations on blending practices can make it easier for industry to comply with the RFS. But it should be noted that the 10 percent threshold exists primarily for environmental reasons, as it is believed that higher blend rates of ethanol during warmer months could increase smog. Naturally, the next question is: Why is the government requiring that we buy so much ethanol?
The narrow issue of E15 sales obscures the fact that the only reason so much ethanol is consumed is because government requires it.
The justification for the enormous ethanol production requirements—which it takes about 40 percent of the corn grown in the United States to produce—was initially energy security. In 2005, Congress wanted to import less oil from the Middle East and sought to replace gasoline consumption with domestically produced ethanol. In 2007, climate justifications were added to the RFS. The security justification for the RFS has waned, particularly as domestic oil production has nearly tripled since 2005. The environmental justification is similarly weak, as there is considerable debate as to the magnitude of emission benefit ethanol has from replacing gasoline—if there’s any benefit at all. As a result, more recent debates about the worthiness of the RFS have come down to cost, even though any basic economics student could explain that a mandate to buy something will increase what consumers pay.
The debate about the overall costs of the RFS has been plagued by double talk and apparent contradictions. In the past, official assessments of the cost of the RFS posited that the program would have little cost because there would be high demand for ethanol to blend with gasoline anyway. If this were true, though, then there would be no need to have the program at all—yet it is vociferously defended. Obviously, it cannot simultaneously be true that the RFS has little cost but that the program has a large impact. What is most likely is that the program has a big impact on fuel consumption choices and a commensurately big cost.
Recent research from the R Street Institute sheds some light on the real costs of the RFS. In examining the additional cost of ethanol per unit of energy relative to gasoline, as well as estimating the additional cost consumers pay at the pump for the program’s compliance, the program has likely cost $199 billion since 2010. The reason for this high price tag comes down to the difference between old assumptions and what occurred in the past. Gasoline prices have not been as high as predicted when the RFS was initially adopted, making ethanol a less economical substitute to gasoline. This observation is further backed up by the fact that other countries with much higher petroleum prices than the United States have much lower rates of biofuel blending. In lay terms, the assumptions that led policymakers to think the RFS was relatively costless were ultimately untrue, and biofuel consumption levels are pushed upward because of the mandate.
The market is better able to determine the optimal mixture of liquid fuels for sale, which will necessitate more ethanol consumption in some years compared to others as the prices of fuel inputs fluctuate.
But ultimately, from an economics perspective, it does not really matter who is right about the RFS’s cost, because no economic justification for the program exists. The market is better able to determine the optimal mixture of liquid fuels for sale, which will necessitate more ethanol consumption in some years compared to others as the prices of fuel inputs fluctuate. The government has introduced inefficiency into markets by shielding the ethanol industry from competition via the RFS and passing the costs to Americans at the pump.
The debate about E15 blending exists because of an artificial problem stemming from the failures of the RFS. In an ideal world, the market would determine the optimal mixture of ethanol and gasoline, but the tension between environmental regulations and the government mandating enormous purchases of ethanol has created this problem. From a policy standpoint, the solution is obvious: get rid of the RFS, and let the market determine the optimal level of ethanol consumption instead of politicians.
Philip Rossetti conducts research for the R Street Institute on energy, climate, and environmental policy to identify low-cost and free-market opportunities to improve environmental outcomes. He is also the lead author of Low-Energy Fridays, a weekly series where R Street breaks down a complicated energy topic.