Many Americans have the mistaken idea that oil companies don't like ethanol. Perhaps this derives from the general lack of enthusiasm of oil companies for installing E-85 pumps in every gas station, or the sense that ethanol competes with oil and thus reduces oil company profitability. However, after a difficult transition away from MTBE, the industry's preferred fuel oxygenate, ethanol has generally turned out to be a good thing for oil companies--such a good thing, in fact, that we ought to rethink the rationale and mechanism for the 51 cent-per-gallon ethanol blenders credit.
A year ago, in an address to USDA Agricultural Outlook Forum the CEO of the American Petroleum Institute, Red Cavaney, said, "Clearly, there is a bright future for ethanol, as well as for biodiesel, although the latter is starting from a smaller base. We look forward to the promise of an ever-growing relationship between our two industries in the years ahead." To understand why the US oil industry is supportive of ethanol, you have to examine the US motor fuels supply and demand balance and the economics of ethanol blending.
Start with the fuel balance. US refineries produce on average 8.4 million barrels per day (MBD) of motor gasoline, or "mogas", while we consume 9.3 MBD. The difference is made up by imports of finished mogas and various unfinished petroleum-based blending components and ethanol. In fact, the quantity of imported finished mogas is roughly equal to current US ethanol production. That means that the volume displaced by a further doubling of ethanol output would come largely at the expense of foreign refineries, not US ones. As long as US oil companies made more on ethanol blending than their typically thin margins on imported mogas, they would be no worse off.
Historically, ethanol was more expensive than either gasoline or methyl-tert-butyl-ether (MTBE), another additive used to meet mandated fuel oxygenate standards. Today, MTBE is out of favor, and ethanol is cheaper than the RBOB--shorthand for "reformulated gasoline blendstock for oxygenate blending"--with which it is blended at distribution terminals to make finished gasoline for sale to consumers. If you compare the spot price of RBOB in the Gulf Coast this week, at $2.58/gallon, with the ethanol price on the Chicago Board of Trade, at $2.51/gal. plus approximately $0.12/gal. freight, and then subtract the blenders' credit, ethanol ends up 46 cents per gallon cheaper than the mogas with which it's blended. It would be the rare cargo of imported mogas, indeed, that yielded anything close to that kind of uplift. As a result, the industry has a healthy incentive to use this oil substitute that the government has deemed useful in reducing emissions and enhancing our energy security.
But here is where the interests of oil companies and ethanol producers diverge from those of consumers and taxpayers: A gallon of ethanol carries only about 70% as much energy as a gallon of gasoline. Fuel suppliers are indifferent to this fact, because, unlike your natural gas utility, they sell by volume, not energy content. But unless you are burning nearly pure ethanol in an engine optimized to make the most of its characteristics, that energy difference manifests in lower gas mileage. This effect is particularly pronounced for E-85, which contains only 75% as many BTUs as a gallon of ethanol-free mogas, and the EPA's fuel economy statistics on the performance of flexible-fuel vehicles bear that out. But even a 10% blend has about 3% less energy than normal gasoline, translating into about 0.7 mpg loss in a typical car. Some cars are more sensitive to this than others, but it works out to the equivalent of a hidden 10 cent-per-gallon tax on gasoline, at current prices.
What we have then, on balance, is a substantial federal subsidy that gives oil companies a significant incentive to produce a fuel that reduces consumer value and forces motorists to purchase more fuel to travel the same number of miles. Now, my industry colleagues would rightly point out that ethanol isn't quite the bonanza I've simplistically portrayed above. Because it can't be shipped in the petroleum products pipelines that are the heart of our national fuel distribution system, the logistics of ethanol are challenging, especially at remote locations far from Midwestern or coastal ethanol sources. It also costs a bit more to make RBOB, versus conventional gasoline, because of the need to compensate for ethanol's impact on gasoline vapor pressure, and thus evaporative emissions. Yet when I look at that RBOB/ethanol price relationship over the last year, I conclude that they are being well-rewarded for the extra effort involved.
I won't delude myself by thinking that we might abandon the federal ethanol subsidy any time soon, particularly in light of the dramatically-increased biofuels mandate enacted with the 2007 Energy Bill. The politics involved are insurmountable. But as the economy weakens and the federal budget deficit expands to fund economic stimulus and financial stabilization measures, it might not be beyond the pale to consider modifying the current fixed subsidy, by adding a floating cap that limited the ethanol blenders' credit to the net difference between prevailing gasoline prices and the delivered cost of ethanol, plus a fixed incentive. That would render ethanol cost-neutral for refiners and blenders, without undermining our national ethanol strategy. Even if this only shaved 10 cents per gallon off the subsidy, that could save taxpayers over a billion dollars per year, as ethanol volumes continue to rise for the next 15 years.