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Drain the Swamp: Sunset the Renewable Fuel Standard

Just before the Thanksgiving weekend I spoke to a trade association about the Renewable Fuel Standards (RFS)—why the Competitive Enterprise Institute (CEI) wants to abolish it, and how reform-minded groups might constructively engage the incoming Trump administration given the President-elect’s well-known support for the RFS. Below is an edited version of my remarks.

The Competitive Enterprise Institute, as our name suggests, believes that refereed competition—competition under rules of fair play—advances the public interest. Austrian economist Friedrich Hayek called competition a “discovery procedure.” Competition reveals “which goods are scarce,” “how scarce or valuable they are,” and even “which things are goods.” When government grants special privileges to some industries or firms at the expense of others, consumers pay more for inferior products and services, policymakers become captive to special interests, and the favored industry becomes dependent on corporate welfare. Not good!  

CEI therefore opposes any government policy that aims to pick winners and losers in the marketplace. So naturally, we oppose the RFS and advocate its repeal.

Competition

How does the RFS limit competition? At a House Energy & Commerce Committee hearing in June, Rep. Adam Kinzinger of Illinois asked Janet McCabe, the Environmental Protection Agency official who administers the RFS, why EPA proposed 2 billion gallons as the biodiesel target for 2017 when the biodiesel industry says it can produce much more.

McCabe explained (hearing transcript, p. 71) that biodiesel is one of several fuels that qualify as an “advanced biofuel” in the RFS program. So a question EPA wrestles with is “how much of that advanced category should biodiesel basically get a guarantee on?” She continued: “. . . we believe that it is important to have competition and choice and opportunity for a variety of fuels to compete.” She noted the target is not a cap on how much biodiesel producers can offer for sale. Rather, it is a cap on how much refiners are obligated to buy and blend. Capping that obligation, she said, “leaves room” for other fuels to compete.

Think about what her explanation implies. If the quota for biodiesel leaves less room for other fuels to compete within the advanced biofuel category, then the RFS as a whole leaves less room for choice and competition in the total motor fuel market. Every gallon of renewable fuel which the RFS guarantees for sale restricts overall market competition and choice by the same amount.

Consider the statutory goal of the RFS—squeeze 36 billion gallons of renewable fuel into the marketplace by 2022, with up to 35 billion gallons blended with gasoline for passenger vehicles. That target won’t be met and becomes increasingly unrealistic each year. But imagine it could and will be done. Thirty-five billion gallons is more than one-quarter of the projected size of the total gasoline market in 2022 (see Figure 1 of this testimony). The ultimate aim of the RFS is to deny fossil fuels the opportunity to compete for one out every four gallons of motor fuel households buy.

Ask yourself: Would your company thrive or even survive if Congress required you to cede one quarter of the market to your competitors? What would you think of a World Series in which one team automatically wins one of the first four games? Or a Super Bowl in which only one team is allowed to go on offense in the first quarter?

This year, EPA proposes to lower the statutory RFS goals in light of the blend wall, a set of market constraints that effectively limits the quantity of ethanol sold to less than 10 percent of the gasoline market. EPA does want to force the market beyond the blend wall, but not as much as the corn ethanol lobby demands. A group of senators led by Charles Grassley (R-Iowa) and Amy Klobuchar (D-Minn.) claim the EPA may not consider the blend wall when determining refiners’ annual requirements, known as Renewable Volume Obligations (RVOs). Specifically, they contend that “lack of distribution infrastructure was explicitly rejected by Congress as a reason to grant a waiver [from statutory goals] in 2005.”

The Senators don’t provide a source for their statutory interpretation. Yet even if correct, their claim is irrelevant. The blend wall had no bearing on the RFS as created in 2005. The original RFS annual blending targets maxed out at 7.5 billion gallons in 2012. That is only about half the quantity of ethanol U.S. markets can absorb as E10—gasoline blended with 10 percent ethanol. Under the 2005 RFS, there was simply no prospect of biofuel production running up against the E10 blend wall.

Biofuel lobbyists often claim refiners have “obligations” to finance the blender pumps and storage tanks that supposedly would enable them to meet the RFS program’s statutory targets. But where in either the 2005 Energy Policy Act, which the created the RFS, or the 2007 Energy Independence and Security Act, which expanded the program, is such an obligation discussed or mentioned?

Biofuel interests have never cited any such provision because it does not exist. Apparently, they want us to believe that if Congress willed the end, it must have willed the means. But sausage-making—writing and passing laws—is not an exercise in abstract logic. Laws embody tradeoffs and compromises and rarely give the affected interests everything they want. Congress considered several bills with provisions requiring refiners to install E85 infrastructure at their affiliated stations. None of those provisions actually made it into the law.

The proximate cause of the blend wall is the incompatibility of high ethanol blends with most retail fuel infrastructure and vehicles on the road. The vast majority of service stations are small businesses with thin profit margins. Installing an E15 or E85 dispenser with a dedicated storage tank can cost up to $200,000. Although EPA approved the use of E15 for 2001 and newer models, most owners’ manuals and warranties for vehicles manufactured before 2015 caution against using E15. Biofuel lobbyists yack a lot about those barriers and demand refiners “invest” in biofuel infrastructure to overcome them. However, they ignore the root cause of the blend wall: crummy fuel economy.

Although ethanol is cheaper by the gallon than gasoline, it has one third less energy. At today’s relative prices, the typical motorist, depending on the size of the vehicle, would have to spend $50-$300 more each year to fill up with E85 instead of regulatory gasoline. In recent years the annual price penalty has been as big as $1,450. If high-ethanol blends actually saved consumers money, they would demand it, and the ethanol industry itself would invest in the blender pumps and storage tanks required to serve that market. Why don’t they?

RFS defenders claim it’s because Big Oil uses its “market power” to prevent retail outlets from offering high-ethanol blends. Rubbish. More than 95 percent of gas stations are independent businesses, and more than 50 percent are unbranded single station operators. A franchise agreement may require the service station to offer premium, regular, and mid-grade gasoline, so if the station has only three pumps, none will be available to provide E15 or E85. But that is not an abuse of market power. It simply means that infrastructure is not free.

Think about it this way. When you take the kids to McDonald’s, you expect the local franchise to carry all the standard items on the McDonald’s menu. That’s the same kind of reliable, predictable service oil companies require their franchisees to offer customers. With this critical difference. McDonald’s does not allow franchisees to sell Burger King Whoppers even if they do so at their own expense. In contrast, branded service stations are free to offer products in addition to the standard fare if they want to and can raise the requisite capital. So far, however, the biofuel lobby has shown little interest in putting its own skin in the game.

How come? Maybe because they know that if ethanol were really the great bargain they claim it is, we would not need a law to make us buy it.

Legal Plunder

I jokingly call the RFS a Soviet-style production quota system. Jokingly, because Lenin and Stalin had the intellectual modesty to establish only five-year plans whereas the RFS, as expanded by Congress in 2007, is a 15-year plan. It sets annual biofuel targets for 2008 through 2022.

Like other central planning schemes, the RFS is fraught with unintended consequences. It incentivizes land conversions eradicating millions of acres of wildlife habitat. Compared to the gasoline it replaces, the RFS increases certain types of air and water pollution, raises food prices, and may actually increase net greenhouse gas emissions.

But even if the RFS worked exactly as advertised, Congress should still repeal it. The RFS literally compels one set of companies to purchase, process, and create a market for other companies’ products. It makes one business the involuntary servant of another. That is not the American way.

To see the anomaly, imagine the shoe were on the other foot. Suppose Congress proposed to enact WVOs (wheat volume obligations) requiring corn farmers to buy and sell annually increasing quantities of wheat. Or IVOs (input volume obligations) requiring corn farmers to purchase annually increasing quantities of specific seeds, fertilizers, and farm machinery—those deemed “sustainable” by the EPA. The howls from RFS supporters would be loud and furious. And justifiably so.

The implication is obvious. The RFS is a system of special privilege. It conflicts with the basic constitutional principle of equality under law.

Prospects for Reform

In the Texas GOP primary debate, Sen. Marco Rubio (R-Fla.) opined that Congress doesn’t have to repeal the RFS because “it is phasing out” and by 2022 “it will go away.” Unfortunately, that’s not the case.

Although the statutory targets don’t increase after 2022, the RFS does not expire. Rather, Section 211(o)(2)(B)(ii) of the Clean Air Act directs EPA, in coordination with the Departments of Energy and Agriculture, to establish RVOs for the motor fuel industry in “other calendar years”—in principle, until the end of time. The provision also limits EPA’s authority to reduce post-2022 RVOs for biodiesel, cellulosic ethanol, and biomass-based diesel.

Terminating the RFS after 2022 will require congressional action and executive leadership.

Our various groups must keep making our separate yet complementary cases for repealing the RFS so there’s a fighting chance the program will sunset after 2022.

How should we engage the Trump administration on RFS reform? In 2007, Congress and President Bush touted the RFS as a policy to mitigate climate change, enhance U.S. energy security, and strengthen rural economies. I suspect only one of those three rationales resonates strongly with the President elect.

Trump doesn’t seem to worry much about climate change. Besides, many environmentalists now attack corn ethanol as more carbon-intensive than gasoline.

Trump cares about energy security but also likely understands that fracking, not the RFS, has made America great again as an energy producer.

So what Trump probably likes most about the RFS is the jobs and wealth it creates in rural America. We need to familiarize him with other side of the story—the costs and risks the RFS imposes on the livestock farmers and chain restaurants.

In general, we should connect the RFS to core Trump campaign themes. Explain why the RFS is a posterchild for bipartisan collusion to “rig” the marketplace on behalf of special interests. “Draining the swamp” includes abolishing the RFS.

Trump wants to downsize or even dismantle the EPA. Well, if the new administration and Congress don’t amend the Clean Air Act, EPA’s power to meddle in motor fuel markets and dispense corporate welfare will increase after 2022. RFS reform is critical to shrinking the EPA.