Preliminary thoughts on the RFA’s PR campaign

As most ethanol watchers know, the Renewable Fuels Association ran a full-page ad in The Hill magazine last week (May 6, 2008) titled: “Without ethanol, we’d be paying over $4.00 a gallon for gasoline today.” To substantiate this claim, the ad quotes from a March 24, 2008 column by Wall Street Journal reporter Patrick Barta:

“Without biofuels, which can be refined to produce fuels like the ones made from petroleum, oil prices would be even higher. Merrill Lynch commodity strategist Francisco Blanch says that oil and gasoline prices would be about 15% higher if biofuel producers weren’t increasing their output.”

What to make of this? Some preliminary thoughts.

(1) If Blanch’s analysis is correct, then proponents of the ethanol mandate, the 51-cent per gallon blenders tax credit, the 54-cent per gallon tariff, and other forms of policy privilege can no longer claim that ethanol “displaces” petroleum in the nation’s fuel supply. Rather, ethanol adds to the total stock of motor fuel. It is by increasing total liquid fuel supply relative to global demand that ethanol, in Blanch’s analysis, reduces crude oil and gasoline prices.

If correct, this is also an argument for opening the Alaska National Wildlife Refuge (ANWR) and the Outer Continental Shelves to oil production. Increased oil production should also increase supply relative to demand, lowering oil and gasoline prices. 

(2) Blanch’s estimate, as far as I can determine, is not part of a formal or published study. It may merely be one analyst’s back-of-the-envelope. I find it troubling that RFA and others are making political hay out of an estimate based on assumptions, methods, and data that the RFA has not shared with the public, may not have evaluated, and may not even be privy to.

(3) The WSJ article says that global oil demand rose by 900,000 barrels per day (bpd) last year, and biofuel production rose by 300,000 bpd. We may surmise, therefore, that Blanch, assuming a particular elasticity of demand, estimated what would happen if biofuel production had not increased. 

That is a reasonable thought experiment, but it tacitly assumes an “other things being equal” universe. Yes, if demand grows by 900,000 bpd and biofuels don’t grow by 300,000 bpd, then — other things being equal — the price impact might be exactly as Blanch estimates. But usually other things are not equal.

For example, the same WSJ article says that OPEC’s output “declined by about 400,000 barrels per day, according to the IEA [International Energy Agency].” How do we know that if biofuel production had been lower, OPEC output would not have been higher? If OPEC is truly the cunning cartel some commentators claim it is, then OPEC adjusts its production decisions in light of what other actors, including biofuel makers, plan to do. If OPEC’s 400,000 bpd cutback was a strategic decision, designed to prop up oil prices despite planned increases in other liquid fuels, then it wiped out any price reduction from the lesser, 300,000 bpd increase in biofuels.

For years, environmentalists have opposed opening ANWR to oil production on the grounds that its output would be just “a drop in the bucket,” the price-reducing effects of which OPEC could easily negate just by cutting back production. The same critique applies with equal merit (or the lack thereof) to ethanol.

(4) Blanch’s 15% estimate is questionable in light of recent changes in oil prices.  He estimated in late March that without the increase in biofuels, oil would be $115 a barrel instead of $102. However, some six weeks later, oil hit $120 a barrel. Between those dates there was no drop in biofuel production. So it is not obvious that, in March, biofuels were responsible for the price of oil being $102 instead of $115.

(5) As you’d expect, RFA ignores the many ways in which ethanol increases the price of gasoline. These include the increased costs to store and ship ethanol, the increased cost to refine gasoline mixed with ethanol to counteract ethanol’s volatility and the associated hydrocarbon emissions, and the fuel economy penalty resulting from the fact that ethanol has one-third less energy content by volume than gasoline. To what extent Blanch’s estimate takes these factors into account is unknown at this point.

In closing, let me make clear that I mean no criticism of Blanch. Making estimates is what economists do. But I am troubled by the facile conclusions that the RFA and others are drawing from his estimate. They may have no idea what assumptions it is based on. They very likely have never considered whether the estimate takes into account potential strategic behavior by OPEC, or whether it is reasonable to give ethanol credit for lowering oil by $13 a barrel in March when oil prices were $18 a barrel higher in May.