Thursday, August 22, 2013

The Blend of the World

If you have a car you've likely noticed signs at the gas pump indicating that ethanol has been added to your gasoline.  This rise of blended fuel is a product of the government's attempt to increase the use of sustainable fuels and wean America off of foreign oil.  However, as it turns out when this plan was conceived mistakes were made that have led us to a rather ridiculous situation.

Every year refineries are required to blend a certain amount of ethanol into the gasoline they produce. The standard blend rate is 10% ethanol.  This rate is used because essentially all gasoline engines can utilize 10% ethanol gas without any problems (and perhaps more importantly at this point the gasoline is subject to a forty cent per gallon reduction in taxes).

In 2007 when the ethanol mandates were created congress anticipated a constantly increasing rate of gasoline consumption. However, in the years since 2007 gasoline consumption has instead declined by approximately 5%.  Ethanol blending mandates were dictated in terms of raw gallons however. So as the total consumed gas has declined the required amount of ethanol to be blended in has risen.  Unsurprisingly, this has led the industry to the point where it's difficult to shove the required amount of ethanol into the gasoline supply while keeping the blend at the 10% rate.

Refineries are able to buy what are known as Renewable Identification Numbers or RINs in order to comply with ethanol mandates. However, as producers and speculators have realized the impossibility of meeting increasing ethanol blend requirements within the current system RIN prices have sky rocketed.

The EPA has the ability to issue a special waiver which reduces the ethanol mandate each year. However, they are only permitted to issue the waiver on a yearly basis.  More over, eliminating or permanently reducing the ethanol mandates would rapidly devalue the RIN leaving producers and speculators with substantial losses. Leaving the system as is requires special EPA intervention each year or a likely increase in gas prices as producers pass the additional cost of RINs onto consumers.  In any conceivable scenario some party is incurring substantial costs.

It's easy to see the rationalization of the legislators when these mandates were created. After all, everyone agrees renewable energy is a net positive. Had they dictated that ethanol production simply pace gasoline production at a 10% rate we likely wouldn't be in this situation.  However, we'd also simply be treading water in terms of moving our energy supply towards sustainable sources.  In this case their policies certainly haven't worked out, but I find it difficult to fault their intentions.  Of course the whole thing could have been avoided if they'd decided to take the direct route and simply raised gasoline taxes (thus reducing consumption and creating further incentives for fuel efficient or fuel flexible vehicles).

One special note, the economics of using ethanol as a fuel source at all is a topic of great debate which I have purposefully neglected.  Please do not construe this negligence as either an endorsement or condemnation of the practice.

That's all for this week. My apologies for the horrid pun in the title. Until next week stay safe and rationale.

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