Pricing of Ethanol Blends at the Pump Differs in the Short Term Compared with the Long Term

by Simla Tokgoz (U.S. Department of Agriculture Economic Research Service) By law, the U.S. Environmental Protection Agency (EPA) sets targets for blending renewable fuels such as ethanol with traditional transportation fuels to implement the mandates set by the Energy Independence and Security Act of 2007. If demand for blended renewable fuels is not high enough, those mandates are difficult to attain, and EPA can reduce the blending targets to below mandated levels, which has been the case recently. Prices at the pump influence whether and how often consumers select ethanol-blended fuels and, therefore, to what extent blending mandates are met. A key determinant of the price of ethanol-based transportation fuels at the retail level is the price of crude oil, and subsequently wholesale gasoline, both of which can quickly change course with sudden market changes, or shocks.

The unmet mandates for blending renewable fuels with transportation fuels led researchers at USDA, Economic Research Service and the International Food Policy Research Institute to study the relationship between the cost of crude oil and wholesale gasoline, both of which are key inputs for renewable blended fuels, and the price U.S. consumers pay at the pump for ethanol-blended fuels. They found market shocks and the resulting price fluctuations for crude oil and wholesale gasoline are passed on to consumers differently in the short term (before markets fully adjust) than they are in the long term (after markets fully adjust). They also found that price shocks along different points of the supply chain may be reflected differently for consumers.

After the 2007 law expanded Renewable Fuel Standard Program mandates for blending renewable fuels into traditional transportation fuels, ethanol-blended fuels increased as a portion of motor gasoline in the marketplace. In 2006, before implementation of the law, ethanol made up about 3.8 percent of total transportation fuels by volume. By 2008, ethanol accounted for nearly 6.9 percent of the total. By 2019, ethanol’s share of total transportation fuel had leveled off at around 10 percent.

The blending mandates cover four categories of sources, known as feedstocks, for renewable fuel:

While mandates have influenced the rate by which ethanol is blended into transportation fuels, goals for the incorporation of cellulosic and other advanced biofuels into motor vehicles fuels have not been met. This has led EPA, which is responsible for implementation of the Renewable Fuel Standard Program, to lower the blending targets for the cellulosic and other advanced biofuel categories. The most common ethanol blend at the pump in the United States is E10, a blend made up from 10 percent ethanol and 90 percent gasoline. Blends that use more ethanol, such as E15 (15 percent) and E85 (51–85 percent), were relatively less available in the past, which may have affected the rate at which ethanol was blended into transportation fuel. Since E15’s approval in 2011, however, its market has grown, which affects the total volume of ethanol demand and thus may influence relative prices.

Crude oil market prices historically are volatile, especially over the past 10 years. For example, the refiner’s acquisition cost of crude oil was $103 per barrel in June 2014; in April 2020, when the Coronavirus (COVID-19) pandemic curbed global demand for gasoline, crude oil prices fell to $19 a barrel. By June 2022, prices had increased 500 percent to $114 per barrel. Wide swings such as these are known as price shocks. Researchers analyzed the extent to which these types of shocks at the crude oil level reach consumers, as illustrated in the chart below. When a shock increases the crude oil price by 10 cents per gallon, retailers increase the E10 price at the pump by 2.8 cents per gallon in the short term. Over the longer term, when refiners and blenders fully adjust their pricing behavior, the shock is reflected as an increase of 4.2 cents a gallon to the consumer. A similar pattern was observed for wholesale gasoline price shocks for refiners and blenders that are eventually reflected in prices consumers pay at the pump. An increase in wholesale gasoline prices of 10 cents per gallon adds 5.9 cents to a gallon of E10 in the short term and 8.3 cents a gallon in the longer term. These variations between short-term and long-term prices make sense because it takes time for refiners and blenders to fully adjust their pricing responses to changes in input costs and for consumer prices to reflect those changes. While the study did not look at whether E10 prices adjust differently when input costs decrease instead of increase, past studies have shown that U.S. retail gasoline prices respond more quickly to increases in crude prices than to decreases.

These results also indicate that both refiners and blenders may refrain from passing the full crude oil price or wholesale gasoline price increase to consumers, particularly in the short term. Specifically, if blenders allowed full pass-through of cost increases to the pump, a 10-cent per gallon increase in wholesale gasoline price would add 9 cents per gallon to the price of E10 at the pump because E10 is 90 percent wholesale gasoline and 10 percent ethanol. That would be higher than the increase of 5.9 cents a gallon identified in the short-term results but much closer to the additional 8.3 cents a gallon for the longer term.

The findings demonstrate that in both the short and long term, the prices consumers pay more closely track wholesale gasoline price changes than crude oil price changes. For example, a 10-cent increase in the crude oil price adds 4.2 cents a gallon to the E10 price in the long term, nearly half the increase of 8.3 cents when the same wholesale gasoline price shock occurs. That may be because wholesale gasoline is closer in the supply chain than crude oil to consumer markets. READ MORE