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By Robert Rapier on Apr 15, 2006 with no responses

The Future of E85

The federal subsidy for ethanol production – currently $0.51 per gallon – is set to expire at the end of 2007 (1). Unless congress extends the credit (again), consumers may finally get to pay market price for ethanol. Prior to the recent passage of the energy bill, it was widely assumed that the credit would be extended, because ethanol is still not competitive with gasoline without the credit. In fact, the recently released Hirsch report (2) on Peak Oil stated:

The market for ethanol derived from biomass is influenced by federal requirements and facilitated by generous federal and state tax subsidies.

And:

Ethanol from biomass is currently utilized in the transportation market, not because it is competitive, but because it is mandated and highly subsidized.

So, how is ethanol going to fare if the credit expires at the end of 2007? Fortunately for the ethanol proponents, the recently passed energy bill mandates an increase in ethanol usage from the current level of 4 billion gallons up to 7.5 billion gallons within 10 years. It would seem to me that since it is mandated, the subsidy will no longer be required. However, the full costs will then be passed on to the consumer instead of hidden away. This will amount to a rise in gasoline prices combined with a decline in gas mileage for gasoline blends containing ethanol.

However, let’s consider what it means for E85, the 85% ethanol blend. Unless you have been living in a cave, you have seen the hype surrounding the E85 vehicles being pushed by GM with their “live green, go yellow” campaign (3). People are fueling up with subsidized E85 all over the Midwest. As I write this you can get E85 around Minnesota and Wisconsin for $2.25. But what would it cost without the subsidy? The closing price of ethanol on the CBT on Friday, April 14th was $2.71 a gallon (4). The closing price of mid-grade gasoline on the same date was $2.11 a gallon. So, ignoring state and federal gasoline taxes, E85 without any state or federal subsidies based on today’s prices would cost 0.85*$2.71 + 0.15*$2.11, or $2.62. The price is $0.51 higher than gasoline, and you will get worse gas mileage. The DOE lists the gas mileage of various flex fuel vehicles running on E85 and gasoline (5). A Ford Taurus, for instance, is reported to get 29 mpg on the highway running on gasoline, and 21 mpg running on E85.

So, let’s fill our Taurus up and see how much it costs (minus state and federal taxes), and how far we can drive. A quick Google search indicates that the Taurus has an 18 gallon gas tank. If we fill it with E85, it is going to cost us $47.16, and we are going to be able to drive it 378 miles. If we fill it with mid-grade gasoline, it is going to cost us $37.98 and we are going to be able to drive it 522 miles. For every 1,000 miles driven, we are going to pay $72.76 using gasoline and $124.76 using E85. This indicates to me that if the subsidies actually do disappear then so will the market for E85.

Of course, this won’t stop us from using ethanol, since it is now mandated into our fuel supply. What I think it will do is dry up E85 demand and shift all of the ethanol into a 10% ethanol blend where it’s disadvantages can be more easily hidden. In this case, it would only increase the true cost of gasoline by $0.08 a gallon (again based on today’s prices). Gas mileage would be decreased by only 1-2 mpg, so consumers are more likely to absorb the slightly increased costs from an E10 blend than they would from an E85 blend.

There are a couple of caveats. What I have given in the previous paragraph is the true cost of using E85. It is possible that taxpayers will continue in one way or another to subsidize use of E85. There are various state subsidies, and I don’t know what the status is for each individual state. You may find that the price varies wildly from one state to another. I am also assuming that E85 won’t receive waivers of state and federal taxes. I am not sure what the law stipulates on this. (If someone has additional information here, let me know and I will modify this section). Finally, I am assuming that since ethanol is mandated, the federal subsidy will be allowed to expire as scheduled at the end of 2007.

For those who presume that this argument will be moot because grain ethanol will eventually be cheaper than gasoline due to additional technological improvements, consider this graph from the official Nebraska government website :


At no time in the past 23 years has the average annual rack price of ethanol been cheaper than that for mid-grade gasoline. The ethanol market did soften a bit last year due to some overcapacity, leading to a narrowing of the gap. But if we look at 2006, the gap has widened back out. There is no reason to believe at this point that grain ethanol as it is typically produced will ever compete with gasoline, even if gasoline becomes much more expensive. Reference 1 – a paper from the DOE – states as much:

The production of ethanol from corn is a mature technology that is not likely to see significant reductions in production costs.

I will say that there are some options for reducing production costs, as I touched on in Improving the Prospects for Grain Ethanol . Some of these options are pie in the sky, but some are already taking place. I predict that the economics of grain ethanol via coal will be far superior to using natural gas, and more and more plants will be built using coal as an energy source. (Note that this is what I predict will happen, not what I would prefer to see happen).

References

1. Outlook for Biomass Ethanol Production and Demand

2. Peaking Of World Oil Production: Impacts, Mitigation, & Risk Management

3. GM’s FlexFuel Vehicles Page

4. Commodity Prices

5. Gas Mileage of Flexible-Fueled Vehicles