Impact of Ethanol Mandates on Fuel Prices when Ethanol and Gasoline are Imperfect Substitutes

Sebastien Pouliot, Bruce A. Babcock
September 2014  [14-WP 551]

Past studies that examine the impact of ethanol mandates on fuel prices make the assumption that ethanol and gasoline are perfect substitutes because they are both sources of energy in transportation fuels. These studies, however, have been of limited use in informing current policy debates because the short- to medium-run reality is one of strong regulatory and infrastructure rigidities that restrict how ethanol can be consumed in the United States. Our objective here is to improve understanding of how these rigidities change the findings of existing studies. We accomplish this by estimating the impacts of higher ethanol mandates using a new open-economy, partial equilibrium model of gasoline, ethanol, and blending whereby motorists buy one of two fuels: E10, which is a blend of 10 percent ethanol and 90 percent gasoline, or E85 which is a high ethanol blend. The model is calibrated to recent data to provide current estimates. We find that the effects of increasing ethanol mandates that are physically feasible to meet on the price of E10 are close to zero. This result is robust to different gasoline supply elasticities and gasoline export demand elasticities. The impact of the size of the corn harvest on E10 prices is much larger than the effects of mandates. Increased mandates can have a large effect on the price of E85 if the mandates are increased to levels that approach consumption capacity. These findings show that concern about the consumer price of fuel do not justify a reduction in feasible ethanol mandates.

Keywords: Biofuel, Ethanol, Gasoline, Mandate.

JEL codes: Q18, Q41, Q42.

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