Gasoline Prices, Fuel Standards, & Tax Credits

By Mark Edelman and Barry Flinchbaugh

© Copyright Agri-Pulse Communications, Inc.



ME. Professor, I attended a coop meeting for an Iowa ethanol producer last week, in which over 90 percent of the members voted in favor of selling a 55 million gallon ethanol plant that made $10 million last year to a publicly traded agribusiness company headquartered in Ohio.  Industry margins have evaporated since the expiration of the blenders tax credit last December.  It was interesting to note that the biggest applause occurred when a coop member stood up and said he was grateful the ethanol plant was not being sold to an oil company like some others.

BF.  It is amazing to me that gasoline at the pump is nearing $4.00 per gallon and ethanol is priced at $2.30 per gallon.  Oil companies are enjoying record profits, while margins for ethanol-makers are barely break-even.  Of course, corn prices are at levels that provide record farm incomes.  But just think if we had an open market in gasoline and a bigger fleet of flex-fuel cars, some American consumers could be saving a $1.50 per gallon.  That savings might help keep the economy on track and multiply the benefits through the local domestic economy.

ME. Well the comparisons are clouded by record political media spending.  At a time when oil companies are enjoying record profits, they are spending record amounts in trying to convince the public that doing away with the tax breaks for oil companies will increase the price of gasoline even further.  Of course the pitch on doing away with "tax breaks" is spun as another "big government tax increase" that might increase the price of gasoline even more.

BF.  Even the media is doing research suggesting that domestic drilling for crude is not correlated with the price of gasoline.  Analyzing 36 years of gasoline prices and U.S. oil production, the Associated Press recently reported that it finds no statistical correlation between how much is pumped out of the ground in the U.S. and how much is paid at the pump.  While the AP says four independent statisticians came to the same conclusion, it is potentially dangerous for the media to start doing its own economic research.  This "fallacy of composition" exists because oil is a commodity bought and sold in a global market for which the U.S. produces a small fraction of the global supply.  In the event of a World War that shuts off global trade, domestic prices for transportation fuels would quickly become correlated to domestic production from all sources.

ME.  Well in recent years, the U.S. has reduced imported oil to less than 50 percent of its crude oil consumption.  We have discovered new reserves and increased production of domestic crude oil.  We have increased production of biofuels and other alternatives. We are adding to fuel efficiency in our vehicle fleet. We are doing more conservation in fuel consumption than we have in the past.  So, it is a big mistake to say that the current policy direction has not been working.  We simply cannot expect domestic energy policies to solve world price fluctuations in the global commodities market for oil.

BF.  If the price of gasoline is independent of domestic factors, then the price of gasoline should not be affected by whether or not there are domestic taxes or tax credits on domestic production.  However, the taxes or tax credits incentives are potentially linked to domestic production.  So if the tax credits are reduced, there will be less incentive to drill domestically.  From a level-playing field perspective, if Congress plans to keep tax credits for the oil industry, then Congress should have also kept the blender tax credits for the biofuels industry.

ME.  Here is another level playing field issue. U.S. policy on vehicle fuel formulation essentially mandates a minimum of 85 percent of fuel for domestic vehicles will be from petroleum sources.  This compares to a 10 percent mandate for biofuels.  Moving to E-15 as the standard blend should help to alleviate some of the price pressure at the margin.  The Renewable Fuel Standard makes some economic sense in this context.  "Big Oil" continues to be in position to extract rents from the marketplace as long as the demand for alternative fuels is effectively capped by industry imposed constraints regarding engine warranty, liability, and infrastructure limitations.

BF.  The economic power of OPEC continues because it able to manage global supply.  The only way to break the power of OPEC is to develop alternatives that are economically competitive in the market place long term. This is why biomass research still makes sense long term if it can eventually be produced in a competitive manner. The whole world has access to biomass and that would break the power of Big Oil.  Speaking of alternatives, you forgot electric cars, drop-in fuels, and compressed natural gas alternatives.

ME. The military is interested in drop-in fuels as they do not require engine or infrastructure modifications. In contrast, compressed natural gas (CNG) requires specific engine modifications and a new fueling infrastructure network.  CNG is emerging as an alternative source for fleet vehicles so they can return to a fueling station. Unlike hybrids, electric cars are limited to a travel distance of about 150 miles before recharging is required and the greenhouse gas emissions depend on the source of fuel used to generate the electricity to power the batteries. That would likely be coal for the Midwest. If so, the carbon footprint would likely be more than a biofuel powered vehicle.

BF.  Some policymakers have proposed an "open source" fuel standard that would essentially require all vehicles to be flex-fuel.  Notwithstanding additional infrastructure investments, this would help to reduce your so-called gasoline mandate.  In fact, apparently most vehicles which roll of the line as "flex-fuel" vehicles today are virtually identical to others that are the same model, with the only difference being computer programming and a few minor adjustments.  The bottom line is that it no longer costs more to produce a "flexfuel" vehicle.

ME.  At least with an "open fuel standard," the American consumer would have "fuel choice at the pump."  As we impose policies like differential taxation, preferential fuel policy mandates, and oligopolistic industry-imposed constraints in the manner that we have done in the past, the more we limit the opportunities for our domestic economy to be market-oriented and efficient in generating the maximum standard of living in the future.

BF.  Sounds good, but we are in the middle of the most mean-spirited partisan and dysfunctional political campaign in my lifetime and I remember the Truman-Dewey campaign.  The country has never been more divided with Super-Pac spending now available.  Hanging in the balance is the future direction in our domestic energy policy.

*  Mark Edelman is a professor of economics at Iowa State University and Barry Flinchbaugh is an emeritus professor of Agricultural Economics at Kansas State University.

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