April 8, 2005 | WebMemo on Energy and Environment
Included in the pending energy bill are provisions requiring the use of ethanol in the gasoline supply. This proposed ethanol mandate would raise the cost of gasoline, running against the original purpose of the energy bill-to make energy more affordable. For that reason, the mandate should have no place in the energy bill.
Ethanol, a corn-derived motor fuel additive, has long benefited from favorable tax treatment and federal regulations encouraging its use. But its sales have not grown quickly enough to satisfy the ethanol industry or its allies in Congress.
A 5 billion gallon mandate was included in an earlier version of the energy bill that was narrowly defeated, on other grounds, in 2003. The House recently reintroduced its energy bill, with the 5 billion gallon mandate, while the Senate has two proposals in the works-for 6 billion and 8 billion gallons. Any of these targets could become part of the final version of the bill. The President has already signaled his support for increased ethanol use, citing both its domestic origin and benefits to the agricultural sector.
While an ethanol mandate would benefit Midwestern corn farmers and ethanol producers, it would make gasoline more expensive for everyone. Indeed, the only reason ethanol needs federal help is that it is too expensive to compete on its own. Whether 5 billion, 6 billion, or 8 billion gallons, an ethanol mandate would mean significant cost increases for the driving public.
In 1978, President Carter signed the Energy Tax Act, which encouraged the use of fuel ethanol by partial exempting it from the federal gasoline tax. Though intended only to help the fledgling ethanol industry establish itself, this tax break has persisted and was recently renewed through 2010. The current tax credit is 52 cents for each gallon of pure ethanol. Thus, a blend of 10 percent ethanol and 90 percent gasoline receives a 5.2-cent reduction from the 18.4 cent per gallon federal gas tax. This tax credit helps offset ethanol's higher cost relative to gasoline.
Other federal laws and regulations also encourage the use of ethanol. Since 1996, the Clean Air Act has required many of the nation's largest metropolitan areas to use reformulated gasoline (RFG). Originally intended to reduce summer smog, RFG now comprises one-third of the nation's fuel supply. RFG must contain 2 percent oxygen content by weight. This necessitates the addition of oxygenates, either methyl tertiary butyl ether (MTBE) or ethanol.
MTBE is cheaper than ethanol and was initially more popular. But concerns about MTBE contamination of water supplies have led several states to ban its use. Last year, for example, both New York and California put bans in place, forcing a switch to ethanol in those states. Thus, ethanol use has increased in recent years, from less than 2 billion gallons in 2001 to a record 3.5 billion gallons in 2004.
In addition to the Clean Air Act, tax credits for small ethanol producers and assistance and price supports for corn farmers also serve to promote ethanol. These provisions were enacted through the efforts of Midwestern legislators. Most ethanol production facilities-as well as the corn grown to supply them-are located in Iowa, Illinois, Nebraska, Minnesota, Missouri, Kansas, Indiana, and other Midwestern states. In Washington, the ethanol lobby has become a powerful special interest, benefiting from both strong bipartisan support among the region's legislators and only sporadic opposition from those representing the rest of the country.
Doubts over the environmental benefits of using oxygenates in RFG led to provisions in previous versions of the energy bill to eliminate the oxygenate requirement. But this would jeopardize ethanol sales. For this reason, the ethanol lobby insists on replacing the requirement with a "renewable fuels" standard, which would effectively mandate 5 billion gallons or more of annual use by 2012. No surprise, ethanol is the primary renewable fuel that would benefit from the standard, with other agriculturally derived fuels making up only a small percentage of the total. Versions of the energy bill containing this provision have repeatedly passed the House but stalled in the Senate, on other grounds.
Amidst a backdrop of rising gasoline prices, Congress has now renewed debate on the energy bill. The House has reintroduced the 5 billion gallon target, while the Senate has upped the ethanol provision in its energy bill to 6 billion gallons by 2012. At the same time, 19 Midwestern senators have introduced a competing 8 billion gallon bill.
Neither the House nor Senate version of the energy bill alters or eliminates the existing provisions that benefit the ethanol industry. If the bill becomes law, ethanol would enjoy an overlapping array of subsidies and preferential tax treatment-as well as a provision requiring its use.
There is little doubt that federal ethanol policy has increased the cost of gasoline. Much of that cost is hidden from consumers and not seen at the pump due to the preferential tax treatment that masks the true cost of ethanol. An ethanol mandate would increase this cost further.
A 2002 Energy Information Administration study of the energy bill's impact put the cost of the 5 billion gallon ethanol mandate at no more than one cent per gallon, but there is good reason to believe that the cost could be higher. Raising ethanol production to 6 or 8 billion gallons would increase costs disproportionately: The higher the level of production, the more pressure on corn prices, and the harder it is for ethanol producers to meet demand. Larger ethanol targets also mean that more of it will have to be used outside of the Midwest. Since ethanol cannot be distributed through pipelines, the cost of transporting it long distances will be high.
Overall, an ethanol mandate could end up adding several cents to the price of a gallon of gasoline-a burden that American motorists hardly need.
The ethanol mandate is an anti-consumer provision. It benefits special interests at the expense of the driving public. As such, it has no place in an energy bill that seeks to make energy more affordable for the American people.
Ben Lieberman is Senior Policy Analyst in the Thomas A. Roe Institute for Economic Policy Studies at The Heritage Foundation.
 Energy Information Administration, "Impact of Renewable Fuels Standard/MTBE Provisions of S. 1766," March 2002, p. 6.