April 28, 2006

April 28, 2006 | WebMemo on Energy and Environment

How the Energy Bill Boosted Prices at the Pump

The Energy Policy Act of 2005 is less than a year old and is already having an impact on gasoline prices. The law's provisions have, in fact, added to the pain at the pump. Today, congressional incumbents are wary of an electorate angered by a summer of steep prices, and so the urge to act on gas prices is stronger than it was a year ago. Before taking action on gas prices, Congress and the administration should review the energy bill's effects on gasoline markets in order to avoid any counterproductive consequences.

 

The Energy Policy Act of 2005: Worse Than Doing Nothing At All

A large part of the energy bill debate last year concerned oil and gasoline prices, but the best provisions for dealing with prices, particularly those proposing the expansion of domestic oil production and refinery capacity, were not included in the final legislation.

  

The final energy bill did contain two major provisions affecting motor fuels: an ethanol mandate and the repeal of a 1990 law requiring the use of gasoline additives such as methyl tertiary-butyl ether (MTBE). These measures, however, have contributed to the current jump at the pump.

 

Ethanol: A Success for Special Interests, but a Failure for the Driving Public

Prior to passage of the energy bill, corn-based ethanol enjoyed a number of advantages. Because it has been touted as a domestic and clean-burning fuel additive that can stretch the petroleum-based fuel supply and thus reduce imports, ethanol has for decades received special treatment from Washington. Most significantly, ethanol gets a 50 cent per gallon federal tax credit to help make it competitive with gasoline. Also, tariffs on foreign ethanol keep imports relatively low. Other provisions, such as tax credits for small ethanol producers and assistance to corn farmers, have given ethanol a big advantage in the motor fuels marketplace.

 

Despite the special treatment of ethanol, the ethanol lobby was not happy with the size of the ethanol market, and it persuaded the federal government to mandate ethanol use in the energy bill. The law requires that four billion gallons of ethanol must be added to the fuel supply this year; that number will slowly rise to 7.5 billion gallons in 2012.  

 

While the ethanol mandate is good news for Midwestern corn farmers and ethanol producers such agri-business giant Archer Daniels Midland, it is bad news for the driving public. Since the mandate began on January 1st, ethanol has been more expensive than gasoline.  Beyond its high price, ethanol also imposes costs in other ways. For example, it is more costly to ship than gasoline, which is especially troublesome now that ethanol use is expanding beyond the industry's Midwestern base. Ethanol is currently adding several cents to the price at the pump and will likely do more damage in the months and years ahead.

 

The energy security arguments for ethanol also fall short. Ethanol requires more energy to make and transport than a comparable volume of gasoline does. Its use also substantially lowers fuel economy. Overall, the amount of petroleum imports displaced by ethanol is small, especially for the price.

 

The environmental arguments for ethanol use also fail to hold up to scrutiny. Although ethanol use reduces some forms of vehicular pollution, it increases other forms. In fact, in regions not in compliance with the federal standard for smog, ethanol cannot be added to ordinary gasoline without violating EPA regulations-it must be added to a specialized ultra-clean blend of gas that compensates for ethanol's shortcomings. Also, the EPA has found that ethanol plants are significant sources of emissions, especially now that high natural gas prices have forced some plants to burn more coal.  

 

The ethanol mandate has failed to reduce oil imports or clean the air significantly, but it has succeeded in transferring wealth from already hard-pressed drivers to the ethanol industry.

           

MTBE: A Costly Effort to Federally Micromanage the Fuel Supply

In the span of 15 years, Congress went from a de facto mandate on MTBE to a de facto ban on it. The costs of this reversal also add to the current jump in prices.  

 

The 1990 Clean Air Act Amendments required that reformulated gasoline (RFG) be used in those metropolitan areas with the smoggiest air. RFG, which is used in one-third of the nation's fuel supply, must contain two percent oxygen content by weight, necessitating the addition of so-called oxygenates.  The two most economical oxygenates were MTBE and ethanol. As anticipated, MTBE was the most widely used oxygenate, with ethanol a distant second.

 

By the mid-1990s, MTBE was in widespread use and traces of it started appearing in groundwater supplies. Lawsuits from property owners and municipalities whose water had been affected began to target oil companies.  The fuel industry's best defense was that it was using MTBE in order to comply with the two percent oxygen content requirement.

 

The energy bill repealed the two percent oxygen content requirement, which will end on May 6. The repeal is a good idea-the requirement has done more harm than good-but its abrupt elimination has caused transitional problems. Refiners requested but did not get liability relief from lawsuits, many of which are pending.  For this reason, the fuel industry is quickly phasing down MTBE use in anticipation of the deadline, which has added to the supply shortfalls over the past several weeks.

 

Like ethanol, MTBE never did much good for the environment, but the elimination of this component of the fuel supply at a time of already-tight gasoline supplies has contributed to the recent price rise.

 

Conclusion

The best that can be said of the Energy Policy Act of 2005 is that it is only part of the reason gasoline prices have risen in recent months. That the law has raised them at all should serve as a warning to Congress before it leaps to any additional measures designed to "help" consumers hit hard by high gasoline prices.

 

Ben Lieberman is Senior Policy Analyst in the Thomas A. Roe Institute for Economic Policy Studies at The Heritage Foundation.

About the Author

Ben Lieberman Senior Policy Analyst, Energy and Environment
Thomas A. Roe Institute for Economic Policy Studies

Related Issues: Energy and Environment