E85 loyalty

Economist finds buyers willing to pay more

By Holly Jessen

Research showing consumers are willing to pay a premium for ethanol was published in the March issue of the Journal of Environmental Economics and Management. Soren Anderson, a Michigan State University economist, calculated that when ethanol increased 10 cents per gallon above the price of gasoline, there was only a 12 to 16 percent decrease in demand.

Frankly, Anderson was surprised at what he found. “I was expecting to see a sharp reduction in sales of E85 the moment that the price rose above the price of gasoline on an energy-adjusted basis,” he tells EPM. “But this doesn’t seem to be happening. Instead, it appears that many E85 buyers are willing to pay a premium for the fuel, and some fraction of these buyers continue to buy the fuel, even when its price rises above that of gasoline.”

Anderson developed a model based on information gathered in Minnesota from 1997 to 2006, during which nearly 5,000 monthly observations of ethanol prices and sales volumes were made at more than 200 retail gas stations. The economic analysis is one of the first to examine the way in which consumers value ethanol, Anderson says. Previous analysis assumed consumers viewed the two fuels in the same way, with ethanol and gasoline considered perfect substitutes after adjusting for the lower gas mileage of ethanol.

The findings have economically significant implications for policy decisions affecting cellulosic ethanol, he says. Looking ahead to 2022, he calculates that the cost of producing cellulosic ethanol will be considerably higher than the projected cost of gasoline. “If consumers treat gasoline and ethanol as perfect substitutes, only buying the fuel that gives them the lowest fuel cost per mile, then fuel retailers will need to price ethanol at or below the price of gasoline for consumers to buy ethanol,” he says. This means, he adds, that producers will lose money in an attempt to comply with the renewable fuel standard (RFS)—unless cellulosic ethanol is subsidized or consumers are willing to pay a premium for the fuel.

Despite the encouraging results of his study, Anderson concludes it wasn’t enough to justify the ethanol blending mandates contained in the renewable fuel standard. “This reduces substantially the simulated efficiency cost of an ethanol content standard, since some households choose ethanol without large subsidies, mitigating deadweight losses,” he says, adding that mandating ethanol blending is expensive. Another consideration is the amount of emissions ethanol actually reduces, a topic he notes is hotly debated.

Ethanol industry supporters, on the other hand, point to the role of the RFS in moderating gasoline prices, reducing imports of foreign oil and supporting growth of the advanced and cellulosic biofuels sectors. On March 27, a coalition of eight groups, including the Renewable Fuels Association and Growth Energy, sent a letter to Congressional leaders urging them to reject attempts to reduce, waive or eliminate the RFS. They pointed to a Center for Agriculture and Rural Development study that found that in the decade from 2000 to 2010, ethanol reduced gasoline prices an average of 25 cents per gallon, saving consumers $34 billion yearly. The groups also partially credited the RFS with reducing oil imports below 50 percent for the first time in 2010. Finally, they pointed to the need to bolster the second-generation biofuels industry still in its infancy. “Efforts to amend or reform the RFS would send a chilling signal to a marketplace just when the advanced and cellulosic biofuels industries are on the cusp of commercial production to help meet this nation’s energy independence and security needs,” the letter says.  —Holly Jessen


Our Take:
Here’s a very interesting study based on E85 consumer behavior right here in Minnesota. The findings are a cause for optimism about our renewable energy future, but the author’s conclusion that America’s still-growing renewable fuel production capacity can live without the requirements in RFS is premature. Killing RFS will inhibit the growth of advanced biofuels right at the moment when commercial viability is happening.

Though 80-plus percent of customers remained loyal to E85 when the price rose above that of gasoline, A) that other 12 to 16 percent are crucial to the profitability of the fuel and B) the current consumers of E85 are early adopters. These folks have flocked to cleaner-burning renewable fuel out of a sense of idealism about improving air quality, lowering carbon emissions and ending our addiction to foreign energy sources. While it’s safe to say that this type of customer will continue to be well represented among the population of drivers using E20, E30, E50 and E85, we have to realize that the customer profile will look a bit different when America is producing 36 billion gallons of renewable fuel a year (ten years from today) and ethanol has a dollar-plus advantage over the price of gasoline, per gallon. To make up for lower energy content, ethanol has to be priced about 25 percent less than gasoline. Ethanol’s continued success will depend on maintaining that price differential because for a whole group of motorists, the price will be the reason to come over to the flex-fuel pump at the gas station.

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