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Energy Policy Follies

Congress seems intent on doing something to address current gasoline prices. Last time around all they could muster was a pork-laden energy bill that did nothing meaningful to address consumer concerns about energy costs and price volatility. Alas, Congress does not seem to have learned its lesson, and is pursuing a new set of policies that will do little good, and may cause harm -- or so I argue in this NRO column.

If Congress really cares about high gasoline prices -- even if the gasoline is more affordable than in decades past -- they should consider the role of current federal policies in reducing supply, balkanizing markets, enhancing price volatility, and discouraging alternative fuel sources. Yet if Congress won't even reduce tariffs on ethanol imports -- which would significantly reduce the costs associated with current ethanol mandates -- I see little hope for more meaningful policy reforms.

On a related note, here is a new study on SSRN quantifying the effect of reformulated gasoline requirements on wholesale gasoline prices and price volatility. The abstract is below:

The 1990 Clean Air Act Amendments stipulated gasoline content requirements for metropolitan areas with air pollution levels above predetermined federal thresholds. The legislation led to exogenous changes in the type of gasoline required for sale across U.S. metropolitan areas. This paper uses a panel of detailed wholesale gasoline price data to estimate the effect of gasoline content regulation on wholesale prices and price volatility. In addition, we investigate the extent to which the estimated price effects are driven by changes in the number of suppliers versus geographic segmentation resulting from regulation. We find that prices in regulated metropolitan areas increase significantly, relative to a control group, by an average of 3.6 cents per gallon. The price effect, however, varies by ten cents per gallon across regulated markets and the heterogeneity across markets is correlated with the degree of geographic isolation generated by the discontinuous regulatory requirements.

jimbino (mail):
The only concern of a congressman is to get re-elected. How can you expect him to consider the welfare of the American people at large? Cheap ethanol from Brazil would be of great help and an ethanol-powerered nation has the added advantage that when you wake up in the morning the whole country smells just like the bar you left last night.

I can't shed any tears for the Amerikan people who have long aupported a policy that makes a $1.50 liter-bottle of Brazilian "51" aguardente cost $20 at my local liquor store. If that policy were extended to ethanol for cars, a gallon of alcohol that now costs about $4.68 at the Brazilian pump would cost $62.50 here.

Let's just get the gummint entirely off our backs and out of our fuel supply, booze supply and sex lives!
5.18.2006 11:06am
Blar (mail) (www):
I'm not sure what the reason is for including the aside "even if the gasoline is more affordable than in decades past", since the graph that you linked from Agoraphilia clearly shows that, even looking only at prices through the first three months of 2006, gasoline is less affordable than it has been since the early 1980s, at least outside of the top quintile of household income.
5.18.2006 11:10am
Jonathan Adler (mail) (www):
Blar -- I made the comment based on the longer set of data provided in the Goklany post to which I also linked. Note that the Agoraphilia data does not go back nearly as far. I also included so as to make clear that my prior posts placing gas prices in historical context were not meant to imply that chrrent gas prices are of no concern.

JHA
5.18.2006 11:27am
Christopher Cooke:
One typo in your NRO article is the sentence saying that other countries such as Brazil, make ethanol far more cheaply "from corn." Brazil makes ethanol from sugar cane, not corn. As for suspending the Clean Air Act requirements, or ditching reformulated gasoline, I am not sure the environmental costs are worth the pennies per gallon saved. Perhaps we can simply make all states adopt California's clean air standards, rather than have a race to the bottom. That way, the price variations in having different gas formulations for different regions would be eliminated, and the air quality in other parts of the country would improve.
5.18.2006 12:06pm
Jonathan Adler (mail) (www):
Mr. Cooke --

Thanks for catching the typo. The reason ethanol is so much cheaper in Brazil is because it is made from sugar cane, rather than corn.

As for your latter concern, let me make a few points:
1) The environmental benefits of some fuel content requirements -- such as summertime oxygen content -- are basically non-existent. With the wintertime oxygen content, the primary benefits are in a small portion of older vehicles in which the engines do not already control the fuel-air mixture.

2) Insofar as some fuel formulation requirements do produce environmental beenfits, it would stil be valuable to reduce the overall number. There are currently over one dozen different fuel content requirements. Simply cutting that number in half would reduce price volatility inretail gasoline markets by lessening the extent to which such market are balkanized.

3) There are two problems with simply going to a national RFG blend. First, the optimal blend will vary some from place to place. Second, one can question whether the federal government should require consumers to purchase a "cleaner," yet more expensive gasoline belnd in parts of the country where the level of air pollution would not justify the expenditure.

JHA
5.18.2006 12:41pm
brahma:
Some economist out there has an understanding of all the characteristics of the pricing dynamic from the supply/cost of the raw materials through the local retail marketing methods. Won't they please speak up. There is a lst, There are knobs and levers on each component of the list. The feds can effect some of those. Let's line 'em up and develop a specific comprehensive strategy. BTW, I don't think it's a foregone conclusion that market energy prices are a bad thing.
5.18.2006 12:42pm
Clint9LawrenceKS (mail):
Oh, come now! Having trouble with tariffs on ethanol imports? Isn't it quite clear that the big problem with oil (at least right now), is that IT IS IMPORTED! So strategically, if we need to reduce our dependence on oil, whatever takes its place ALSO MUST NOT BE IMPORTED. Otherwise we just introduce a new "slave master."

Regards,

C.L.
5.18.2006 12:43pm
Jonathan Adler (mail) (www):
C.L. --

No, the problem with oil is not that it is imported. Even if all of our oil supply was domestic, oil prices would still be driven by the global market. Moreover, insofar as domestic oil is more expensive than imported oil, reducing oil use on the margin will actually increase the percentage that comes from overseas.

This is a topic all of its own, so perhaps I will address it more fully in a subsequent post.

JHA
5.18.2006 12:58pm
Taimyoboi:
"Yet if Congress won't even reduce tariffs on ethanol imports -- which would significantly reduce the costs associated with current ethanol mandates..."

Or sugar in general. CAFTA was an abomination.
5.18.2006 1:19pm
Taimyoboi:
"... they should consider the role of current federal policies in reducing supply..."

Another that comes to mind was the recent ban on MTBE. A lot of refineries and retail gasoline stations are currently in the process of phasing out MTBE formulated gasoline to switch over to ethanol.

Perhaps extending the timeline on the ban might have also mitigated some of the shortage as a result of the switchover.
5.18.2006 1:23pm
steveh2:
The abstract was a little difficult to follow for a non-economist like me, but is the abstract saying that the content requirements are adding less than ten cents per gallon?

Based on other references to this issue, I thought the regs actually had some significant effect. A dime a gallon is nothing, given that gas here has gone up 50 cents or more in just the last few weeks.
5.18.2006 1:54pm
pallen:
Dear Sir,
You write: "No, the problem with oil is not that it is imported. Even if all of our oil supply was domestic, oil prices would still be driven by the global market. Moreover, insofar as domestic oil is more expensive than imported oil, reducing oil use on the margin will actually increase the percentage that comes from overseas."

I made a very similar point in an earlier post: http://volokh.com/posts/1147391770.shtml#89932

but let me take a moment to temper this point. there are frictional reasons why marginal cut-backs might not increase our fraction of foreign oil consumed. First long-term supply contracts dampen the process of adjustment. Second, oil comes in different grades. So a refinery able to process West Texas Crude may be unable to process Brent Crude with its higher sulfur content. Obviously in the longer-term these frictional problems would not apply.
5.18.2006 2:30pm
JohnMc (mail):
Mr. Adler,

I have a most signicant reform to suggest that will garner immediate returns for both current and future high gas prices. Stop the illegal immigration and deport the 10-12m that are here. Yes sounds draconian, but hear me out.

The current illegals probably represent between 3-4m automobiles in use and their requisite gas consumpation. That consumpation represents the total output of the 4 largest oil refineries on the Gulf Coast. The impact of not having that consumation would impact the cost of gas used by those that are legally here.

Then consider this, depending on the report you read, over the next 20 years another 40-90m people could be here which would mean another 10-15m cars in use. By preventing that influx it represents a conservation effort worth about 12 new oil refineries. If we don't prevent the influx and don't build the refineries then the price of gas will have to double to ration available supplies.

In the entire debate over both gas and illegals I have yet to see anyone make the obvious connections and impacts.

Thanks for your time.
5.18.2006 3:42pm
Broncos:
If we are solely concerned with minimizing the volatility and price of retail gasoline prices, less regulation would generally be a good idea.

But our petroleum energy policy implicates two further policy goals:
1. National security and global politics.
2. Emissions externalities.

Some people deny #2; but the security costs (and costs to supporting democracy abroad) are becoming increasingly clear of having these sorts of assets in the hands of authoritarian regimes. Right now we are financing #2 primarily with debt; it is unclear whether consumers of gasoline would make the same purchasing decisions if the proportion of #2 attributable to petroleum were priced into their decision-making.
5.18.2006 3:46pm
Broncos:
Oops. Mistake: I meant to say that we are financing *#1* with debt; and consumers might not make the same decisions if the portion of *#1* which is attributable to petroleum were priced into their choices.
5.18.2006 3:48pm
Bob Smith (mail):

As for suspending the Clean Air Act requirements, or ditching reformulated gasoline, I am not sure the environmental costs are worth the pennies per gallon saved.

What environmental costs? Reformulated gasoline adds an oxygenate to gasoline. A modern fuel-injected car (pretty much anything in the last 15 years, most everything in the last 20) doesn't need oxygenates. Oxygenates make things worse because fuel economy drops, and gas prices increase, without any (I say that again, *any*) improvement in the emissions output of an injected car. Oxygenates do offer a small emissions improvement for carbureted cars, but generally only if they're out of tune. It would be far more effective, and much less expensive, if we got old smoking clunkers (responsible for at least 90% of auto emissions) off the road by (a) ticketing gross polluters, and (b) raising (not lowering, like CA does) annual registration fees as a car gets older.
5.18.2006 4:57pm
Bob Smith (mail):

Isn't it quite clear that the big problem with oil (at least right now), is that IT IS IMPORTED!

If you believe that oil has a limited supply, and you want to eventually eliminate Middle Eastern economic power, you should take the long view: all our oil should be imported. When they run out, we'll be sitting on decades of now incredibly valuable oil supplies.
5.18.2006 5:02pm
Christopher Cooke:
I agree with Professor Adler's position on eliminating tariffs on ethanol, as they only serve to protect ADM's (and other domestic producers') profits and make ethanol, and thus blended gasoline, more expensive for consumers. If ADM had to compete with Brazi in producing ethanol, ADM would likely switch to growing sources of ethanol that are cheaper to produce, like sugar cane. However, given ADM's substantial political clout, I deem this highly unlikely.

As far as relaxing Clean Air standards, I am sorry, but I must disagree that that is a good way to go. While, admittedly, I am not familiar with all of the science behind, nor all of the benefits vs. the costs of requiring oxygenated fuels, I am familiar with the cars driven in California (Los Angeles, SF, and elsewhere). Many do not have fuel-injection systems, and are, for lack of a better word, "clunkers."

California already has a "sell your clunker" program in place (paying something like $1000 per car), but there are many of them still on the road, for one reason or another (usually, economic reasons). And, we also have a smog enforcement program in place, whereby you can report grossly polluting vehicles, simply by calling 1-800-CUT-SMOG. But, for budget reasons, it is underfunded. So, if the "cleaner" fuels only work on the clunker, out of tune, carburated vehicles, these fuels are still likely to have a substantial impact on the air pollution generated by automobiles in California.

I agree with Bob Smith that perhaps, in theory, a better way to go than using these fuels would be either to (1) impose a gasoline tax that would be used to buy back all older trucks and cars that are responsible for 90% of the smog and take them off of the roads; or (2) progressively increase vehicle registration fees for cars and trucks, so that you essentially force vehicle owners to get newer, cleaner and safer vehicles (they do something like this in Singapore). I doubt either would be acceptable politically, however, as they involve raising taxes or fees.

So, I stand by my previous post, which is that relaxing Clean Air standards to reduce gasoline costs is not a trade off I would want to make, at least not in California (where we have a large, growing population, many clunker cars, and frequently poor air quality).

Also, I would note that reducing gasoline costs should increase gasoline use, and make our air problems worse. Finally, where, in the costs-benefits analyses being discussed from the use of these fuels, are the estimates for the real costs caused by the adverse health effects from air pollution taken into consideration? These costs are quite real. In California' central valley, where the agribusiness lobby reigns supreme in killing any environmental or air quality control regulation of their unsmogged tractors or of their crop burning practices, etc. it is estimated that up to 40% of the residents suffer from asthma due to airborne particulants. What are the costs associated with this? Quite high, I would imagine.
5.18.2006 5:44pm
Barry P. (mail):
Bob Smith: the claim the RFG does nothing but add oxygenate is incorrect. The Clean Air Act Amendments of 1991, the genesis of RFG, lists several performace standards (that is, specific targets for the reduction of several pollutants in vehicle exhaust.)

However, it also (insanely, IMHO) added the very specific oxygen content standard. This was a sop to the ethanol lobby. Unfortunately for them, the industry chose MTBE over ethanol, as it is a superior product in every way. In th latest energy bill, the ethanol lobby did not make the same mistake: they included specific reference to specific amounts of ethanol
5.18.2006 5:47pm
A. Zarkov (mail):
Why not simply condemn the "clunkers," that is don't allow the owners to re-register them? Of course I know the answer, it would be too much of an economic hardship to the owners to have their cars taken off the road. What ever happened to the concept of the greatest good for the greatest number? Answer: it was murdered by John Rawls.
5.18.2006 6:58pm
Bob Smith (mail):

The Clean Air Act Amendments of 1991, the genesis of RFG, lists several performace standards (that is, specific targets for the reduction of several pollutants in vehicle exhaust.)

It did set targets, but those aren't met by the gasoline, they're met by advanced engine controls and catalytic converters. Gasoline only had to change because catalytic converters are poisoned by sulphur, so all fuel these days is low-sulphur.

At this point the auto pollution war has already been won. California wants to make their emissions rules even more strict, and is looking for new measuring equipment because 2006 cars are so clean their emissions can barely be measured. Considering that emissions are measured in parts per billion, California's quest is simply foolish: reducing emissions by 99.8% instead of 99.5% might make a good sound bite for its politicians (60% reduction!), but it will have no measurable effect on air quality. One old clunker, literally, pollutes as much as thousands of newer cars.

I also feel compelled to point out that the latest emissions standards, specifically the oxides of nitrogen standard, are incompatible with high-fuel-efficiency engine concepts like lean-burn. The particulates standard has killed passenger-diesel in the US. None of this prevents environmentalist whackos from demanding both extremely strict emissions control and high fuel efficiency.
5.18.2006 6:58pm
Bob Smith (mail):

Why not simply condemn the "clunkers," that is don't allow the owners to re-register them?

Every politician who suggests it gets shouted down (usually by Democrats) as somebody who "hates the poor". Apparently the poor have a greater right to pollute than everybody else.
5.18.2006 7:03pm
james (mail):
I was under the impression that there are different regional mixtures because of climate. Basicly, cars in cold weather need a different mixture to allow the engine to function properly.

Wasn't MTBE being fazed out due to some type of ground water polution not found with the ethanol mixture?
5.18.2006 7:57pm
Bob Smith (mail):

I was under the impression that there are different regional mixtures because of climate. Basicly, cars in cold weather need a different mixture to allow the engine to function properly.

It's for emissions, not proper function. Might make a difference if the car were carbureted. Makes no difference if it's fuel-injected (electronic, not mechanical injection like old Porsches).

Wasn't MTBE being fazed out due to some type of ground water polution not found with the ethanol mixture?

Yes, there has been groundwater contamination due to MTBE. I don't know if ethanol is any better, and ethanol is very hydrophilic. It also kills gas mileage, which is great if you're an ethanol producer as that increases demand. Somehow I doubt the petroleum producers would be getting the kind of fawning treatment from the MSM ethanol producers get if they added something to their gasoline that increased demand for it.
5.18.2006 9:11pm
Emanuelson (mail) (www):
Anyone who is serious about dealing with this problem needs to be ready to take a hard look at solving some fundamental problems with both agricultural ethanol and agricultural biodiesel.

Making ethanol from sugar cane or sugar beets appears to be the best ethanol option in the short term, but ethanol doesn't really become viable on a large scale until you can start fermenting the entire plant (including the cellulose). We're still years away from that technology, but it's a question of applied research. Further, someone needs to figure out how to separate the ethanol from the water without boiling the fermented mash. These are two purely technological problems standing between us and viable ethanol. Without solving these issues, it's not totally clear that agricultural ethanol even has a positive energy balance. On top of this, most automobiles on the road in the US won't run on more than about 15% ethanol, so we'd need a new fleet, or perhaps some conversion kits.

WRT biodiesel, we're still looking for a good, hearty crop capable of producing massive amounts of vegetable oil per acre. As suitable crops, palm oil and algae are looking pretty good, but neither is perfect. Given a sufficient quantity of raw vegetable oil, I'm not aware of any major technological hurdles to using biodiesel on a large scale. Post processing is minimal as compared to ethanol. Mostly, you just render the fat to pull out the glycerin (yes, just like in Fight Club). We also have a large fleet of diesel vehicles which could start using biodiesel tomorrow. Long term, we'd need to move a much larger proportion of US automobiles over to diesel technology in order for agricultural biodiesel to make a dent in our foreign energy dependence.
5.19.2006 2:56am
JonBuck (mail):
As far as a gasoline replacement is concerned, we have a nascent technology in butanol. Butanol is a four-carbon alcohol with very similar combustion characteristics to gasoline, with nearly the same energy density. It can also be sent through pipelines, unlike ethanol.

You can make butanol from pretty much anything you can make ethanol from, using the microbes the company I linked to has. Including cellulose.

This tech is very new, though. Only within the past few years. It's not even on the energy radar yet. But it can replace gasoline drop-for-drop without enigne modifications. That much ethanol cannot do.
5.19.2006 3:04am
abb3w:
Butanol sounds interesting, but they don't seem to be prepared for the key test: closed cycle. If you run a 100 acre farm on butanol without petroleum-derived fertilizers (although alternative feedstocks are acceptable), how many gallons of butanol do you use per acre, and how many gallons of butanol are yielded, and at what cost?
5.19.2006 12:21pm
Barry P. (mail):
Bob:


It did set targets, but those aren't met by the gasoline, they're met by advanced engine controls and catalytic converters.


Actually, if you read the text of the law, you'll discover that the performance standards were for Reformulated Gasoline versus a baseline fuel in a baseline engine. Emissions of VOC's and toxics had to be 15% lower from RFG than baseline gas *in the same motor*."

I generally agree with you, though. A modern car emits essentially zero pollution, at least when the engine and catalytic converter are at operating temperature.

As you and others have mentioned, most passenger car pollution comes from old clunkers, and why doesn't the law just ban these old cars? I'm no lawyer, but I think that this would fall afoul of constitutional restrictions on retroactive lawmaking. If a car was legal to be used on the road in 1965 or 1975 or 1985, it would be unconstitutional to summarily render those vehicles illegal after the fact. A government buy-back and destruction of pre-1985 cars would probably be the most cost-effective method of reducing vehicular emissions today.
5.19.2006 12:24pm
Emanuelson (mail) (www):
I'm no lawyer, but I think that this would fall afoul of constitutional restrictions on retroactive lawmaking. If a car was legal to be used on the road in 1965 or 1975 or 1985, it would be unconstitutional to summarily render those vehicles illegal after the fact.
It would be an ex post facto law to punish, in 2006, acts occurring in 1985 which were legal under the laws in place at that time. It is not, however, an ex post facto law to revise emissions standards for existing equipment. If it were, every factory ever built, now matter how nasty and noxious its output, could continue to operate (and generate emissions) forever according to the government emissions standards in place at the time of its construction. We know, of course, that this isn't the rule. We should not, for a number of reasons, pass laws uniformly banning old cars. We can and should, however, require that all cars on the road meet reasonably high emissions standards.

Butanol certainly does sound interesting. I'd imagine the tech limitations I outlined above re: ethanol would generally apply to butanol, but a plug &play replacement for gasoline is always worth looking at closely.
5.19.2006 2:58pm
blognround (mail) (www):
Addressing the demand side of the extremely "distorted" and "imperfect" oil market.

Refineries are being built by global oil companies in China and India with profits derived from American consumers. No refineries have been initiated in the US for more than 2 decades.

US oil Refinery production levels consistently operate in the mid 90's, with little production safety factor.

Pricing is elastically coupled to world futures markets which are now hypersensitive to global geopolitical events and the lack of consistent supply flows: note Iraq is below prewar production levels, Iran sabre rattling, causes daily futures blips.

some oil analysts suggest that between 1.00 and 1.50/gal of retail pricing is due to 4th generation terrorist networks disrupting supply, threats and execution of terrorist acts, and the US's seemingly 1 dimensional international negotiation strategy and tactics (Iran).
Congress could also impede the Administration's tendency towards diplomatic brinksmanship, and insist on utilizing real diplomacy.

arguing about policy changes amounting to 0.03/gal seems sort of trivial. without building new refineries, pricing will not improve in the US. without addressing the geopolitical concerns driving up wholesal prices, the other stuff is talk.

in a perfect market, oil companies would rush to build new refineries,to grab market share from one another, and supply more retail product.

they are building refineries to do so just not in the US,
by keeping supply constrained in the US, OilCo can fund their expansion in emerging markets.

if congress wants to do anything they should revoke or curtail oilCo subsidies, and offer tax incentives only if companies build US refineries. (Carrot and Stick)

consumers already subsidizing oil companies through oil pricing and government give backs. congress should also unburden the environmental issues and streamline approvals process and get refinery construction into real time.

nothing else i see will produce any longer term pricing and supply improvement in the oil market proper.
5.20.2006 12:41pm