Demand and Supply: The Ethanol Mandate
Several years ago, when former Treasury Secretary Lawrence Summers walked past me, I stopped him with a question. “What is the most important economic idea to teach my students,” I asked. Without missing a beat, he said, “the power of the market,” and continued walking.
Now, with an ethanol mandate from Congress, I keep thinking, “the power of the market.”
Here is the story. We have to start with the power of Congress before we get to the market.
In 2007, Congress passed the Energy Independence and Security Act. Hoping to mandate more use of biofuels, they established quotas and subsidies. One goal was to increase ethanol use from 2008-2022. On the production end, they mandated the amount of ethanol to be increasingly produced and then blended into gasoline. With a 46 cent per gallon subsidy, they made ethanol production cheaper until 2011.
Make sense? It is not quite working out how they planned. The market has been colliding with the “commands” from Congress.
One problem has been that the price of corn responds to market supply and demand. A lot of US ethanol is corn based. More expensive corn can increase the price of ethanol production.
Congress has also not been able to control the price of credits called RINs. Through RINs (Renewable Identification Numbers), the EPA makes sure that the required amount of ethanol is blended into gasoline. Simply (if possible) explained, RINs accompany every batch of ethanol. Gasoline blenders can sell RINs if they blended more than required to blenders with less. Ultimately, they hand them in to the government to prove compliance. Demand and supply affect the RIN price. The RIN price is currently soaring.
Then also, we have the price of gas. A result of demand and supply, when price is high, people tend to buy less. But, if they buy less, then they will not be consuming the annual amount of ethanol that Congress mandated (13.8 billion gallons of ethanol during 2013; 14.4 billion gallons during 2014). But ethanol producers and blenders have to create a certain amount, no matter how much consumers buy.
Sorry this sounds so convoluted. But it takes us back to Secretary of the Treasury Summers. The power of the market is reducing the power of Congress.
Sources and Resources: If you really want to learn about how Congress mandates ethanol production, this 2009 report is only a page or so and easy to understand. It ideally complements recent articles, here and here, on market distortions that resulted from the Congressional ethanol mandates interacting with market forces of demand and supply.
Please note that this entry has been minimally edited since it was posted.