Ethanol pushes gas prices higher

Demand for ethanol aggravates pain at the pump
By Peter A. McKay

Ethanol has been touted by President Bush and others as a possible long-term cure for Americans' addiction to fossil fuels, especially expensive gasoline. But right now it is pushing pump prices higher in the U.S.

Ethanol, a plant-based fuel, is being used in the U.S. primarily as an additive to blend with gasoline in proportions of up to 10 percent, not as an outright substitute. Demand for ethanol as an additive has caused its price to soar about 65 percent since early May to around $4.50 a gallon in U.S. spot markets, according to the Oil Price Information Service. That makes it far more expensive than gasoline, which costs about $2.90 a gallon at the pump on average, according to the AAA driving club.

At service stations across the U.S., the gasoline that drivers pump into their cars is up to 10 percent ethanol.

Analysts say this has set up a lesson straight out of the Economics 101 textbook: If you add an ingredient to a product that is pricier than the product itself, in effect, you're driving up the price of the product.

"We'd probably have retail gasoline prices between $2.30 and $2.40 a gallon if not for ethanol," estimates economist James Glassman of J.P. Morgan.

Ethanol trader Sal Gilbertie of brokerage firm Fimat USA agrees the additive is pushing up gasoline prices -- but he pegs ethanol's impact at only around eight cents a gallon, including such factors as a federal tax credit refiners get for using it. He expects ethanol's influence won't fully abate until sometime in 2008, when supplies are expected to increase.

Other factors are contributing to high pump prices these days, including hefty crude-oil prices and tight global refining capacity. The ethanol squeeze has gradually become yet another catalyst in gasoline's recent climb, running counter to many consumers' perception of ethanol as a source of relief.

Ethanol "may be helpful to the overall market in the long term, but in the short term, there are transition costs," says AAA spokesman Geoff Sundstrom. "We don't think people should see it as a panacea."

Ethanol's price also surpassed recent levels for a competing gasoline additive -- methyl tertiary butyl ether. MTBE was trading below $2 a gallon early last month, when it was phased out by most refiners. A return to MTBE could help gasoline prices, but it would also make refiners susceptible to the kind of environmental lawsuits that forced them to give up the additive in the first place.

Despite widespread anxiety about pump prices, fuel additives aren't typically water-cooler-chat fodder. But they are an important part of the process of refining crude oil into gasoline. Strictly speaking, they are oxygenates, allowing fuel to burn more cleanly, especially in hot weather. They also expand volume, like any liquid added to another.

MTBE came into widespread use in the 1990s as a way for refiners to comply with federal clean-air standards. At that time, MTBE was more readily available than ethanol, but its storage posed an environmental risk, particularly when it leaked into groundwater.

In an effort to drive down fuel costs, Congress phased out the oxygenate requirement as part of last year's energy bill, effectively ending the use of MTBE as an additive in the U.S. Those provisions went into effect last month, just in time for the start of the summer driving season.

In theory, that meant selling purer blends of gasoline to consumers. But, as a practical matter, the nation's refinery shortage meant additives are still needed to stretch out supply to meet the demands of drivers, says Larry Goldstein, president of the Petroleum Industry Research Foundation.

Enter ethanol, which now enjoys the support of another federal initiative, this one pushed by farmers and environmentalists: Refiners must use at least four billion gallons of it in 2006 and more in the years ahead, Mr. Goldstein says. Essentially, the government threw out the incentive to use one additive and replaced it with a requirement to use another, energy experts say.

Looking ahead, most analysts believe ethanol prices will eventually pull back from their current highs, perhaps when colder weather arrives this winter. But they say it could take much longer before supply and demand really stabilize -- a process that will also require refiners and energy companies to invest in facilities to produce and deliver ethanol.

"The gasoline market is really in a transition phase right now," says Daniel Brusstar, senior director of energy research at the New York Mercantile Exchange, a key commodity-trading venue. "There's not a lot of flexibility in terms of the blends that the refiners can deliver to consumers."