Demand For Gas Falls, Gas Prices Rise: Blame Ethanol (And Congress)

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For fans of fuel efficiency, the New York Times has good news and bad news.

The good news is: drivers in the U.S. are using less gas these days.

The bad news is: that's driving up the cost of gas.

To anyone who's taken Econ 101, that probably seems counter-intuitive -- mostly because it is.

To locate the source of this conundrum, we have to visit America's wellspring of counter-intuition: the United States Congress.

PAVED WITH GOOD INTENTIONS

In December of 2007, President George W. Bush signed into law the Energy Independence and Security Act [PDF]. Among the many bits and bobs included in that sprawling piece of legislation were heightened fuel economy standards, incentives for the development of hybrid and electric vehicles, and a requirement that refineries use more biofuels in the production of gasoline.

That's where the trouble began.

Six years ago, American refineries used fewer than 5 billion gallons of biofuel in the creation of gasoline. The Energy Independence and Security Act of 2007 required that figure to ramp up every year, until it reaches 36 billion gallons in 2022. (This year, the magic number is 16.55 billion.)

If U.S. demand for gasoline had continued to increase, the new regulations wouldn't have caused problems. But demand has stagnated. In fact, it's fallen. Perhaps that's because we're driving less these days. Or maybe it has something to do with the improved fuel economy of our vehicles and the growing availability of hybrid and electric cars -- ironically, two other provisions of the 2007 law.

EXTRA CREDITS

America's declining appetite for gasoline means that refineries have had to use an increasing volume of ethanol to keep up with the regulations imposed in 2007. That, too, would be just fine if cars and gas pumps could handle it, but many vehicles and service stations can't utilize anything beyond the mixture of 10% ethanol and 90% gasoline commonly known as E10.

So basically, refineries are required on paper to use more and more ethanol, but they can't in practice, because they won't have any way to distribute this hybrid fuel and customers won't be able to use it. What are they to do?

As luck would have it, refineries can purchase renewable energy credits, or RINs. These RINs serve as a system of ethanol indulgences: a means by which refineries can stay within the bounds of the 2007 law and avoid federal penalties.

Given the drop-off in gas consumption, trade in RINs has been brisk -- and sudden. A week or so ago, RINs cost mere pennies. Today, they can top $1.

No one can say for sure what's causing the current boom in RIN prices, but the effects are pretty clear. 

SERVICE STATIONS & SHOWROOMS

Naturally, refineries pass the cost of these RINs on to consumers. Today, the price for a gallon of premium unleaded gasoline sits at $4, or 31 cents above regular. Last year, the difference between the two was closer to 27 cents. In 2010, it was 24 cents, and way back in 2000, it was around 18 cents.

These prices at the pump, in turn, could have a nasty effect on new car sales, since a considerable number of new cars are meant to run exclusively on premium gas.

We hope that, just like the demand for gasoline, the volatile trade in RINs eventually ratchets down, which should reduce the price of premium gasoline. We'll keep you posted.

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