Indirect Subsidies

Indirect subsidies are paid by consumers through high prices at the pump. The USDA found that between 1982 and 2006 the wholesale price of ethanol averaged 57¢ more than the wholesale price of gasoline (USDA 2007c). The average subsidy during that period was 54¢. From the blender's perspective, after the subsidy, the price of ethanol was just 3¢ more than the cost of gasoline. Apparently there is a strong tendency for the price of ethanol to equal the price of gasoline, but something is giving the ethanol price a little boost.

    Although it may seem obvious that ethanol and gasoline would sell for the same price per gallon, the USDA's chief economist points out that with more supply, the premium could "decline toward ethanol’s energy equivalent with gasoline." (USDA, 2007) In other words, Collins is saying that in a balanced market, ethanol and gasoline will tend to sell for the same price per energy, not the same price per gallon. That seems reasonable since it's energy that powers a car, and not just gallons .

    But the USDA found that for the last 25 years there was no tendency towards this balance. Ethanol and gasoline have sold at the same price per gallon (after subtracting the subsidy) and not at the same price per energy. Ethanol selling at the same price per energy as $2.00 gasoline would not sell at $2.00 per gallon but at $1.33 per gallon. At $2.00 per gallon, ethanol is getting a 67¢ price subsidy simply because its lack of energy is ignored by the market.

    Why does the market make this mistake? First, consumers often don't know they are buying the ethanol--it's just blended in for smog control. Second, they have no choice because all the gasoline has it included. Third, very few people know it has less energy. These market anomalies are the source of the mis-pricing and the primary source of ethanol's indirect subsidy. In 2006, because of the MTBE phaseout and the switch to ethanol as an additive, wholesale ethanol sold (after subtracting the subsidy) for 13¢ more per gallon than gasoline. This added to the subsidy from mis-pricing.

In 2006, the effective wholesale price of ethanol, after subtracting the blender's subsidy, was 80¢ higher than the price of gasoline with the same energy content, hence the indirect subsidy to ethanol, paid at the pump, was 80¢ per gallon of ethanol.