Ethanol & Petroleum:Substitute Goods or

Complementary Goods

Joel Schumacher

Associate Specialist

Dept. of Ag. Economics & Economics

What is a substitute product?

What makes a good substitute?

Economic Principle: Substitution

Consumers substitute one product for another based on product attributes.• Price• Quality• Availability

What is a complementary product?

Definition of complement

A good or service the is used in conjunction with another good or service.

Examples:• Trucks and Truck Tires• Automobile and Automobile Insurance

Which best describes the relationship between Ethanol & Gasoline?

1. They are substitute goods

2. They are complementary goods

What is gasoline used for?

Transportation• Cars, Pickups, Vans, Motorcycles

Recreational Equipment• Small Boat Engines, Four-Wheelers, Snowmobiles

Other Stuff• Small Engines (lawnmowers, snow blowers, etc.)• Generators• Older Farm Equipment

2011 US Energy Supply & Demand

How is Gasoline Manufactured?

Gasoline Additives: Oxygenates 1970s & 1980s: Two Types of Gasoline• Leaded & Unleaded

1990s: One Type of Gasoline• Reformulated Gasoline (Modified Unleaded)

• MTBE was the primary additive

2000s: Two Types of Gasoline• MTBE & Ethanol• About 25 States have banned MTBE

How do we use ethanol?

Ethanol is blended with Gasoline:

• 1% to 10% Ethanol & Gasoline Blend (E10)

• 15% Ethanol & Gasoline Blend (E15)

• 85% Ethanol & Gasoline Blend (E85)

Ethanol Markets

10% or less ethanol blends• Responsible for 98%-99% of all ethanol sales

15% Blend (E15)• New to the market

85% Blend (E85)• Requires flex fuel vehicle• Few retail locations

• 1.6% of stations offer E85

• Consumer Choice

What is ethanol?

A Substitute Product• Ethanol is a substitute at blends of over 5-7%• Ethanol is a substitute for MTBE and Lead

A Complement Product• Ethanol is complement at blends over 5-7%

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 20110%

1%

2%

3%

4%

5%

6%

7%

8%

9%

10%

Ethanol as a % of Gasoline Consumption

Substitutes for Gasoline

Substitutes for Gasoline

Propane Natural Gas Ethanol • Several Products: E10, E15 & E85

Diesel or Biodiesel Electric• Battery (fork lifts, plug-in cars, golf carts)• Wired (Subway Trains)

Transportation Fuels

Cars, Light Trucks• Gas, Diesel, Biofuels, Propane, Natural Gas, Electric

Medium & Long Haul Trucks• Diesel, Biodiesel, Natural Gas

Train• Diesel, Electric

Plane• Petroleum Based Jet-Fuel

Ship• Diesel or Bunker Fuels

Barriers to Substitution

Common barriers:• Availability• Utility companies• E85 fuel

• Price• Capital Investments• Selling your gasoline car and buying an electric car• Selling your non-flex fuel vehicle and buying a flex

fuel vehicle

Short Term vs. Long Term Options Drive less• Short & Long Term Lower Utility

Reduce Shipping• Short & Long Term Lower Utility, Higher Costs

Improve fuel efficiency• Long Term Capital Investment Required

Increase use of alternatives• Biofuels: Short & Long Term ?????• Electric: Long Term Capital Investments & Technology• Natural Gas: Mid-Term Capital Investments

Substitution & Elasticity

Demand for transportation fuels is relatively inelastic

PriceSupply**

Supply

P**

P*

Demand

00 Q* Q**

Quantity

Do State or Federal Governments play a role in Ethanol?

Government Involvement

Environmental Issues• Oxygenate Requirements (Clean Air Act-EPA)• Missoula

• MTBE Bans State Level• Montana has a ban (Sort of)• About ½ of states ban MTBE

Renewable Fuels Standard

YearRenewable

BiofuelAdvanced

BiofuelCellulosic

BiofuelBiomass Based

DieselUndifferentiated Advanced Biofuel

2008 9.00 0.00 0.00 0.00 0.002009 10.50 0.60 0.00 0.50 0.102010 12.00 0.95 0.10 0.65 0.202011 12.60 1.35 0.25 0.80 0.302012 13.20 2.00 0.50 1.00 0.502013 13.80 2.75 1.00 0.00 1.75

2022 15 21 16.00 0.00 5.00

Advanced Biofuels DetailsRenewable Fuels Standard

Why is this important?

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 20110%

1%

2%

3%

4%

5%

6%

7%

8%

9%

10%

Ethanol as a % of Gasoline Consumption

2012 Ethanol Blend Level

9.9% of Gasoline Consumption

Why Don’t Americans Purchase E85?

Availability?? Car Compatibility?? Price??

2012 2011 2010 2009 2008 20070%

5%

10%

15%

20%

25%

30%

35%

40%

Price Premium E85 vs. Gasoline (Per BTU)

Expanding Ethanol Use

E15 Blends• EPA approved E15 for 2007 and newer vehicles • October 13, 2010

• EPA approved E15 for 2001-2006 vehicles • January 21, 2011

E15 Issues

Retail Infrastructure• Gas Stations currently 3 to 6 products• Low Octane Gasoline (85.5 to 87)• Mid Grade Gasoline (88-89)• Premium Gasoline (91)

Montana’s Role in Ethanol No commercial ethanol production in Montana

No small scale fuel ethanol production technology

2012 Montana corn production was 4.5M bushels• If all of it was used for ethanol…• MT could produce 13.3 million gallons of ethanol• This is about 2.7% of Montana gasoline use

What is the future of ethanol?

Will E15 replace with E10 or will it be an additional option?

What happens if the Renewable Fuels Standard is reduced or eliminated?

What if gasoline consumption falls?• Better fuel economy• Natural Gas Vehicles• Electric Vehicles

Which best describes the relationship between Ethanol & Gasoline?

1. They are substitute goods

2. They are complementary goods

3. Not sure

Questions

Joel Schumacher

jschumacher@montana.edu

406-994-6637

www.ampc.montana.edu