Oft-cited study showing ethanol lowering gasoline prices draws fire

Source: Amanda Peterka, E&E reporter • Posted: Monday, July 23, 2012

Two economists are questioning a frequently cited study showing that ethanol reduced gasoline prices last year by more than $1 a gallon.

The Massachusetts Institute of Technology’s Christopher Knittel and the University of California, Davis’ Aaron Smith say the study was based on “implausible economic assumptions” and “spurious statistical correlations.”

Ethanol, they argue, has a negligible effect on gasoline prices.

“We find that empirical models that are most consistent with economic and statistical theory suggest effects that are near zero and statistically insignificant,” Knittel and Smith say in a working paper released Thursday.

The Renewable Fuels Association and Agriculture Secretary Tom Vilsack have frequently cited the gasoline price study by Iowa State University professor Dermot Hayes and University of Wisconsin assistant professor Xiaodong Du as they try to drum up support for ethanol.

Hayes and Du’s study found that ethanol reduced the 2010 price of gasoline by 89 cents a gallon on average. In 2011, ethanol’s contribution to lowering gas prices was $1.09 a gallon. Their findings update a study that was first published in 2009 (Greenwire, May 15).

Knittel and Smith take issue with the methods that Hayes and Du used to come to their conclusions. They criticize the choice of variables and controls used in the analysis and say that the Midwestern economists failed to distinguish between short- and long-term effects.

Their results are “(a) inconsistent with the basic economics of the industry, (b) at the high end of the distribution of possible estimates, and (c) outside of the distribution of estimates one obtains when taking the economics of the industry seriously,” Knittel and Smith write.

The results by Hayes and Du “merely reflect” that ethanol production increased during the sample period, while the ratio of gasoline to crude prices decreased, Knittel and Smith write. They argue that because ethanol production increased relatively smoothly during that time, any variable that exhibited a similar increase or decrease could be correlated.

Using that logic, Knittel and Smith apply the model that Hayes and Du used to variables unconnected to ethanol production. They find that ethanol production also “caused” reductions in natural gas prices and increases in unemployment.

“Obviously, anyone using these models to advocate eliminating ethanol production to end the Great Recession or make children age more quickly would be greeted by extreme skepticism,” Knittel and Smith say. “We encourage similar skepticism about the estimated effect of ethanol on gasoline prices generated from these models.”

In a footnote, Knittel and Smith write that neither author received funding from any relevant stakeholders for the study. The Giannini Foundation of Agricultural Economics, a foundation whose members are faculty at the University of California, provided financial support.

Neither Hayes nor Du could be reached for comment.

Matt Hartwig, a spokesman for the Renewable Fuels Association, noted that the study by Hayes and Du was based on a published, peer-reviewed study. A 2010 review of the study by Louisiana State University researchers found that ethanol helped lower gasoline prices by 78 cents a gallon, just 11 cents lower than what Hayes and Du determined.

“The new work from MIT seems less academic curiosity and more personal opinion or vendetta,” Hartwig said in a statement. “The tone of the piece alone, including attacking the Secretary of Agriculture directly, severely calls into question the validity of the paper.”