Gas Prices May Go Up Too Because Of Drought

The slim silver lining to the global economic malaise has been low prices at the gas pump. That’s about to change.

Economists are already predicting price increases for staples like milk and beef as scorching heat and drought wreak havoc on America’s corn crop. Now, beleaguered consumers can add gasoline to that list.

“We’re pretty well hooked on ethanol,” said Bruce Babcock, professor of economics at Iowa State University. “It’s 10 percent of our gasoline supply.” The complexity of the market makes it hard to predict exactly what this will mean for drivers, but Babcock estimated the impact of ethanol, which is derived from corn, among other grains, could be as high as 15 cents a gallon.

A 46-cent per gallon subsidy to ethanol producers expired at the end of last year, which means the product is exposed to market gyrations. One-month corn futures already are trading at record highs, said Dan Flynn, an analyst at Price Futures Group. “We are definitely at all-time highs and right now, with the drought, there’s no end in sight. Expect higher prices at the pump.”

Babcock said a recent glut in ethanol production was one of the factors responsible for driving down the cost of gasoline at the wholesale level, where it is bought by refiners and mixed with ethanol. Since drivers today are used to falling gas prices, a sharp reversal could have a ripple effect across the economy, especially if the cost of food is climbing at the same time.

But that overproduction might give consumers a bit of breathing room, according to one economist. Nicholas Paulson, a professor in the University of Illinois' agriculture and consumer economics department, wrote a paper earlier this year that explored a type of credit called RINs.

RINs are associated with the Environmental Protection Agency's fuel mandate that energy companies get for using ethanol in their gasoline blends. These companies are required to earn a certain number of RINs based on the total amount of gas they produce, and if they have extra credits, they can stockpile them and apply some to the following year's requirement.

There are a lot of these "extra credit" RINs floating around now, according to Paulson's research. If the price of ethanol got prohibitively high, oil companies could elect to cash in these credits instead of paying a bundle for ethanol and then passing that cost along to drivers. "The current level of RIN stocks can serve to act as a buffer for the mandate should conditions arise which threaten the economic viability of conventional ethanol production or importing, and ethanol blending," he wrote.

The caveat is that energy companies weren't just saving those credits for a rainy day; they were hoarding them in advance of a change in EPA rules that would require more ethanol usage. Burning them now might be a less desirable option than just buying expensive ethanol and passing the cost onto consumers.

Up until now, "ethanol in 10 percent blends has been sold at the same price as gasoline," University of Illinois agriculture and consumer economics professor Darrel Good said via email. "If ethanol prices go above gasoline prices, then that will tend to raise prices at the pump."


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