California, USA -- Gasoline prices have been falling in the last few weeks, but – for most U.S. drivers – they remain painfully high. With regular unleaded costing a national average of $3.78 per gallon Tuesday, and more than $4 a gallon in six states and the District of Columbia, prices are more than $1 higher than they were a year ago. "When you fill your tank and you're putting $60, $70 or $80 into your vehicle at a shot, you start to wonder if there's an alternative to this madness," said Scott Doggett, associate editor for Edmunds.com.
In 2008, the last time gasoline approached $4 a gallon, the sticker shock prompted many drivers to trade in their gas-guzzlers – often at enormous losses – and buy more efficient cars and hybrids, he said. Investors pumped money into new fuel and vehicle technologies, including biofuels and electric cars, which seemed more competitive compared to higher gas prices. And analysts began considering $4 gas the tipping point for change.
So you might think that the return of high gasoline prices would be great news for alternative fuels and electric-vehicle technologies. But this time around, analysts say, they're not seeing the same dramatic response from consumers and investors. Drivers aren't flocking to car dealerships to trade in their cars. Investors aren't spending hundreds of millions on algae-based biofuels or electric-vehicle batteries. And there's no sign that the prices will spark the kind of government spending that the stimulus brought soon after the prices breached $4 a gallon last time.
Why It's Different This Time
What's different? For one thing, today's economy is very different than it was three years ago. Even though the economy had already begun to slump in 2008, far more people find themselves caught in challenging conditions today, Doggett said. Drivers don't have the discretionary income to switch cars and they're holding on to their old cars longer, he added. In other words, drivers don't have much of a choice. "They see themselves putting $60 or $70 into their gas tanks and they aren't happy about it, but there's not much they can do about it either," he said. "They don't see another viable option."
Even if they want to spend the money on a new car, many would-be car buyers just can't get the financing they'd need now that banks have become more cautious about lending and home values have dropped. "People's buying habits are totally different than they were two or three years ago because of what people have lived through and uncertainty about what's going to happen in the future," said Rick Kment, a biofuels analyst at DTN. "With more uncertainty about jobs and a challenging economy, are you going to lock yourself into a 5- to 6-year car purchase now?"
Most Americans who are buying new cars aren't buying the plug-in hybrid Chevy Volt or the all-electric Nissan Leaf, or even a regular hybrid like the Toyota Prius. With General Motors targeting sales of a mere 10,000 Volts in its first year and Nissan aiming to sell 10,000 Leafs by the end of this year, these cars will make up a tiny part of the U.S. sales that automakers predict could top 13 million in 2011. And while more hybrid models are available today than there were two years ago, the percentage of hybrids in the U.S. market shrank to 2.4 percent in 2010 from 2.7 percent in 2009, even as gasoline prices grew, Doggett said. "Even with more hybrid choices available, Americans are purchasing fewer of them on a percentage basis," he said.
At $40,000, the Volt – which drivers can charge with electricity or fill with gas – is simply beyond the means of many Americans, Doggett said. And the Leaf doesn't have the range that many drivers would like, in many cases topping out at around 80 to 100 miles per charge, he added. "For a lot of people, that's just not enough," he said. "It may be true that the average American drives 40 miles a day, but there are many times when that average American is going to want to drive 120 or 150 miles. The Leaf just doesn't meet a lot of people's expectations of what an automobile is supposed to do."
Other hybrids cost less, but still can be expensive. Many models, including the Toyota Prius, have price tags $3,000 higher than their comparable nonhybrid counterparts. They're facing increased competition from more fuel-efficient internal-combustion-engine vehicles. Because while the gas prices are beginning to make consumers look more closely at alternative vehicles, many are finding that the most convenient choice – aside from driving less – is a smaller, more fuel-efficient car with traditional technology, said Thilo Koslowski, lead automotive analyst at Gartner.
So while car buyers are paying more attention to fuel efficiency nowadays, traditional – albeit higher-MPG – vehicles seem to be winning out over new technologies, analysts say. One reason is that internal-combustion-engine cars have gained fuel efficiency since 2008. "The 40-MPG club is growing, and it offers a lot of competition to hybrids," Doggett said. "Almost every major automakers feels pressure to have at least one model that gets 40 MPG on the highway. There's the thinking that you need to have a place at that table."
Those conventional cars haven't gained their fuel efficiency for free. Prices are going up as automakers pass research costs to consumers, Doggett said. But the fuel-efficient ICE vehicles remain cheaper than hybrids, and -- as the MPG gap between hybrids and conventional cars narrows -- buyers seem to be growing less willing to pay those premiums for smaller fuel-efficiency gains. Meanwhile, many of those early adopters inclined to buy hybrids at the sight of $4 gas probably already did so in 2008, and aren't likely to switch out their green cars for newer ones only three years later, Kment said.
Changing the Fuel Instead of the Car
Another option that drivers have is to fill their regular cars with ethanol or biodiesel. Biofuel retailer Propel Fuels has seen its customer ranks grow steadily amid the higher gas prices, with a double-digit monthly growth rate for the last six months, according to CEO Matt Horton. The company just opened its 24th station in Redwood City, Calif., in May. Horton estimates that Propel probably has nearly 10,000 customers now, with a much larger potential market. After all, more than 65 percent of drivers with flexible-fuel vehicles, which can run on a blend of 85 percent ethanol and 15 percent gasoline called E85, aren't aware they have such vehicles, he says.
"Most American consumers are absolutely sleepwalking when it comes to fuel," CEO Matt Horton said. "It's a mindless process – you go to the gas station, grumble a bit and fill up. But gas prices like these shake people out of their sleep and make them think about what they're doing. They look for alternatives, and because of that, our business has been doing very well in this environment. Whenever people think about their fueling choices, it's good for our business."
It's interesting to hear that E85 sales have grown considering that ethanol prices actually have outpaced gasoline prices lately. Ethanol is still cheaper than gasoline, but a gallon of ethanol contains 25 to 30 percent less energy than a gallon of gasoline, so if isn't 25 to 30 percent cheaper – or $3 a gallon when gas is at $4 -- it's not a good deal for drivers, Kment said. The average price of E85 nationwide is $3.23 per gallon, which – because of the lower energy content – would equate to a price of $4.25 per gallon for regular gasoline, according to AAA. The gap between the price of gasoline futures and ethanol futures for June – the so-called gas-to-ethanol spread – has shrunk from almost 81 cents per gallon on May 10 to 52 cents on Tuesday, Kment said, meaning that ethanol futures cost only 16.5 percent less than gasoline futures.
Why? Well, corn prices have been soaring, with flooding and planting delays exacerbating higher food prices overall. Horton calls the oil price the No. 1 contributor to the rise in corn prices, pointing out that food and other commodity prices tend to rise whenever oil prices do. Fertilizer is petroleum-based, for one thing, and transportation is needed to produce and distribute corn. Oddly enough, while oil and gas prices have boosted ethanol prices, ethanol has actually helped keep gas prices down, according to a Center for Agricultural and Rural Development study in May. The report concluded that ethanol had reduced wholesale gas prices by an average of 82 cents per gallon in 2010 and that gas could cost up to 92 percent more today if it weren't for ethanol.
In any case, the shrinking gas-to-ethanol gap hasn't trickled down to Propel's stations. The company has cut its margins to keep ethanol competitive, Horton said. At its new station in Redwood City, Calif., Propel sells E85 for 76 cents per gallon less than gasoline. That's a bigger discount than the nationwide average, which prices E85 at 55 cents, or 14.5 percent, less than gasoline. And Horton claims that customers haven't been seeing big mileage reductions, in spite of ethanol's lower energy content. Of course, customers aren't using 100 percent ethanol, but a blend, which tempers the mileage reduction. Most Propel customers report a loss of only 1 to 2 fewer miles per gallon, Horton said.
Still, sales of E85 still make up a small fraction of the U.S. ethanol market today. Most of the ethanol is blended with gasoline, and that market seems to be stuck where it is for now, analysts say. Ethanol is cheaper than gasoline, so blenders have an incentive to add as much as most cars can use. But a blend of up to 10 percent ethanol and 90 percent gasoline, E10, is the practical limit for the majority of U.S. pumps because it’s the maximum blend that all gas vehicles can use today.
The Environmental Protection Agency in January approved the use of E15 for cars released in 2001 and later, but most retailers are unlikely to add expensive E15 pumps when only about half of the cars on the road could use the fuel, Kment said. Adding to the reluctance is the fact that retailers aren't guaranteed any protection against lawsuits if drivers with older cars use the fuel, according to oil and ethanol refiner Valero spokesman Bill Day. "Until and unless E15 gets some product-liability protection and until and unless it's approved for all vehicles, it's not going anywhere," he said, adding that Valero doesn't plan to sell E15 at any of its company-owned stores. "EPA's approval of E15 made for good politics, but it was – for all practical matters – useless."
Valero's Renewable Plans
Valero plans to continue to blend E10, which meets the federal renewable fuel standard (RFS), as well as E85 for flex-fuel vehicles. It also plans to add E85 dispensers any time it opens a new store or significantly renovates an old store. So far, the high gasoline prices and low margins for ethanol haven't altered Valero's interest or activities in renewables, Day said.
The company has been running its ethanol factories, which it bought from VeraSun in 2009, at full capacity – and at a profit – and intends to continue to do so, he said. "The price of corn has gone up and margins for ethanol have been squeezed a little bit, but our plants are large, low-cost operations, so it's still viable for us to operate them at capacity."
While Valero got permits to slightly increase the capacity at its Minnesota ethanol plant, it doesn't have any firm ethanol expansion plans, Day added. It has considered buying more factories, but the valuations have gone up and Valero hasn't been able to find the same kind of bargain that it got for the VeraSun plants, he said. It also hasn't seen much of change in the ethanol market as a result of the high gas prices, he added. "We haven't said we've seen an increase, but it's stayed at elevated levels."
Meanwhile, gas prices could be heading downward, even as summer – traditionally a time of heavy driving and higher demand for fuel – approaches, Kment said. "In the last three weeks, we have seen a significant pullback in expected demand, a significant selloff in the gasoline market," he said. Gasoline futures for June delivery fell from $3.38 per gallon on May 10 to $2.95 per gallon on May 18, indicating expectations of sluggish demand, he added. By Tuesday, the price had recovered somewhat to $3.15 per gallon, but that's still below previous expectations for this time of the year, and Kment predicts that demand will remain slower than usual.
If gasoline prices drop significantly, as futures traders expect, and corn prices remain high, ethanol prices could actually meet or exceed gasoline prices, Kment said. (Horton believes that gas prices will remain high this summer – and will continue to grow in the long term, even if they fluctuate in the short term – while corn prices come down. Ethanol futures are now priced at $2.63 per gallon for June delivery.) If ethanol prices do top gas prices, E85 sales could drop, but the market for ethanol blended into gasoline is unlikely to see much of an impact, Kment added.
That's because the federal RFS calls for about 13.95 billion gallons of biofuel this year, increasing to 36 billion gallons in 2022. Corn-based ethanol could make up about 13 billion gallons of that requirement, an amount equal to more than 9 percent of the country's annual gasoline consumption. So for all practical purposes, most of the ethanol blending is stuck in the narrow window between 9 percent and 10 percent, Kment said. That means that when the gas-to-ethanol spread grows or shrinks, it ends up having a limited effect on the market, he added.
Day disagrees that there's little room for discretionary blending. Not everybody is blending at the 10 percent level now, he said, adding that ethanol blending is not required in some parts of the country. But he acknowledged that the discretionary-blending window will keep shrinking as the RFS requirement grows to 36 billion gallons in 2022. "That's why we're interested in increasing the amount of E85 that we sell," he said.
Back in 2008, the RFS required only 9 billion gallons of biofuel in 2008, which gave blenders more discretion to react to fuel prices by adding more or less ethanol to their gasoline. And, unlike in 2008, investment in advanced biofuels, such as algae-based biodiesel or cellulosic ethanol, hasn't seen a big jump either. Those second-generation fuels could deliver more environmental benefits than corn-based ethanol or soybean-based biodiesel and could potentially cut costs in the long run, analysts say. The fuel standard calls for 1.35 billion gallons of advanced biofuels this year. But those fuels are "still economically unfeasible" in spite of sky-high corn prices, Kment said.
Is $5 Gas the New $4 Gas?
The question remains: Why is this spike above $4-a-gallon gas bringing less change than the last one? Have drivers become more tolerant of higher prices now that $4 gas is nothing new? Listening to consumers' comments, Day doubts it. But this time around, customers realize the price spike is the result of temporary disruptions in the market and already have seen prices start to slide, he said.
What would it take to bring those technologies the same momentum they saw back in 2008? For the last three years, analysts have confidently called $4 gas a tipping point because of the flurry of renewable support they saw in 2008. But just because it happened before doesn't mean it will happen again. Maybe it takes higher and higher gas prices to cause the same type of sticker shock. Back in 2004, after all, gas prices above $2 a gallon were enough to shine a spotlight on renewables.
Now, it looks like $4 gas might not be enough, Doggett said. "A lot of people were saying – and people are saying it now – that $4 gas is a tipping point, but the fact is that we do have $4 gas nationwide and we're not seeing anywhere near the selloff of gas guzzlers and demand for fuel-efficient vehicles that we saw three years ago," he said. "It'll be interesting to see, if we get to $5 gas, if people will say 'Enough is enough.'" Koslowski predicts that it could take $10-a-gallon gas to drive consumers toward big changes, like electric vehicles, a price we're unlikely to see soon. Companies developing new vehicle technologies likely hope to prove him wrong.