Order Code RL30369
Report for Congress
Received through the CRS Web
Fuel Ethanol:
Background and Public Policy Issues
Updated May 8, 2003
Brent D. Yacobucci
Environmental Policy Analyst
Resources, Science, and Industry Division
Jasper Womach
Specialist in Agricultural Policy
Resources, Science, and Industry Division
Congressional Research Service ˜ The Library of Congress

---

Fuel Ethanol: Background and Public Policy Issues
Summary
In light of a changing regulatory and legislative environment, concern has arisen
regarding the future prospects for ethanol as a motor fuel. Ethanol is produced from
biomass (mainly corn) and is mixed with gasoline to produce cleaner-burning fuel
called “gasohol” or “E10.”
The market for fuel ethanol, which consumes 10 % of the nation’s corn crop, is
heavily dependent on federal subsidies and regulations. A major impetus to the use
of fuel ethanol has been the exemption that it receives from the motor fuels excise
tax. Ethanol is expensive relative to gasoline, but it is subject to a federal tax
exemption of 5.2 cents per gallon of gasohol (or 52 cents per gallon of pure ethanol).
This exemption brings the cost of pure ethanol, which is higher than that of
conventional gasoline and other oxygenates, within reach of the cost of competitive
substances. In addition, there are other incentives such as a small ethanol producers
tax credit. It has been argued that the fuel ethanol industry could scarcely survive
without these incentives.
The Clean Air Act requires that ethanol or another oxygenate be mixed with
gasoline in areas with excessive carbon monoxide or ozone pollution. The resulting
fuels are called oxygenated gasoline (oxyfuel) and reformulated gasoline (RFG),
respectively. Using oxygenates, vehicle emissions of volatile organic compounds
(VOCs) have been reduced by 17%, and toxic emissions have been reduced by
approximately 30%. However, there has been a push to change the oxygenate
requirements for two reasons. First, methyl tertiary butyl ether (MTBE), the most
common oxygenate, has been found to contaminate groundwater. Second, it is
argued that emissions could be reduced to similar levels through the use of clean
burning gasoline that does not contain oxygenates.
Uncertainties about future oxygenate requirements, as both federal and state
governments consider changes, have raised concerns among farm and fuel ethanol
industry groups and have prompted renewed congressional interest in the substance.
Without the current regulatory requirements and incentives, or something
comparable, much of ethanol’s market would likely disappear. Expected changes to
the reformulated gasoline requirements could either help or hurt the prospects for fuel
ethanol (subsequently affecting the corn market), depending on the regulatory and
legislative specifics. As a result, significant efforts have been launched by farm
interests, the makers of fuel ethanol, agricultural states, and the manufacturers of
petroleum products to shape regulatory policy and legislation.
Ethanol will play a key role in the debate over omnibus energy legislation. On
April 3, 2003, the House Energy and Commerce Committee completed a draft bill
that would require the use of 5.0 billion gallons of renewable fuel (including ethanol)
by 2015. This draft is expected to be sent to the House floor during the week of April
7, 2003. The Senate is expected to begin committee deliberation the same week.
This report provides background concerning various aspects of fuel ethanol, and
a discussion of the current related policy issues. It will be updated as events warrant.

---

Contents
Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
Ethanol and the Agricultural Economy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2
Ethanol Refining and Production . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
Fuel Consumption . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5
Research and Development in Cellulosic Feedstocks . . . . . . . . . . . . . . . . . . . . . . 8
Costs and Benefits of Fuel Ethanol . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8
Economic Effects . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8
Air Quality . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10
Climate Change . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12
Energy Security . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13
Policy Concerns and Congressional Activity . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13
Reformulated Gasoline and MTBE . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14
Renewable Fuels Standard . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15
“Boutique” Fuels . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16
Alcohol Fuel Tax Incentives . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16
Fuel Economy Credits for Dual Fuel Vehicles . . . . . . . . . . . . . . . . . . . . . . 17
Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18
List of Tables
Table 1. Corn Utilization, 2002/2003 Forecast . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
Table 2. Top 10 Ethanol Producers by Capacity, 2003 . . . . . . . . . . . . . . . . . . . . . 4
Table 3. Estimated U.S. Consumption of Fuel Ethanol, MTBE and Gasoline . . . 7
Table 4. Price of Pure Ethanol Relative to Gasoline . . . . . . . . . . . . . . . . . . . . . . . 9

---

Fuel Ethanol: Background and
Public Policy Issues
Introduction
Ethanol (ethyl alcohol) is an alcohol made by fermenting and distilling simple
sugars. Ethyl alcohol is in alcoholic beverages and it is denatured (made unfit for
human consumption) when used for fuel or industrial purposes.1 The biggest use of
fuel ethanol in the United States is as an additive in gasoline. It serves as an as an
oxygenate (to prevent air pollution from carbon monoxide and ozone), as an octane
booster (to prevent early ignition, or “engine knock”), and as an extender of gasoline.
In purer forms, it can also be used as an alternative to gasoline in automobiles
designed for its use. It is produced and consumed mostly in the Midwest, where
corn—the main feedstock for ethanol production—is produced.
The initial stimulus to ethanol production in the mid-1970s was the drive to
develop alternative and renewable supplies of energy in response to the oil
embargoes of 1973 and 1979. Production of fuel ethanol has been encouraged by a
partial exemption from the motor fuels excise tax. Another impetus to fuel ethanol
production has come from corn producers anxious to expand the market for their
crop. More recently the use of fuel ethanol has been stimulated by the Clean Air Act
Amendments of 1990, which require oxygenated or reformulated gasoline to reduce
emissions of carbon monoxide (CO) and volatile organic compounds (VOCs).
While oxygenates reduce CO and VOC emissions, they also can lead to higher
emissions of nitrogen oxides, precursors to ozone formation. While reformulated
gasoline has succeeded in reducing ground-level ozone, the overall effect of
oxygenates on ozone formation has been questioned. Furthermore, ethanol’s main
competitor in oxygenated fuels, methyl tertiary butyl ether (MTBE), has been found
to contaminate groundwater. This has led to a push to ban MTBE, or eliminate the
oxygenate requirements altogether. High summer gasoline prices in the Midwest,
especially in Chicago and Milwaukee, where oxygenates are required, have added to
the push to remove the oxygenate requirements. The trade-offs between air quality,
water quality, and consumer price have sparked congressional debate on these
requirements. In addition, there has been a long-running debate over the tax
incentives that ethanol-blended fuels receive.
Fuel ethanol is used mainly as a low concentrate blend in gasoline, but can also
be used in purer forms as an alternative to gasoline. In 2002, 99% of fuel ethanol
1 Industrial uses include perfumes, aftershaves, and cleansers.

---

CRS-2
consumed in the United States was in the form of “gasohol” or “E10” (blends of
gasoline with up to 10% ethanol).2
Fuel ethanol is usually produced from the distillation of fermented simple sugars
(e.g. glucose) derived primarily from corn, but also from wheat, potatoes and other
vegetables, but can also be produced from cellulosic material such as switch grass,
rice straw, and sugar cane (bagasse). The alcohol in fuel ethanol is identical to
ethanol used for other purposes, but is treated (denatured) with gasoline to make it
unfit for human consumption.
Ethanol and the Agricultural Economy
Corn constitutes about 90% of the feedstock for ethanol production in the
United States. The other 10% is largely grain sorghum, along with some barley,
wheat, cheese whey and potatoes. Corn is used because it is a relatively low cost
source of starch that can be converted to simple sugars, fermented and distilled. It
is estimated by the U.S. Department of Agriculture (USDA) that about 920 million
bushels of corn will be used to produce about 2.5 billion gallons of fuel ethanol
during the 2002/2003 corn marketing year.3 This is 9.6% of the projected 9.6 billion
bushels of corn utilization.4
Producers of corn, along with other major crops, receive farm income support
and price support. Farms with a history of corn production received “production
flexibility contract payments” of about $1.186 billion during the 2000/2001 corn
marketing year. Emergency economic assistance (P.L. 106-224) more than double
the corn contract payments. Corn producers also are guaranteed a minimum national
average price of $1.89/bushel under the nonrecourse marketing assistance loan
program.5
The added demand for corn created by fuel ethanol raises the market price for
corn above what it would be otherwise. Economists estimate that when supplies are
large, the use of an additional 100 million bushels of corn raises the price by about
4¢ per bushel. When supplies are low, the price impact is greater. The ethanol
market is particularly welcome now, when the average price received by farmers is
forecast by USDA to average about $1.80 per bushel for the 2000/01 marketing year.
This price would be the lowest season average since 1986. The ethanol market of
615 million bushels of corn, assuming a price impact of about 25¢ per bushel on all
corn sales, means a possible $2.4 billion in additional sales revenue to corn farmers.
2 U.S. Department of Energy (DOE), Energy Information Administration (EIA).
Alternatives to Traditional Transportation Fuels 1999. Updated February 2001.
3 One bushel of corn generates approximately 2.7 gallons of ethanol.
4 Utilization data are used, rather than production, due to the existence of carryover stocks.
Corn utilization data address the total amount of corn used within a given period.
5 Detailed explanations are available in CRS Report RS20271, Grain, Cotton, and Oilseeds:
Federal Commodity Support, and CRS 98-744, Agricultural Marketing Assistance Loans
and Loan Deficiency Payments.

---

CRS-3
In the absence of the ethanol market, lower corn prices probably would
stimulate increased corn utilization in other markets, but sales revenue would not be
as high. The lower prices and sales revenue would be likely to result in higher
federal spending on corn payments to farmers, as long as corn prices were below the
price triggering federal loan deficiency subsidies.
Table 1. Corn Utilization, 2002/2003 Forecast
Quantity
Share of Total Use
(million bushels)
Livestock feed & residual
5,600
58.2%
Food, seed & industrial:
2,265
23.6%
– Fuel alcohol
920
9.6%
– High fructose corn syrup
545
5.7%
– Glucose & dextrose
212
2.2%
– Starch
250
2.6%
– Cereals & other products
187
1.9%
– Beverage alcohol
131
1.4%
– Seed
20
0.2%
Exports
1,750
18.2%
TOTAL USE
9,615
100.00%
TOTAL PRODUCTION
9,008
Source: Basic data are from USDA, Economic Research Service, March 13, 2003.
Ethanol Refining and Production
According to the Renewable Fuels Association, about 55% of the corn used for
ethanol is processed by “dry” milling plants (a grinding process) and the other 45%
is processed by “wet” milling plants (a chemical extraction process). The basic steps
of both processes are as follows. First, the corn is processed, with various enzymes
added to separate fermentable sugars. Next, yeast is added to the mixture for
fermentation to make alcohol. The alcohol is then distilled to fuel-grade ethanol that
is 85-95% pure.6 Finally, for fuel and industrial purposes the ethanol is denatured
6 The byproduct of the dry milling process is distillers dried grains. The byproducts of wet
milling are corn gluten feed, corn gluten meal, and corn oil. Distillers dried grains, corn
gluten feed, and corn gluten meal are used as livestock feed.

---

CRS-4
with a small amount of a displeasing or noxious chemical to make it unfit for human
consumption.7 In the U.S. the denaturant for fuel ethanol is gasoline.
Ethanol is produced largely in the Midwest corn belt, with almost 90% of
production occurring in five states: Illinois, Iowa, Nebraska, Minnesota and Indiana.
Because it is generally less expensive to produce ethanol close to the feedstock
supply, it is not surprising that the top five corn-producing states in the U.S. are also
the top five ethanol-producers. Most ethanol use is in the metropolitan centers of the
Midwest, where it is produced. When ethanol is used in other regions, shipping costs
tend to be high, since ethanol-blended gasoline cannot travel through petroleum
pipelines, and must be transported by truck, rail, or barge.
This geographic concentration is an obstacle to the use of ethanol on the East
and West Coasts. The potential for expanding production geographically is a
motivation behind research on cellulosic ethanol, since if regions could locate
production facilities closer to the point of consumption, the costs of using ethanol
could be lessened. Furthermore, if regions could produce fuel ethanol from local
crops, there would be an increase in regional agricultural income.
Table 2. Top 10 Ethanol Producers by Capacity, 2003
Million Gallons Per Year
Archer Daniels Midland (ADM)
1070
Williams Bio-Energy
135
Cargill
118
VeraSun Energy Corporation
100
New Energy Corp.
95
High Plains Corporation
85
Midwest Grain Processors
78
A.E. Staley
65
Chief Ethanol
62
AGP
52
All Others
1372
U.S. Total
3232
Note: These include existing plants and those under construction.
Source: Renewable Fuels Association, Ethanol Industry Outlook 2003.
Ethanol production is also concentrated among a few large producers. The top
five companies account for approximately 47% of production capacity, and the top
ten companies account for approximately 58% of production capacity. (See Table
2.) Critics of the ethanol industry in general — and specifically of the ethanol tax
incentives — argue that the tax incentives for ethanol production equate to “corporate
7 Renewable Fuels Association, Ethanol Industry Outlook 2002, Growing Homeland Energy
Security. [http://www.ethanolrfa.org/outlook2002.html]

---

CRS-5
welfare” for a few large producers.8 However, the share of production capacity
controlled by the largest producers has been dropping as more producers have entered
the market.
Overall, by the end of 2003, domestic ethanol production capacity will be
approximately 3.2 billion gallons per year. With current laws and incentives,
consumption is expected to increase from 1.8 billion gallons per year in 2001 to
approximately 3.0 billion gallons per year in 2005. Production will need to increase
proportionally to meet the increased demand.9 However, if the Clean Air Act is
amended to limit or ban MTBE, or if other incentives for ethanol use are enacted,
ethanol production capacity may expand at a faster rate. This is especially true if
MTBE is banned while maintaining the oxygenate requirements, since ethanol is the
most likely substitute for MTBE.10
Fuel is not the only output of an ethanol facility, however. Co-products play an
important role in the profitability of a plant. In addition to the primary ethanol
output, the corn wet milling generates corn gluten feed, corn gluten meal, and corn
oil, and dry milling creates distillers grains. Corn oil is used as a vegetable oil and
is higher priced than soybean oil. Approximately 12 million metric tons of gluten
feed, gluten meal, and dried distillers grains are produced in the United States and
sold as livestock feed annually. A major market for corn gluten feed and meal is the
European Union, which imported nearly 5 million metric tons of gluten feed and
meal during FY1998.
Revenue from the ethanol byproducts help offset the cost of corn. The net cost
of corn relative to the price of ethanol (the ethanol production margin) and the
difference between ethanol and wholesale gasoline prices (the fuel blending margin)
are the major determinants of the level of ethanol production. Currently, the ethanol
production margin is high because of the low price of corn. At the same time, the
wholesale price of gasoline is increasing against the price of ethanol, which
encourages the use of ethanol.
Fuel Consumption
Approximately 2.1 billion gallons of ethanol fuel were consumed in the United
States in 2001, mainly blended into E10 gasohol. While large, this figure represents
only 1.6% of the approximately 131 billion gallons of gasoline consumption in the
same year.11 According to DOE, ethanol consumption is expected to grow to 3.0
billion gallons per year in 2005 and 4.5 billion gallons per year in 2025. This would
increase ethanol’s market share to approximately 2.2% by 2005. Under current
conditions, which may change considerably in the near future, this 2.2% share is
8 James Bovard, Archer Daniels Midland: A Case Study in Corporate Welfare. Cato
Institute. September 26, 1995.
9 DOE, EIA, Annual Energy Outlook 2003. January, 2003. Table A18.
10 For more information, see section on MTBE.
11 DOE, EIA, Alternatives to Traditional Transportation Fuels 2000. Table 10.

---

CRS-6
projected to remain constant through 2020.12 However, ethanol’s market share could
increase more quickly if a renewable fuels standard (RFS) is enacted. (See the
section on Renewable Fuels Standard.)
The most significant barrier to wider use of fuel ethanol is its cost. Even with
tax incentives for ethanol producers (see the section on Economic Effects), the fuel
tends to be more expensive than gasoline per gallon.13 Furthermore, since fuel
ethanol has a somewhat lower energy content, more fuel is required to travel the
same distance. This energy loss leads to an approximate 3% decrease in miles-per-
gallon vehicle fuel economy with gasohol.14
However, ethanol’s chemical properties make it very useful for some
applications, especially as an additive in gasoline. Major stimuli to the use of ethanol
have been the oxygenate requirements of the Reformulated Gasoline (RFG) and
Oxygenated Fuels programs of the Clean Air Act.15 Oxygenates are used to promote
more complete combustion of gasoline, which reduces carbon monoxide and volatile
organic compound (VOC) emissions.16 In addition, oxygenates can replace other
chemicals in gasoline, such as benzene, a toxic air pollutant (see the section on Air
Quality).
The two most common oxygenates are ethanol and methyl tertiary butyl ether
(MTBE). MTBE, primarily made from natural gas or petroleum products, has been
preferred to ethanol in most regions because it is generally much less expensive, is
easier to transport and distribute, and is available in greater supply. Because of
different distribution systems and blending processes (with gasoline), substituting
one oxygenate for another can lead to significant cost increases.
Despite the cost differential, there are several possible advantages of using
ethanol over MTBE. Ethanol contains 35% oxygen by weight—twice the oxygen
content of MTBE. Furthermore, since ethanol is produced from agricultural
products, it has the potential to be a sustainable fuel, while MTBE is produced from
natural gas and petroleum, fossil fuels. In addition, ethanol is readily biodegradable,
eliminating some of the potential concerns about groundwater contamination that
have surrounded MTBE (see the section on MTBE). However, there is concern that
ethanol use can lead to contamination by benzene and other toxic compounds.17
12 DOE, EIA, Annual Energy Outlook 2003. January, 2003. Tables A2 and A18.
13 However, gasoline prices have been high recently, making ethanol more attractive as a
blending component.
14 It should be noted that the use of ethanol does not effect the efficiency of an engine.
There is simply less energy in one gallon of ethanol than in one gallon of gasoline.
15 Section 211, subsections k and m (respectively). 42 U.S.C. 7545.
16 CO, VOCs and nitrogen oxides are the main precursors to ground-level ozone.
17 Susan E. Powers, David Rice, Brendan Dooher, and Pedro J. J. Alvarez, “Will Ethanol-
Blended Gasoline Affect Groundwater Quality?,” Environmental Science and Technology.
January 1, 2001. p. 24A.

---

CRS-7
Both ethanol and MTBE also can be blended into otherwise non-oxygenated
gasoline to raise the octane rating of the fuel. High-performance engines and older
engines often require higher octane fuel to prevent early ignition, or “engine knock.”
Other chemicals may be used for the same purpose, but some of these alternatives are
highly toxic, and some are regulated as pollutants under the Clean Air Act.18
Furthermore, since these additives do not contain oxygen, their use may not lead to
the same emissions reductions as oxygenated gasoline.
In purer forms, ethanol can also be used as an alternative to gasoline in vehicles
specifically designed for its use, although this only represents approximately 0.9%
of ethanol consumption in the U.S. The federal government and state governments,
along with businesses in the alternative fuel industry, are required to purchase
alternative-fueled vehicles by the Energy Policy Act of 1992.19 In addition, under the
Clean Air Act Amendments of 1990, municipal fleets can use alternative fuel
vehicles to mitigate air quality problems. Blends of 85% ethanol with 15% gasoline
(E85), and 95% ethanol with 5% gasoline (E95) are currently considered alternative
fuels by the Department of Energy.20 The small amount of gasoline added to the
alcohol helps prevent corrosion of engine parts, and aids ignition in cold weather.
Table 3. Estimated U.S. Consumption of Fuel Ethanol, MTBE
and Gasoline
(Thousand Gasoline-Equivalent Gallons)
1996
1998
2000
2002
E85
694
1,727
7,074
10,075
E95
2,699
59a
13
0
Ethanol in
660,200
889,500
1,106,300
1,118,900
Gasohol (E10)
MTBE in
2,749,700
2,903,400
3,087,900
2,531,000
Gasoline
Gasolineb
117,783,000
122,849,000
125,720,000
130,735,000
Source: Department of Energy, Alternatives to Traditional Transportation Fuels1999 .
a A major drop in E95 consumption occurred between 1997 and 1998 because of a
significant decrease in the number of E95-fueled vehicles in operation (347 to 14), due
to the elimination of an ethanol-fueled bus fleet in California. DOE currently lists no
E95 vehicles in operation.
b Gasoline consumption includes ethanol in gasohol and MTBE in gasoline.
18 Lead was commonly used as an octane enhancer until it was phased-out through the mid-
1980s (lead in gasoline was completely banned in 1995), due to the fact that it disables
emissions control devices, and because it is toxic to humans.
19 P.L. 102-486.
20 More diluted blends of ethanol, such as E10, are considered to be “extenders” of gasoline,
as opposed to alternatives.

---

CRS-8
Approximately 10 million gasoline-equivalent gallons (GEG)21 of E85 were
consumed in 2002, mostly in Midwestern states.22 (See Table 3.) One reason for the
relatively low consumption of E85 is that there are relatively few vehicles on the road
that operate on these fuels. In 2002, approximately 82,000 vehicles were fueled by
E85,23 as compared to approximately 210 million gasoline- and diesel-fueled vehicles
that were on the road in the same year.24 One obstacle to the use of alternative fuel
vehicles is that they are generally more expensive than conventional vehicles,
although this margin has decreased in recent years with newer technology. Another
obstacle is that, as was stated above, fuel ethanol is generally more expensive than
gasoline or diesel fuel. In addition, there are very few fueling sites for E85,
especially outside of the Midwest.
Research and Development in Cellulosic
Feedstocks
For ethanol to play a more significant role in U.S. fuel consumption, the fuel
must become price-competitive with gasoline. Since a major part of the total
production cost is the cost of feedstock, reducing feedstock costs could lead to lower
wholesale ethanol costs. For this reason, there is a great deal of interest in the use of
cellulosic feedstocks, which include low-value waste products, such as recycled
paper and rice hulls, or dedicated fuel crops, such as switch grass and fast growing
trees. A dedicated fuel crop is one that would be grown and harvested solely for the
purpose of fuel production.
However, as the name indicates, cellulosic feedstocks are high in cellulose, and
cellulose cannot be fermented. Cellulose must first be broken down into simpler
carbohydrates, and this can add an expensive step to the process. Therefore, research
has focused on both reducing the process costs for cellulosic ethanol, and improving
the availability of cellulosic feedstocks.
Costs and Benefits of Fuel Ethanol
Economic Effects
Given that a major constraint on the use of ethanol as an alternative fuel, and as
an oxygenate, is its high price, ethanol has not been competitive with gasoline as a
fuel. Wholesale ethanol prices, before incentives from the federal government and
21 Since different fuels produce different amounts of energy per gallon when consumed, the
unit of a gasoline-equivalent gallon (GEG) is used to compare total energy consumption.
22 DOE, EIA, Alternatives to Traditional Transportation Fuels 2000.
23 Ibid. In 1997, some manufacturers made flexible E85/gasoline fueling capability standard
on some models. It is expected, however, that most of these vehicles will be fueled by
gasoline.
24 Federal Highway Administration, Highway Statistics 2001. November, 2002.

---

CRS-9
state governments, are generally twice that of wholesale gasoline prices. With
federal and state incentives, however, the effective price of ethanol is much lower.
Furthermore, gasoline prices have risen recently, making ethanol more attractive.
The primary federal incentive to support the ethanol industry is the 5.2¢ per
gallon exemption that blenders of gasohol (E10) receive from the 18.4¢ federal
excise tax on motor fuels.25 Because the exemption applies to blended fuel, of which
ethanol comprises only 10%, the exemption provides for an effective subsidy of 52¢
per gallon of pure ethanol. (See Table 4.)
Table 4. Price of Pure Ethanol Relative to Gasoline
March 2002 to February 2003
Ethanol Wholesale Pricea
94 - 133 ¢/gallon
Alcohol Fuel Tax Incentive
52 ¢/gallon
Effective Price of Ethanol
42 - 81 ¢/gallon
Gasoline Wholesale Priceb
65 - 103 ¢/gallon
Source: “Oxy-Fuel News’ Monthly Markets Update,” Hart’s Oxy-Fuel News. May 27, 2002
through February 3, 2003.
a This is the average price for pure (“neat”) ethanol.
b This is the average Gulf Coast spot price for regular conventional gasoline (i.e. non-
oxygenated, standard octane).
It is argued that the ethanol industry could not survive without the tax
exemption. An economic analysis conducted in 1998 by the Food and Agriculture
Policy Research Institute, in conjunction with the congressional debate over
extension of the tax exemption, concluded that ethanol production from corn would
decline from 1.5 billion gallons per year, and stabilize at about 290 million gallons
per year, if the exemption were eliminated.26
The tax exemption for ethanol is criticized by some as a corporate subsidy,27
because, in this view, it encourages the inefficient use of agricultural and other
resources, and deprives the Highway Trust Fund of needed revenues.28 In 1997, the
General Accounting Office estimated that the tax exemption lead to approximately
$7.5 to $11 billion in foregone Highway Trust Fund revenue over the 22 years from
25 26 U.S.C. 40.
26 Food and Agriculture Policy Research Institute. Effects on Agriculture of Elimination
of the Excise Tax Exemption for Fuel Ethanol, Working Paper 01-97, April 8, 1997.
27 James Bovard. p. 8.
28 U.S. General Accounting Office (GAO), Effects of the Alcohol Fuels Tax Incentives.
March, 1997.

---

CRS-10
FY1979 to FY2000.29 The petroleum industry opposes the incentive because it also
results in reduced use of petroleum.
Proponents of the tax incentive argue that ethanol leads to better air quality, and
that substantial benefits flow to the agriculture sector due to the increased demand
for corn created by ethanol. Furthermore, they argue that the increased market for
ethanol leads to a stronger U.S. trade balance, since a smaller U.S. ethanol industry
would lead to increased imports of MTBE to meet the demand for oxygenates.30
Air Quality
One of the main motivations for ethanol use is improved air quality. Ethanol
is primarily used in gasoline to meet minimum oxygenate requirements of two Clean
Air Act programs. Reformulated gasoline (RFG)31 is used to reduce vehicle
emissions in areas that are in severe or extreme nonattainment of National Ambient
Air Quality Standards (NAAQS) for ground-level ozone.32 Ten metropolitan areas,
including New York, Los Angeles, Chicago, Philadelphia, and Houston, are covered
by this requirement, and many other areas with less severe ozone problems have
opted into the program, as well. In these areas, RFG is used year-round. By contrast,
the Oxygenated Fuels program operates only in the winter months in 16 areas33 that
are listed as carbon monoxide (CO) nonattainment areas.34
EPA states that RFG has led to significant improvements in air quality,
including a 17% reduction in volatile organic compounds (VOCs) emissions from
vehicles, and a 30% reduction in toxic emissions. Furthermore, according to EPA
“ambient monitoring data from the first year of the RFG program (1995) also showed
strong signs that RFG is working. For example, detection of benzene (one of the air
toxics controlled by RFG, and a known human carcinogen) declined dramatically,
with a median reduction of 38% from the previous year.”35
However, the need for oxygenates in RFG has been questioned. Although
oxygenates lead to lower emissions of VOCs, and CO, they may lead to higher
29 Jim Wells, GAO, Petroleum and EthanolFuels: Tax Incentives and Related GAO Work.
September 25, 2000.
30 Katrin Olson, “USDA Shows Losses Associated with Eliminating Ethanol Incentive,”
Oxy- Fuel News. May 19, 1997. p. 3.
31 Clean Air Act, Section 211, subsection k. 42 U.S.C. 7545.
32 Ground-level ozone is an air pollutant that causes smog, adversely affects health, and
injures plants. It should not be confused with stratospheric ozone, which is a natural layer
some 6 to 20 miles above the earth and provides a degree of protection from harmful
radiation.
33 Only the Los Angeles and New York areas are subject to both programs.
34 Clean Air Act, Section 211, subsection m. 42 U.S.C. 7545.
35 Margo T. Oge, Director, Office of Mobile Sources, U.S. EPA, Testimony Before the
Subcommittee on Energy and Environment of the Committee on Science, U.S. House of
Representatives. September 14, 1999.

---

CRS-11
emissions of nitrogen oxides (NO ). Since all three contribute to the formation of
X
ozone, the National Research Council recently concluded that while RFG certainly
leads to improved air quality, the oxygenate requirement in RFG may have little
overall impact on ozone formation.36 Some argue that the main benefit of oxygenates
use is that they displace other, more dangerous compounds such as benzene.
Furthermore, the high price of Midwest gasoline in Summer 2000 has raised further
questions about the RFG program (see the section on Phase 2 Reformulated
Gasoline).
Evidence that the most widely-used oxygenate, methyl tertiary butyl ether
(MTBE), contaminates groundwater has led to a push by some to eliminate the
oxygen requirement in RFG. MTBE has been identified as an animal carcinogen,
and there is concern that it is a possible human carcinogen. In California, MTBE was
to be banned as of December 31, 2002. However, because of a projected spike in
consumer gasoline prices California Governor Gray Davis postponed the ban until
December 31, 2003.37 California petitioned EPA to exempt the state from the
oxygenate requirement, but on June 12, 2001, Administrator Whitman announced
that the Agency could not grant California’s request.38
If the oxygenate requirements were eliminated, some refiners claim that the
environmental goals of the RFG program could be achieved through cleaner,
although potentially more costly, gasoline that does not contain any oxygenates.39
These claims have added to the push to remove the oxygen requirement and allow
refiners to produce RFG in the most cost-effective manner, whether or not that
includes the use oxygenates. However, some environmental groups are concerned
that an elimination of the oxygenate requirements would compromise air quality
gains resulting from the current standards, since oxygenates also displace other
harmful chemicals in gasoline. This potential for “backsliding” is a result of the fact
that the current performance of RFG is substantially better that the Clean Air Act
requires. If the oxygenate standard were eliminated, environmental groups fear that
refiners would only meet the requirements of the law, as opposed to maintaining the
current overcompliance.
While the potential ozone benefit from oxygenates in RFG has been questioned,
there is little dispute that the winter Oxy-Fuels program has led to lower emissions
of CO. The Oxy-Fuels program requires oxygenated gasoline in the winter months
36 National Research Council, Ozone-Forming Potential of Reformulated Gasoline. May,
1999.
37 Caroyln Whetzel, “California Governor Delays MTBE Ban by 12 Months, Citing Possible
Price Hikes,” Daily Environment Report. March 18, 2002. p. A-15.
38 EPA, Headquarters Press Release: EPA Issues Decision on California Waiver Request.
June 12, 2001.
39 Al Jessel, Senior Fuels Regulatory Specialist of Chevron Products Company, Testimony
Before the House Science Committee Subcommittee on Energy and Environment.
September 30, 1999.

---

CRS-12
to control CO pollution in NAAQS nonattainment areas for the CO standard.
However, this program is small relative to the RFG program.40
The air quality benefits from purer forms of ethanol can also be substantial.
Compared to gasoline, use of E85 can result in a 30-50% reduction in ozone-forming
emissions. And while the use of ethanol also leads to increased emissions of
acetaldehyde, a toxic air pollutant, as defined by the Clean Air Act, these emissions
can be controlled through the use of advanced catalytic converters.41 However, as
was stated above, these purer forms of ethanol have not seen wide use.
Climate Change
Another potential environmental benefit from ethanol is the fact that it is a
renewable fuel. Proponents of ethanol argue that over the entire fuel-cycle42 it has
the potential to reduce greenhouse gas emissions from automobiles relative to
gasoline, therefore reducing the risk of possible global warming.
Because ethanol (C H OH) contains carbon, combustion of the fuel necessarily
2
5
results in emissions of carbon dioxide (CO ), the primary greenhouse gas. However,
2
since photosynthesis (the process by which plants convert light into chemical energy)
requires absorption of CO , the growth cycle of the feedstock crop can serve—to
2
some extent—as a “sink” that absorbs some of these emissions. In addition to CO2
emissions, the emissions of other greenhouse gases may increase or decrease
depending on the fuel cycle.43
According to Argonne National Laboratory, using E10, vehicle greenhouse gas
emissions (measured in grams per mile) are approximately 1% lower than with the
same vehicle using gasoline. With improvements in production processes, by 2010,
the reduction in greenhouse gas emissions from ethanol relative to gasoline could be
as high as 8-10% for E10, while the use of E95 could lead to significantly higher
reductions.44
While some studies have called into question the efficiency of the ethanol
production process, most recent studies find a net energy gain.45 If efficiency were
40 In 1998, an average of 90.9 million gallons per day of RFG were sold in the U.S., as
opposed to 8.0 million gallons per day of Oxy-Fuel gasoline.
41 California Energy Commission, Ethanol-Powered Vehicles.
42 The fuel-cycle consists of all inputs and processes involved in the development, delivery
and final use of the fuel.
43 For example, nitrous oxide emissions tend to increase with ethanol use because nitrogen-
based fertilizers are used extensively in agricultural production.
44 M. Wang, C. Saricks, and D. Santini, “Effects of Fuel Ethanol on Fuel-Cycle Energy and
Greenhouse Gas Emissions.” Argonne National Laboratory.
45 Hosein Shapouri, James A. Duffield, and Michael S. Graboski, USDA, Economic
Research Service, Estimating the Net Energy Balance of Corn Ethanol. July 1995.

---

CRS-13
diminished, overall reductions in greenhouse gas emissions would also be
diminished, due to higher fuel consumption during the production process.
Energy Security
Another frequent argument for the use of ethanol as a motor fuel is that it
reduces U.S. reliance on oil imports, making the U.S. less vulnerable to a fuel
embargo of the sort that occurred in the 1970s, which was the event that initially
stimulated development of the ethanol industry. According to Argonne National
Laboratory, with current technology the use of E10 leads to a 3% reduction in fossil
energy use per vehicle mile, while use of E95 could lead to a 44% reduction in fossil
energy use.46
However, other studies contradict the Argonne study, suggesting that the amount
of energy needed to produce ethanol is roughly equal to the amount of energy
obtained from its combustion, which could lead to little or no reductions in fossil
energy use.47 However, because most of the energy used to produce ethanol comes
from natural gas or electricity, overall petroleum dependence could be diminished
through the use of ethanol.
As was stated above, fuel ethanol only accounts for approximately 1.6% of
gasoline consumption in the United States by volume. In terms of energy, ethanol
accounts for approximately 0.9%. This small market share led GAO to conclude that
the ethanol tax incentive has done little to promote energy security.48 Furthermore,
since ethanol is currently dependent on the U.S. corn supply, any threats to this
supply (e.g. drought), or increases in corn prices, would negatively affect the cost
and/or supply of ethanol. This happened when high corn prices caused by strong
export demand in 1995 contributed to an 18% decline in ethanol production between
1995 and 1996.
Policy Concerns and Congressional Activity
Recent congressional interest in ethanol fuels has mainly focused on five issues:
1) RFG oxygenate requirements and a possible phase-out of MTBE; 2) a renewable
fuels standard; 3) “boutique” fuels; 4) the alcohol fuel tax incentives; and 5) fuel
economy credits for dual fuel vehicles. Several of these issues are addressed in either
H.R. 6 or S. 14, the House or Senate versions of a comprehensive energy package.
The House passed H.R. 6 on April 11, 2003; the Senate began floor debate on S. 14
on May 6, 2003.

46 Wang, et. al. p. 1
47 Shapouri, et. al. Table 1.
48 U.S. General Accounting Office, Effects of the Alcohol Fuels Tax Incentives. March,
1997.

---

CRS-14
Reformulated Gasoline and MTBE
A key issue involving ethanol is the current debate over MTBE. Since MTBE,
a possible human carcinogen, has been found in groundwater in some states
(especially in California), there has been a push both in California and nationally to
ban MTBE.49 In March 1999, California’s Governor Davis issued an Executive
Order requiring that MTBE be phased out of gasoline in the state by December 31,
2002, although the date of the ban was pushed back to December 31, 2003. At least
twelve other states have also instituted limits or bans on MTBE. In July 1999, an
advisory panel to EPA recommended that MTBE use should be “reduced
substantially.”50
A possible ban on MTBE could have serious consequences for fuel markets,
especially if the oxygenate requirements remain in place. Since ethanol is the second
most used oxygenate, it is likely that it would be used to replace MTBE. However,
there is not currently enough U.S. production capacity to meet the potential demand.
Therefore, it would likely be necessary to phase out MTBE over time, as opposed to
an immediate ban. Furthermore, the consumer price for oxygenated fuels would
likely increase because ethanol, unlike MTBE, cannot be shipped through pipelines
and must be mixed close to the point of sale, adding to delivery costs. Increased
demand for oxygenates could also be met through imports from countries such as
Brazil, which is a leader worldwide in fuel ethanol production, and currently has a
surplus.51
While a ban on MTBE would seem to have positive implications for ethanol
producers, it could actually work against them. Because MTBE is more commonly
used in RFG and high-octane gasoline, and because current ethanol production can
not currently meet total U.S. demand for oxygenates and octane, there is also a push
to suspend the oxygenate requirement in RFG, which would remove a major stimulus
to the use of fuel ethanol. Furthermore, environmental groups and state air quality
officials, although supportive of a ban on MTBE, are concerned over the possibility
of “backsliding” if the oxygenate standard is eliminated. Because current RFG
formulations have a lower level of toxic substances than is required under the Clean
Air Act, there are concerns that new RFG formulations without oxygenates will meet
the existing standard, but not the current level of overcompliance.
Along with California’s ban on MTBE, the state requested that the oxygen
requirement be waived. On June 12, 2001, EPA informed California that the agency
could not grant the request. CAA only grants EPA the authority to suspend fuel
requirements if there are threats to air quality, despite potential hazards to water
49 For more information, see CRS Report 98-290 ENR, MTBE in Gasoline: Clean Air and
Drinking Water Issues.
50 Blue Ribbon Panel on Oxygenates in Gasoline, Achieving Clean Air and Clean Water:
The Report of the Blue Ribbon Panel on Oxygenates in Gasoline.
51 Adrian Schofield, “Brazilian Ambassador Sees Opportunity in United States Ethanol
Market,” New Fuels & Vehicles Report. September 16, 1999. p. 1.

---

CRS-15
quality.52 Some have proposed that the CAA be amended to allow EPA the authority
to suspend fuel requirements in the case of water contamination.
Supporters of ethanol have proposed that along with a ban of MTBE, a
renewable standard should be introduced. This would require that a certain
percentage of fuel in the U.S. be made from renewable sources. This type or
requirement, if large enough, would protect the ethanol market if the RFG oxygenate
standard were eliminated. (See below)
As the 108th Congress is currently considering comprehensive energy legislation,
MTBE and RFG have already seen considerable action. On April 11, 2003, the
House passed H.R. 6, the Energy Policy Act of 2003. The bill would eliminate the
oxygen standard for RFG, but would not ban the use of MTBE. In addition, the bill
would provide a “safe harbor” that would exempt MTBE and ethanol producers and
blenders from defective product liability.
On May 6, 2003, the Senate began floor debate on S. 14, the Senate version of
the Energy Policy Act of 2003. While the current version of S. 14 does not contain
provisions on MTBE or RFG, S. 791 will be offered as an amendment to S. 14.
Among other provisions, S. 791 would eliminate the RFG oxygen standard. Further,
the bill would ban the use of MTBE four years after enactment. The bill would also
provide a similar safe harbor, except that the provision would only apply to
renewable fuels, and not MTBE.
Renewable Fuels Standard
There is congressional interest in establishing a renewable fuels standard. This
would require motor fuel to contain a certain percentage or set amount of renewable
fuel. It is likely that most of the fuel required would be ethanol, while some would
be biodiesel.53 Supporters argue that without an oxygen requirement in RFG (see
above), a key market for ethanol would be lost. They argue that demand for ethanol
creates jobs, and that there are major environmental and energy security benefits to
using renewable fuels. However, opponents argue that any renewable fuels standard
would only exacerbate a situation of artificial demand for ethanol. Any requirement
above the existing level for ethanol would require the construction and/or expansion
of ethanol plants, and would likely lead to increased fuel prices and further instability
in an already tight fuel supply chain. Further, they argue that a renewable fuels
standard would lead to increased corn prices caused by higher demand.
The House-passed version of the Energy Policy Act of 2003 (H.R. 6) would
require the use of 2.7 billion gallons of renewable fuel in 2005, increasing to 5.0
billion gallons by 2015. The Senate version (S. 14) does not contain a provision for
a renewable fuels standard, but S. 791, which will be offered as an amendment,
52 EPA, Headquarters Press Release: EPA Issues Decision on California Waiver Request.
June 12, 2001.
53 Biodiesel is an synthetic diesel fuel made from oils such as soybean oil. Fore more
information, see CRS Report RL30758, Alternative Transportation Fuels and Vehicles:
Energy, Environment, and Development Issues.

---

CRS-16
would require the use of 2.6 billion gallons of renewable fuel in 2005, increasing to
5.0 billion gallons in 2012. Both the House and Senate versions would establish a
credit trading system to provide flexibility to fuel producers. As was stated above,
both versions would create a “safe harbor” from defective product liability for
renewable fuel suppliers.
“Boutique” Fuels54
As a result of the federal reformulated and oxygenated gasoline requirements,
as well as related state and local environmental requirements, gasoline suppliers may
face several different standards for gasoline quality. These different standards
sometimes require a supplier to provide several different fuels in that area. These
different formulations are sometimes referred to as “boutique” fuels.55 Because of
varying local requirements, if there is a disruption to the supply of fuel in one area,
refiners in other areas may not be able to supply fuel quickly to meet the increased
demand.
EPA conducted a study on the effects of harmonizing standards, and released
a staff white paper in October, 2001. In its preliminary analysis, EPA concluded that
some minor changes could be made that might mitigate supply disruptions without
significantly increasing costs or adversely affecting vehicle emissions. However, all
of the scenarios in EPA’s study would require amendments to the RFG provisions
in the Clean Air Act.
Congressional interest has centered on the question of whether the various
standards could be harmonized to reduce the number of gasoline formulations. The
House-passed version of H.R. 6 would require EPA to study the feasibility of
developing harmonized national standards. S. 791, which will be offered as an
amendment to S. 14, contains a similar provision.
Alcohol Fuel Tax Incentives56
As stated above, the exemption that ethanol-blended fuels receive from the
excise tax on motor fuels is controversial. The incentive allows fuel ethanol to
compete with other additives, since the wholesale price of ethanol is so high.
Proponents of ethanol argue that this exemption lowers dependence on foreign
imports, promotes air quality, and benefits farmers.57 A related, albeit smaller
incentive for ethanol production is the small ethanol producers tax credit. This credit
54 EPA, Office of Transportation and Air Quality, Staff White Paper: Study of Unique
Gasoline Fuel Blends (“Boutique Fuels”), Effects on Fuel Supply and Distribution and
Potential Improvements. October, 2001.
55 For more information on boutique fuels, see CRS Report RL31361, “Boutique Fuels” and
Reformulated Gasoline: Harmonization of Fuel Standards.
56 For more information, see CRS Report 98-435 E, Alcohol Fuels Tax Incentives.
57 U.S. General Accounting Office (GAO), Effects of the Alcohol Fuels Tax Incentives.
March, 1997.

---

CRS-17
provides 10 cents per gallon for up to 15 million gallons of annual production by a
small producer.58
Opponents of the tax incentives argue that the incentives support an industry
that could not exist on its own, and reduce potential fuel tax revenue. Despite
objections from opponents, Congress in 1998 extended the motor fuels tax exemption
through 2007, but at slightly lower rates (P.L. 105-178). The 108th Congress is
expected to undertake a new transportation authorization bill, and it is expected that
the alcohol fuels tax exemption will play a role in that debate.
Fuel Economy Credits for Dual Fuel Vehicles
The Energy Policy and Conservation Act (EPCA) of 197559 requires Corporate
Average Fuel Economy (CAFE) standards for motor vehicles.60 Under EPCA, the
average fuel economy of all vehicles of a given class that a manufacturer sells in a
model year must be equal to or greater than the standard. These standards were first
enacted in response to the desire to reduce petroleum consumption and promote
energy security after the Arab oil embargo. The current standard for passenger cars
is 27.5 miles per gallon (mpg), while the standard for light trucks is 20.7 mpg.
However, EPCA and subsequent amendments provide manufacturing incentives
for alternative fuel vehicles, including ethanol vehicles.61 For each alternative fuel
vehicle a manufacturer produces, credits are provided which increase that
manufacturer’s average. These credits include dual fuel vehicles–those vehicles
which can be operated on both a conventional fuel (gasoline or diesel) and an
alternative fuel, usually ethanol. Concerns have been raised over that fact that while
manufacturers are receiving credits for production of these dual fuel vehicles, they
are generally operated solely on gasoline, because of the cost and availability of
alternative fuels. Supporters of the credits argue that the incentives are necessary for
the production of alternative fuel vehicles, and that as the number of vehicles
increases, the infrastructure for alternative fuels will grow.
The credits are set to expire at the end of the 2004 model year. However, on
March 11, 2002, the Department of Transportation (DOT) issue a proposed rule
extending the credits through model year 2008. The rule has not been finalized.
Under EPCA, DOT does not have the authority to extend the credits past model year
2008; any further extension would require legislation. H.R. 6, the House-passed
energy bill, would statutorily extend the credits through model year 2008, and would
extend DOT’s authority (to continue the credits) through 2012. The Senate energy
bill, S. 14, does not contain any similar provision.
58 Defined as having a production capacity of less than 30 million gallons per year.
59 P.L. 94-163.
60 For more information on CAFE standards, see CRS Issue Brief IB90122, Automobile and
Light Truck Fuel Economy: Is CAFE Up to Standards?
61 49 U.S.C. 32905.

---

CRS-18
Conclusion
As a result of the current debate over the future of MTBE in RFG, and the RFG
program in general, the future of the U.S. ethanol industry is uncertain. A ban on
MTBE would greatly expand the market for ethanol, while an elimination of the
oxygenate requirement would remove a major stimulus for its use. Any changes in
the demand for ethanol will have major effects on corn producers, who rely on the
industry as a partial market for their products.
The current size of the ethanol industry is depends significantly on federal laws
and regulations that promote its use for air quality and energy security purposes, as
well as tax incentives that lessen its cost to consumers. Without these, it is likely that
the industry would shrink substantially in the near future. However, if fuel ethanol
process costs can be decreased, or if gasoline prices increase, ethanol could increase
its role in U.S. fuel consumption.

---