Octane and Gasoline

After my post The Hidden Tax on Gasoline, I was asked to provide more information on octane.  Here is my attempt at a Dick and Jane.

Gasoline and engines are a system.  As engines change so must gasoline.  Today’s engines reflect engineering designed for them to meet strict CAFÉ standards, tail pipe emissions standards and to incorporate technology advances. In general, this has led to higher compression engines which provide better performance, greater efficiency, and more horse power but as a result many of these engines require a higher octane gasoline.

Octane measures a gasoline’s knock resistance or the ability to avoid premature ignition. Most cars still run on regular gasoline–85 %–while cars in the class of BMW and Mercedes and many turbocharged engines require premium or 91-93 octane.  Race cars burn fuel with 100 octane or higher.

Until the mid 1980s, refiners used Tetraethyl lead to prevent knocking.  Lead was phased out for health reasons.  Refiners turned to ethanol or ethers to boost octane.  Ethanol has an octane rating of 115 but has a number of problems which is why it is limited to a 10% blend for most vehicles. Ethers—MTBE—were banned about a decade ago.

As more refineries began dealing with more light—lower sulfur crudes—from imports and shale oils and stricter fuel specifications, they had to find additional sources of octane because gasoline from light crudes have a lower octane rating.

Gasoline is a complex chemical mixture and various refining processes are used to rearrange hydrocarbon molecules to produce higher octane. These include catalytic reforming, isomerization, and dehydrogenation. Probably most refiners use catalytic reforming to produce reformate which is a high octane blending component.  All of these processes add to the cost of producing gasoline.

A Hidden Gasoline Tax

According to EIA, the price spread between regular gasoline and premium, which has been increasing since 2000, accelerated over the past few years.  It is now roughly 50 cents per gallon, more than double the spread in 2009.  Part of the reason is an increase in demand and part of the reason is the cost to produce higher octane gasoline.

Premium gasoline as a percentage of the gasoline pool has increased from about 7% to almost 12%.  While some increase in the use of premium can be attributed to motorists choosing a higher grade because of low gasoline prices, the major driver is the changes in engines that have been necessary to meet the fuel economy increases imposed by the Obama Administration.

CAFÉ regulations finalized in 2012 raised fuel economy for model years 2017-21 from 27.5 miles per gallon (mpg) to 40-41 mpg.  Subsequently, the Obama EPA raised the standards to 54 mpg for model years 2022-25.  The motivation for setting such stringent standards had little to do with improving air quality and everything to do with a goal of reducing CO2 emissions.  To meet the tougher CAFE standards, automakers have had to implement a number of technological solutions, all of which have added at least $4000 to the average price of cars and more to the cost of trucks.  In addition, to weight reduction, better aerodynamics, and engine and transmission efficiency, manufacturers have turned to producing turbocharged engines, which for many engines require the use of premium gasoline to avoid incomplete combustion.

At the same time, the changing slate of crude oils and environmental regulations have increased the cost of producing higher octane gasoline, 91-93 octane for premium versus 87-89 for regular.  Between 2000 and 2012, refiners could rely primarily on blending ethanol, which has an octane rating of 115, to boost the octane rating of gasoline. Increasing volumes of light crude oils from imports and shale oil contain higher levels of parafifins which lead to lower gasoline octane levels and the hydro treating needed to meet the 2017 gasoline specifications also results in a loss of octane.  As a result, refiners have had to turn to more expensive octane boosting processes.

Changes in CAFÉ standards and fuel specifications, ostensibly for environmental reasons, have raised the cost of light duty vehicles and the fuel that they must use without making a real contribution to air quality or climate change mitigation.  They were driven by ideology and the increases in cost are simply a hidden tax on the use of gasoline and diesel, one that is highly regressive.


The Missing Links

Critics of corporate tax reform reveal an economic myopia that either reflects an abundance of ignorance or a willingness to engage in deception.  The primary criticism of the corporate tax reform contained in the just enacted legislation is that the lower tax rate, the territorial tax approach to foreign earnings, and the incentive to repatriate about $2 trillion will benefit corporations, their executives and shareholders but not workers.  That charge shows at best a lack of understanding of how an economy operates.

When corporations get an infusion of revenue from lower taxes, they don’t reward the entitled few and lock the rest of it away.  Increased revenue is used to invest, to reward workers, and reward shareholders through share buybacks and dividend increases.

If companies invest in either new equipment, new projects, or new technology, they send money to other companies and that benefits the workers who make the equipment or carry out the new projects.  The companies on the receiving end of those investments go through the same process of investing, hiring, or rewarding shareholders.  All those actions benefit the economy.

As companies expand from new investment, they hire more workers who then spend and invest.  The benefits to economic growth are positive.  Most analyses of the just passed tax legislation estimate that the economy will grow by an additional 2%-3%.  Economic analysis also shows that labor benefits from lower tax rates.  Glen Hubbard, former chair of the Council of Economic Advisers and Dean of the Columbia School of Business has made that point clearly and cited a recent Berkley and Boston University study that showed wages increasing 8%.  This is consistent with other analyses showing the impact of taxes on wages.

If companies engage in share buybacks, they make shareholders wealthier and pension funds containing their stock richer.  The recipients of buyback money will either reinvest it in another company, spend their increased wealth, or do both.  In either case, the money gets into the economy.  Richer pension funds enable workers to have larger pensions which they will choose to spend and/or invest.

The bottom line is that increased corporate revenue from lower taxes leads to more employment and stronger economic growth.  Arguments to the contrary show an economic myopia.  Looking at only one link in a chain tells you nothing about the length and strength of the chain.