Fowlie, Meredith, Reguant, Mar, and Ryan, Stephen “Market-Based Emissions Regulation and Industry Dynamics” (December 2012) (Revised version published in Journal of Political Economy, 124(1): 249-302, 2016) | WP-234R
Ethanol and methyl-tertiary butyl ether (MTBE) were close substitutes in the gasoline additive market until MTBE was banned due to concerns about groundwater contamination, leading to a sudden and dramatic substitution toward ethanol as an alternative oxygenate and octane-booster. We use variation in the timing of MTBE bans across states to identify their effects on gasoline prices. We find that state bans increased reformulated gasoline prices by 6 cents in non-Midwestern states for which the bans were binding, with larger impacts during times of high ethanol prices relative to MTBE and crude oil. We find quantitatively similar, yet smaller effects for conventional gasoline. We argue on the basis of a simple conceptual model and supporting empirical evidence that these bans functioned as implicit state-level ethanol blending mandates in areas that were previously using MTBE to comply with strict environmental constraints. Overall, our results are consistent with the theoretical prediction that mandating a minimum market share for a more costly alternative fuel – either directly, or implicitly through a ban on the preferred conventional fuel – will inevitably increase fuel prices in a competitive market.