Each year motor vehicles in the U.S. consume over 10 billion gallons of fuel ethanol. Used primarily in ethanol blended gasoline, biofuel advocates argue that ethanol reduces air pollution and green-house gas emissions, supports local agriculture and, in times of high oil prices, is a cost-effective alternative to petroleum. Because of these and other factors, the federal Renewable Fuel Standard (RFS) seeks to double or triple ethanol consumption over the next decade. New climate change policies such as a national carbon cap and trade system or low carbon fuel standard may further accelerate the growth in ethanol consumption.
Produced primarily in the U.S. Midwest, fuel ethanol is shipped via rail to demand centers in the eastern and western United States. Given the long distances, the ethanol transportation market is dominated by a small number of railroads who operate large multi-state networks. Most routes are highly concentrated with one or two firms competing at the route endpoints. In many cases, the role of alternative modes such as truck or barge transport is limited. Together, these conditions suggest considerable potential for market power in ethanol transportation. Furthermore, ethanol policies themselves may result in higher prices by providing opportunities for railroads to price discriminate among customers.
This paper investigates whether railroads exercise market power in ethanol shipments. I exploit a cross section of shipment-level prices collected from the pubic ethanol tariffs from five of seven North American Class I railroads. These prices are combined with detailed geographic information system (GIS) data that describe each firm’s rail network, control variables as well as the locations and characteristics of ethanol plants.
The empirical model examines whether prices vary based on the level of competition at route endpoints. I use the number of firms participating at the route endpoints as an indication of the level of competition. This approach is similar to Schmidt (2001). However, Schmidt treats the number of firms as exogenous and ignores the possibility of capacity constraints as an explanation for the correlation between prices and firm participation.
Because railroad participation may be endogenous, I instrument for the number of firms at the route endpoints using data from the 1900 U.S. census. To account for the possibility of railroad capacity constraints, I use detailed geographic data on rail traffic density as a measure of route congestion. In addition, I control for cost and demand characteristics using route distance, railroad effects, and origin and destination state effects. I find that ethanol shipment prices are lower for more competitive routes. On average, prices decrease by 3.4% for each entrant at the route origin.
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The Higher Price of Cleaner Fuels: Market Power in the Rail Transport of Fuel Ethanol
