Mitig Adapt Strateg Glob Change (2014) 19:1–13

DOI 10.1007/s11027-012-9422-2

ORIGINAL ARTICLE

Impacts of bioethanol on gasoline prices

in the Philippines: an econometric analysis

Jose Alfred B. Cantos & Robert K. Dixon

Received: 4 June 2012 / Accepted: 12 September 2012 / Published online: 27 September 2012
# Springer Science+Business Media Dordrecht 2012

Abstract The rising prices of crude oil in the world market and the continuing global trend to
mainstream renewable energy use have prompted the Philippines to consider alternative fuels.
Since 2006 when a new law was implemented requiring a 10 % blend to unleaded gasoline, the
use of ethanol has increased significantly. Sugarcane (Saccharum spp.), cassava (Manihot
esculenta) and sweet potato (Ipomoea batatas) have been the major feedstock in ethanol
production. This analysis focused on the impacts of E10 (10 % ethanol content) on the retail
price of gasoline and how this might affect gasoline prices. Recognizing the direct dependence
of the price of E10 on gasoline prices, the analysis focused on analyzing the price of ethanol.
The hypothesis is that since ethanol is what makes E10 cheaper than gas given the lower cost of
its production i.e., domestically grown raw materials, then cheaper ethanol should depress the
price of E10 and therefore gas, ceteris paribus. The price of E10 is endogenous since it is a
function of the price of gasoline, being a major input to its production, 90 % in fact. Using fixed-
effects, 2007–2009 provincial panel data, from second stage least squares econometric estima-
tion, the impact of ethanol use on retail regular gasoline prices is quantified. The partial effect
analysis indicates that a 1-peso (rate: 1USD - PhP 41.96) increase in the price of feedstock
prices as inputs to the production of E10 increases the price of gasoline by 37 centavos per liter.
The analysis shows the positive relationship between the prices of E10 and gasoline.

Keywords Bioethanol . Gasoline prices . Biofuel

1 Introduction

Consistent with the study by Borenstein et al. (1997) that retail gasoline prices respond more
quickly to increases than to decreases in crude oil prices, the pump prices of gasoline and

J. A. B. Cantos (*)
Hubert H. Humphrey Fellowship Program, University of California Davis, 10 College Park, Davis 95616,
USA
e-mail: jcantos@ucdavis.edu

R. K. Dixon
Office of Energy Efficiency and Renewable Energy, US Department of Energy,
1000 Independence Avenue SW, Washington, DC, USA
2 Mitig Adapt Strateg Glob Change (2014) 19:1–13

diesel in the Philippines have escalated between years 2003 and 2008. In fact, the average
gasoline price rose by about 142 % from around PhP 22.00 per liter in the second half of
2003 to over PhP53.20 per liter in early 2008 (rate: 1USD - PhP 41.96). Likewise, diesoline
pump prices rose by 175 % from an average of PhP18.65 per liter for the same period in
2003 to PhP51.36 per liter in 2008 (Department of Energy 2009). According to Bhar and
Malliaris (2011), these increases, at the onset of the global financial crisis, is caused by crude
oil suppliers demanding compensation for the declined value of the US dollar measured by
the appreciation of the Euro and the prices of gold.
These stark increases in gasoline prices prompted the Philippine government to consider
alternative fuel not only to achieve energy independence and reduce greenhouse gas
emissions but also swift the decrease of high gasoline prices (Department of Energy
2009). Republic Act No. 9367, also known as the Biofuels Act of 2006, was enacted and
signed into law in January 2007 which calls for the mandatory mixing of ethanol and
biodiesel in, respectively, gasoline and diesel sold in the country. The law requires that all
gasoline sold in the country must contain at least 5 % ethanol by February 2009. By 2011,
the mandated blend should go up to 10 %.
According to Rajagopal et al. (2007), ethanol, which can be produced domestically by
most countries, can lessen the demand for imported crude oil; addresses energy security
issues and provides support for rural economies. They added, that the physical and chemical
properties of bioethanol allow easy blending with gasoline, thus, requires no or minor
modification to existing automobile engines. Thus, bioethanols are considered clean fuels,
safe to handle because they are biodegradable, and cost-effective given the high price of
imported crude oil. In the Philippines, the most common blend is E10 — 10 % ethanol and
90 % unleaded gasoline. E10 is approved for use in any make or model of vehicle with fuel-
injected engines that are sold in the country without engine modifications. This is signifi-
cantly smaller compared to the ethanol content being implemented in US and Brazil. In the
US for example, the production of ethanol blended fuel is supported by the increasing supply
of flexible fuel vehicles (FFV) designed to run on gasoline or blend of up to 85 % ethanol. In
Brazil, there are FFV’s designed to run on 100 % ethanol (E100) and there are also some
make or model designed to run on a maximum of 25 % ethanol mix (Salvo and Huse 2010).
Changes in engine performance between ethanol blended fuel and pure gasoline were
noted by Ozsezen and Canakci (2011). Performing vehicle tests at various speeds using an
eddy current chassis dynamometer, the study indicate that not only minimum CO2 emission
was obtained but ethanol blended fuel also experience peak wheel power and higher
combustion efficiency at 40 kmh−1, 60 kmh−1, and 80 kmh−1 vehicle speeds. Only at
100 kmh−1 vehicle speed did it provide lower vehicle performance or decrease in engine
performance. However, in terms of environmental impacts, it has much less harmful
emissions and pollution since it does not contain contaminants such as sulfur and benzene
commonly found in gasoline (Philippines Department of Energy 2008). Typically, E10 will
contain approximately 97 % of the energy of a liter of pure gasoline (Tokgoz and Elobeid
2007) and will use approximately one-tenth as much fuel energy to produce as it contains
(Wang et al. 2007). According to Wu et al. (2006), the net energy balance of ethanol is 0.76
units of fossil energy, which means that corn ethanol requires that amount of energy for
every unit of energy it delivered at the pump. This is lower compared to the energy balance
of gasoline, which is equal to 1.22 units. The use of ethanol thus results in the consumption
of 40 % less fossil energy than the gasoline it replaces.
Biofuels, in general, are liquid substitutes to fossil fuels, processed and then refined as
petroleum, that are commonly derived from grains, sugar, corn, and oil seeds. The two most
widely used types of biofuels are bioethanol and biodiesel. Bioethanol is made usually from
Mitig Adapt Strateg Glob Change (2014) 19:1–13 3

sugar (Saccharum spp.) and corn while biodiesel is made from vegetable oils, animal fats or
recycled greases. Available data from Philippine Council for Agriculture, Forestry and
Natural Resources Research and Development show that the ethanol yield of sugarcane is
4,900 l/ha per year. Corn (Zea mays) and cassava (Manihot esculenta) have annual average
yields of 2,960 l/ha and 1,440 l/ha, respectively. Sweet sorghum (Sorghum vulgare),
although not yet being utilized as feedstock, seems more promising than the other crops.
Its ethanol yield is estimated at 5,200 l/ha per year. Meanwhile, coconut (Cocos nucifera)
has become the major feedstock in the production of coco methyl esther or commonly
referred to as cocodiesel (2007).
Figure 1 shows the annual average pump prices of gasoline, E10 and diesel in the country.
In 2009, the average pump price of E10 was about PhP34.27, cheaper by around two pesos
than the price of gasoline, at an average of PhP36.51.
There are various laws that give incentives to biofuel production. This includes the
income tax holiday for investors under EO 226 and PEZA Law, the zero specific tax on
local or imported biofuels component per liter of volume, exemption from VAT for every
sale of raw materials used in the production of biofuels such as, but not limited to coconut,
jathropha, sugarcane, cassava, corn and sweet sorghum, and the zero percent rate on R-VAT
on ethanol. The Department of Agriculture supports in research and development program,
which aims to continue the development of high-yielding varieties of sugarcane, improve
quality assurance and other projects to ensure the sustainability of the industry.
However, compared with the biofuels program already implemented in US, Germany and
Brazil where policy mix of incentives, subsidies and tariffs have already been proven
successful and where significant reductions in gasoline consumption have already been
achieved, the Philippines is yet to meet its ethanol blend mandate of about 200 million liters
per year. The country not only needs to strengthen its existing emission standards but must
also put in place policies on vehicle and fuel economy standards to enhance production of
ethanol. It will also need to expand the available infrastructures for production i.e. refineries
and retail stations, increase quality assurance capacities of biofuel suppliers including third-
party certification laboratories, and ensure availability of qualified storage and transport
facilities to meet the increasing demand.

1.1 Relevant literature

There are previous studies which have analyzed the econometrics of biofuel and its impacts
to gasoline prices. For instance, Salvo and Huse’s (2010) research using vector autoregres-
sions and monthly Brazilian state level panel data of prices from July 2001 to September
2009 concludes that in the Brazilian market, in which about 30 % of all cars are flexible fuel
vehicles in 2008, the ethanol’s effect as a substitute to gasoline dominates. It was reinforced
by the study conducted by de Freitas and Kaneko (2011), which used co-integration

Fig. 1 Average annual domestic 60

pump prices of transportation fu- 50
el, 2003–2009, Philippines; DOE
40
2010 Gasoline
30
Diesel
20
E10
10

0
2003 2004 2005 2006 2007 2008 2009
4 Mitig Adapt Strateg Glob Change (2014) 19:1–13

approach and autoregressive distributed lag bounds tests which indicated that ethanol has
strengthened its position as a substitute for gasoline in Brazil over the periods 2003 to 2010.
However, a different result was presented by Szklo et al. (2007) where they conclude that there
is a limited substitution between ethanol and gasoline due to lack of engine technology that will
take ethanol-blended fuel. They added that by replacing methyl tertiary butyl ether (MTBE),
which is a traditional additive used as an oxygenate to raise the octane number of gasoline;
ethanol blending will not reduce gasoline use until flexible fuel vehicles have become widely
available. It was supported by the study conducted by Tokgoz and Elobeid (2007) for the U.S.
gasoline market which showed that ethanol’s effect as a gasoline additive dominates. Their
analysis used an international ethanol simulation model for US, Brazil, and world prices and
quantities for the year 2005, which consists of behavioral equations for production, consumption
and trade. The study, however, points out that when the share of flexible fuel vehicles increases in
a particular country, the substitution effect is expected to dominate, as is the case in Brazil.
This paper aims to investigate if E10 can effectively substitute gasoline in the Philippines. It
also aims to find out what policy inputs can be drawn from the results of the study to help
accomplish the goals of the law and what other future recommendations can be offered to
further enhance it.

2 Methodology

The data used consists of a time series of variables for each of the 76 provinces in the
Philippines. These same cross-sectional units are followed over a period of 3 years from
2007 to 2009 with information collected on different variables as number of gas stations,
prices of fuel, number of transport vehicles, and many others. These repeated observations of
cross-sections allowed for the study of the dynamics of change with time series. The control
or explanatory variables are: income, number of gas stations, and number of gas engine
vehicles. Data for all the explanatory variables are available for each of the provinces across
years collected from published statistics by government agencies such as Philippines
Department of Energy, National Statistics Office, National Statistical Coordination Board
and Department of Transportation and Communications.
As is shown in Fig. 1, there is a positive correlation between the price of E10 and the
price of gasoline. This could be the result of any of the following cases:
CASE 1: An increase in the price of E10 (PE10) will reduce the demand for E10, ceteris
paribus. What happens with the E10 market directly affects the gasoline market. As a
result, the demand for a substitute fuel, gasoline, will shift from D1 to D2 thereby
increasing the quantity demanded for gasoline from Q1 to Q2. Consequently, the price of
gasoline will rise from P1 to P2, as is shown in the graph below (Fig. 2).
CASE 2: An increase in the price of gasoline (PG) will reduce the demand for gasoline,
ceteris paribus. This will, in turn, shift the demand curve for E10, a substitute good, from
D1 to D2, which will result into an increase in the quantity demanded for E10 from Q1 to
Q2. This will cause an increase in the price of E10. On the supply side, since gasoline is an
input into the production of E10, an increase in the price of gasoline will likewise increase
the marginal cost of producing E10. This can be shown by the leftward shift in the supply
curve from S1 to S2. As a result, the price of E10 will increase, ceteris paribus.

In Case 2A depicted on the graph above, an increase in the price of gasoline will result
into an increase in the price of E10 from P1 to P2 (due to the shift of both the demand curve
Mitig Adapt Strateg Glob Change (2014) 19:1–13 5

Fig. 2 Graphical representations of the movement of two-fuel types, gasoline and E10

to the right and the supply curve to the left), ceteris paribus. However, the quantity of E10
remains unchanged because the magnitude of the shift in the demand and supply curves are
the same.
In Case 2B, the price of E10 increased from P1 to P2 as a result of an increase in the price of
gasoline, ceteris paribus. In this case, the quantity of E10 also increased from Q1 to Q2 because
the magnitude of shift in the demand curve is greater than the shift in the supply curve.
In Case 2C, the price of E10 also increased as a result of an increase in the price of
gasoline. But becuase the magnitude of the shift in the supply curve is greater than that of the
demand curve, the quantity of E10 decreased from Q1 to Q2 as depicted by the graph shown
above.
Cases 1–2C show the possible explanations why the prices of the two fuel types move in
the same, rather than opposite, direction. However, since Cases 1–2C result in observation-
ally indistinguishable outcomes (an increase in the price of one fuel type results to an
increase in the price of the other), one cannot just rely on observed data to infer the effects of
a change in the price of E10 on the price of gasoline. Because of this, a more sophisticated
test is needed to distinguish Case 1 (which shows that the two fuel types are substitutes)
from the other cases. To do this, a two-market model has been devised and an instrumental
variable technique is used to test Case 1 by looking for an individual source of variations for
the price of E10 that are not related to the price of gasoline.

2.1 A two-market model

The study assumes markets for two-goods: gasoline and E10. There are two sides for each
market—the supply and the demand side.
6 Mitig Adapt Strateg Glob Change (2014) 19:1–13

2.2 The gasoline market

For the gasoline market, the supply and demand functions are described as:
SG ¼ SG ðPG ; PE10 ; SÞ ð1Þ

DG ¼ DG ðPG ; PE10 ; V; IÞ ð2Þ

Where: SG is the quantity supplied of gasoline, PG serves as the price of gasoline, S as
number of gas stations considered exogenous and observable variable that affect supply and
V as gas engine vehicles while PE10 as price of fuel ethanol, and I per capita income as
variables that affect the quantity demanded of gasoline or DG .
Equilibrium prices and level of output are determined by the market-clearing condition,
i.e., the intersection of the supply and demand curves:
SG ¼ DG ð3Þ
Plugging in Eqs. (1) and (2) into (3) yields:

S G ðPG ; PE10 ; S Þ ¼ DG ðPG ; PE10 ; V ; I Þ ð3′Þ

Totally differentiating Eq. (3′) generates the following new equation:


¯SG ¯SG ¯SG
dPG þ dPE10 þ dS
¯PG ¯PE10 ¯S


¯DG ¯DG ¯DG ¯DG
¼ dPG þ dPE10 þ dV þ dI ð4Þ
¯PG ¯PE10 ¯V ¯I

Simplifying further Eq. (4) and getting the value of dPG will yield:
ða 4  a 1 Þ a5 a6 a2
dPG ¼ dPE10 þ dV þ dI  dS ð5Þ
ða 0  a 3 Þ ða 0  a 3 Þ ða 0  a 3 Þ ða0  a3 Þ

2.3 The E10 market

Since motorists can choose between gasoline and E10, the demand function of the E10
market is affected by the price of gasoline as a substitute. Gasoline and E10 are substitutes
on the demand side.
This can be shown on the following equation:

As a substitute : DE10 ¼ DE10 ðPG ; PE10 ; V; IÞ ð6Þ

The supply function of the E10 market is affected by the price of gasoline as a
complement. Gasoline and E10 are complements on the supply side, mainly because E10
is an input in the production of gasoline. This is indicated as:
As a complement : SE10 ¼ SE10 ½PG ; PI ; PE10 ðPG ; PI Þ; S ð7Þ
Where: SE10 is the quantity supplied for E10, PG serves as the price of gasoline and as
major input in the production of E10, 90 % in fact, PI as the price of inputs such as cassava,
Mitig Adapt Strateg Glob Change (2014) 19:1–13 7

sugarcane and potato, S as number of gas stations considered exogenous variable that affect
supply, and DE10 as the quantity demanded for E10.
We introduce an exogenous variable PI as price of inputs to exactly identify the effect of
PE10 on PG. Later on, to solve the endogeneity problem, PI will be used as an instrument for
PE10.
As with the gasoline market, prices and level of output in the E10 market are determined
by the market-clearing condition.
SE10 ¼ DE10 ð8Þ
Plugging in Eqs. (6) and (7) into (8) yields:
SE10 ½PG ; PI ; PE10 ðPG ; PI Þ; S ¼ DE10 ðPG ; PE10 ; V; IÞ ð8′Þ
Simplifying further the Eq. (8′) and getting the value of dPE10 will yield:
b0 þ b2  b5 b þ b3 b b b
dPE10 ¼ dPG þ 1 dPI þ 4 dS  7 dV  8 dI ð9Þ
b6 b6 b6 b6 b6

2.4 Simultaneous equilibrium in two markets

To determine the simultaneous equilibrium in the two markets—gasoline and E10, Eq. (9) is
plugged into (5) and solving for dPG yields (see Cantos 2012 for complete mathematical
derivation):
h i
ða4 a1 Þ b1 þb 3
dPG ða0 a3 Þ b 6
¼ h i ð10Þ
dPI 1  ða4 a1 Þ b0 þb2 b5
ða0 a3 Þ b6

The variable ððaa40 a 1Þ

a3 Þ is expected to yield a positive value since α4 is assumed to have a
positive sign because an increase in the price of E10 will increase the demand for gasoline as
consumers go away from E10 to gasoline; α0 has a positive sign since the price of gasoline
will positively affect the supply of gasoline; and, α3 has a negative sign since the price of
gasoline is negatively related to its demand. Hence, ððaa40 a 1Þ
a3 Þ > 0 .
The variable b0 þbb26 b5 is also expected to yield a positive value. Both β0 and β2 have
negative signs since if the price of gasoline or other inputs increase, the supply of E10 will
decrease, ceteris paribus. On the other hand, β5 is expected to be positive since if the price
of gasoline increases, the demand for E10 will also increase. On the other hand, β6 is
negative because if you increase the price of E10 demand for the said product will decrease,
ceteris paribus. Hence, b0 þbb26 b5 > 0 .
The variable b1bþb 6
3
will yield a positive number since all β1, β3 and β6 are negative
numbers. We assume that β1 and β3 are negative numbers since higher input prices will
reduce the supply of E10. Likewise, we also assume that β6 is negative because higher price
of E10 will reduce the demand for E10. That is, b1bþb 6
3
>0.
Hence, dPG/dPI will yield a positive sign. This implies that an increase in the price of
E10 — using the price of i as instrumental variable — increases the price of
h its inputs
ða4 a1 Þb1 þb3
hða0 a3 Þ i>0.
b6
gasoline, that is, dPG
dPI ¼
ða a Þb þb b
1 4 1 0 b2 5
ða0 a3 Þ 6
8 Mitig Adapt Strateg Glob Change (2014) 19:1–13

In addition, aside from the Cases 1–2C presented earlier, there are actually other cases
where the positive correlation between the price of E10 and price of gasoline may be
observed. Other third factors that can lead to a simultaneous increase in the demand for
E10 and gasoline (e.g. population growth, income growth) or a simultaneous reduction in the
supply of both E10 and gasoline (e.g. worldwide crisis, war). These unobserved third factors
would be addressed using fixed effects panel data model.

2.5 Estimating equations

We test whether E10 and gasoline are substitutes using the following panel data equation:
PGit ¼ d 0 þ d 1 PE10it þ d 2 Iit þ d 3 Sit þ d 4 Vit þ d 5 y2008t þ d 6 y2009t þ ai þ uit ; t ¼ 1; 2; 3 ð11Þ

Where: i denotes the provinces included, t denotes the time period, ai is the unobserved or
fixed effect, y2008t is the dummy variable for year 2008 and y2009t is the dummy variable
for year 2009.
On the other hand, the panel data equation for PE10 is as follows:

PE10it ¼ l0 þ l1 PG it þ l2 PI it þ l3 I it þ l4 S it þ l5 V it þ l6 y2008t þ l7 y2009t þ ai

þ uit ; t ¼ 1; 2; 3 ð12Þ

Taking into account time effects on the price of gasoline, we included in Eqs. (11) and
(12) dummy variables for each year starting when the law was made effective to indicate
other factors that could have caused the increase or decrease in the PE10. Year 2007 is used as
a base year.
Since E10 is a blended gasoline and therefore an endogenous variable, we cannot obtain
unbiased and consistent results for Eq. (12). There exists a strong positive relationship
between PE10 and PG since the price of E10 necessarily includes the price of gasoline i.e., the
relationship is definitional. An instrumental variable (IV) for PE10 is needed to estimate Eq.
(14). An independent source in the price of E10 not correlated with the price of gasoline is
required to separately identify the effect of PE10 on the price of gasoline.
Looking at the two equations, there are no exogenous variables appearing in Eq. (11) that do
not appear in Eq. (12) except for PI or the price of other factor inputs (farm gate prices of
sugarcane, cassava, and sweet potato). Hence, PI is used as an instrument for PE10 in Eq. (11).
We represent these factor input prices as PI to instrument for PE10. It is necessary that PI
satisfies the following conditions: (1) cov (PI, u)00, which means that the price of factor
inputs should be uncorrelated with unobserved factors in u. (2) cov (PI, PE10,)≠0, which
means that the price of factor inputs should be correlated with the price of E10. Using PI as
an instrumental variable for PE10 in Eq. (14), we run the following regression models using
2SLS estimation.

PE10it ¼ l0 þ l1 PG it þ l2 PI it þ l3 Iit þ l4 Sit þ l5 Vit þ l6 y2008t þ l7 y2009t þ ai

þ uit ; t ¼ 1; 2; 3 ð13Þ

PGit ¼ d 0 þ d 1 PIit þ d 2 Iit þ d 3 Sit þ d 4 Vit þ d 5 y2008t þ d 6 y2009t þ ai þ uit ; t ¼ 1; 2; 3 ð14Þ

To solve the problem of endogenous explanatory variable PE10, using the 2SLS is the
consistent estimation method in the specified models. The prediction which will be
Mitig Adapt Strateg Glob Change (2014) 19:1–13 9

generated from the process will involve the original regressors and not the instruments. The
use of instrumental variable method with the endogenous variable PE10 takes into account an
unobservable factor that does not change over time (Wooldridge 2006). The estimation will
use fixed effects to ensure precision of estimates and to allow us to control for an unob-
servable individual province’s heterogeneity and temporal effects without aggregation bias.
Fixed effects treat time constant unobserved factors as variables being explicitly considered
in the equation.

3 Results and discussion

3.1 Under Biofuels Act (2007–2009), with PE10 exogenous

Table 1 shows the results of the naïve panel-data estimation model where PE10 is assumed to
be exogenous. The results only serve as benchmarks with which to compare the estimates in
the following sub-section where we controlled for the endogeneity of PE10.
Estimating a naïve model during the years where E10 was implemented is performed and
where results of the estimation using this model will be compared later with the results using
the model of the same regime but accounting for the endogeneity of the PE10 using factor
inputs as instruments. Based on Hausman test at 72.65 chi-square statistic and statistically
significant from zero, we use the fixed effect panel data model estimation.
In the years when E10 has been introduced in the market, the parameter of interest,
PE10 is positively correlated with the PG. The results are statistically significant from
zero and indicate that a 1-peso increase in the price of E10 increases the price of
gasoline by 0.70 pesos.

Table 1 Results of regression

with price of gasoline as dependent Dependent variable: price of gasoline PE10 is exogenous
variable
Variable Fixed Effects

Coefficient Robust St. Error

E10 price in pesos 0.70a 0.07

Real income per capita 0.01 0.01
Number of gas vehicles −0.24a 0.09
Number of gas stations 2.30e-06 3.85e-06
2008 10.16832 0.05
2009 −4.04 0.03
Constant 27.53a 6.25
Observations
Overall 235
Groups 79
obs per group (min,avg, max) 2,3,4
R2 within 0.82
R2 between 0.19
R2 overall 0.17
a
F-test significance 30755.71 0.00
means significant at 1 % level
10 Mitig Adapt Strateg Glob Change (2014) 19:1–13

The estimation result during this period when E10 is already sold in the market indicates
that there are also other factors which determine the price of gasoline. However, the price of
E10 is considerably tied with the price of gasoline as inputs to its production, hence,
whenever the gasoline price increases, it is expected that the price of E10 increases as well.
These estimation results of quantifying the impacts of the price of E10 into the price of
gasoline indicate a positive bias and are therefore not valid and inconclusive since the price
of E10 is endogenous. This positive bias magnified the true estimates of the effect of the
price of E10 to the price of gasoline. Hence, we need to isolate the real effect of ethanol into
the price of gasoline.

3.2 Under Biofuels Act (2007–2009), with PE10 endogenous

Table 2 shows the panel data estimates controlling for the endogeneity of PE10. The
coefficients are estimated using two-stage, least squares (2SLS) procedure. In the first stage,
we estimate income, number of gas engine vehicles, number of gas stations, instruments
sugarcane, cassava and potato in pesos and years 2007 as base year while 2008 and 2009 as
comparison years. Then, in the second stage, we estimate income, number of gas engine

Table 2 Results of First and Second Stage Regressions using PE10 as instrumented variable

First stage regression Second stage regression (Fixed effects)

Dependent variable: price of E10 Dependent variable: price of gasoline

Explanatory Variables Coefficient Robust Std. Explanatory Coefficient Robust

Error Variables Std. Error

Real income per capita 0.01 0.002 E10 price in pesos 0.37b 0.96
Number of gas vehicles .04 0.12 Real income per capita 0.02b 0.02
Number of gas stations −1.67e-06 9.57e-06 Number of gas vehicles −0.93b 0.67
2008 13.54 0.48 Number of gas stations 7.11e-06a 0.02
2009 −1.39 0.51 2008 13.54b 0.64
Sugar price, pesos 0.35b 0.14 2009 −1.56b 0.74
Cassava price, pesos 0.70b 0.29 Constant 27.53b 6.25
Potato price, pesos 0.04 0.15
Constant −238.67 59.34
Observations Observations
overall 235 overall 235
groups 79 groups 79
obs per group 2,3,3 obs per group (min,avg, max) 2,3,3
(min,avg, max)
R2 within 0.9988 R2 within 0.82
2
R between 0.9126 R2 between 0.19
R2 overall 0.9978 R2 overall 0.17
F-test significance (8) 1238 0.001 F-test significance 114.50 0.00
a
means significant at 10 % le
b
means significant at 1 % level
Mitig Adapt Strateg Glob Change (2014) 19:1–13 11

vehicles and number of gas stations with 2007 as base year while 2008 and 2009 as
comparison years.
Our final structural Eq. (14) constitutes a simultaneous equations (SEM) model since one
of the explanatory variables; in this case the price, is jointly determined with the dependent
variable through the equilibrium mechanism. The critical coefficient in the second stage is
the PE10 and our interest is on estimating the effect of PE10 to the PG, where the PE10 as an
explanatory variable is considered endogenous.
In evaluating the degree of correlation between the three factor inputs used as instru-
mental variables and the endogenous regressor PE10, the results of the first stage regression,
which was simultaneously estimated by the statistical software with the second stage
regression, shows that using the fixed effect panel data procedure only the instrument
price potato is not highly correlated with the price of gasoline. The instruments price
of sugarcane and price of cassava are all highly correlated with the instrumented
variable at 1 % significance level.
In addition, results from testing for the joint significance show that all three instrumental
variables are jointly statistically significant. In other words, the condition that the instru-
mental variables must be significant in explaining the variable they instrument for has been
satisfied.
Looking at the coefficient estimate (0.37) from the fixed-effect model from the second
stage regression indicates that the endogenous regressor price of E10 is statistically signif-
icant from zero (0.000), albeit the prices of factor inputs in ethanol production and condi-
tioning on the other factors included in the equation, the PE10 seems to significantly
determine the PG being the dependent variable. However, there are other factors that could
affect changes in the PG not explained in the model. The other coefficient estimates agree
with the predictions of theory and empirical findings.
To test for the endogeneity of the PE10 as the regressor and the validity of the instruments
in our 2SLS model, the Wu-Hausman F-test and Durbin-Wu-Hausman χ2 test are used.
Results show that the regressor PE10 is considered endogenous with p-values 0.092619 and
0.096540 respectively rejecting the null hypothesis that the regressor is exogenous.
To test for the relevance of the instrument, the partial R2 is calculated. In our model of one
endogenous regressor PE10, the estimated equation yields a standard partial R2 (0.0067) and
the test indicates that the model with instrumented variables is essentially identified since
as a rule of thumb, the estimated equation should not yield a large value of the standard
partial R2.
Testing for heteroskedasticity, the Breusch-Pagan test and White test are employed. The
results show that we do not encounter any problem of heteroskedasticity since none of the
tests reject the null hypothesis.
After verifying that the methods used are sound and appropriate, we now show the
estimation results for the two regimes (i.e., PE10 exogenous and PE10 endogenous). The
naïve model assumes the PE10 is exogenous, while the 2SLS model relaxes this assumption
and uses instruments to identify the effects of PE10 on PG. All estimates are obtained through
panel data estimation techniques.
A significant difference is noted if we are to compare the results of both estimations for
the period 2007–2009. In the naïve model, the results indicate that a 1 peso increase in PE10
will likely increase the price of gasoline by 0.70 pesos, ceteris paribus. This is almost double
the estimated coefficient generated by 2SLS estimation at 0.37 pesos.
The model controlled for income, number of gas stations, number of gas vehicles and
price of ethanol. As expected, demand for gasoline is found to increase with income. The
findings indicate that gasoline demand increases as income rises. Although both estimations
12 Mitig Adapt Strateg Glob Change (2014) 19:1–13

showed positive correlation between the price of E10 and the price of gasoline, the
difference in their coefficient estimates may have been caused by factors exogenous to the
model, i.e., crude oil price, especially when gasoline is a major input in the production of
E10, and E10 is being considered exogenous.

4 Conclusion

In the previous years as is shown in Fig. 1, the prices of E10 and gasoline move in the same,
rather than opposite directions. This can be attributed to several possible reasons. The most
obvious is that there exists an exogenous increase in the price of gasoline, which shifts the
demand from gasoline to E10 which then increases the price of E10, ceteris paribus — the
substitution effect. Second, an exogenous increase in the price of gasoline shifts up the
marginal costs of producing E10 showing up as an upward shift in the supply curve of E10
— the complement effect driven by the technological fact that gasoline feeds into E10.
Another possible explanation is that it could be that the two fuel types cater to different
markets, and their respective demands may be increasing at the same time.
This positive relationship between price of E10 and price of gasoline is also indicated by
the results from both estimations i.e. naïve panel estimation versus 2SLS. However, results
obtained using the naïve model statistically magnified the true effects of E10 into the price of
gasoline. Hence, a sophisticated test using the 2SLS procedure was used to distinguish and
test Case 1, which showed that the two fuel types are substitutes. The results of 2SLS
estimation taking into account endogeneity of price of E10 is more valid and conclusive
because it identified an individual source of variations for the price of E10 that are not
related to the price of gasoline. And since the prediction generated from the estimation
involved the original regressor and not the instruments, this source of variation validates the
substitution effect (Wooldridge 2006).
However, results from the 2SLS estimation indicate that the substitutive effect of ethanol
is not strongly identified since ethanol is only 10 % of E10 and that not all vehicles have
flexible fuel engine for consumers to switch fuel type. Nonetheless, this substitution effect
might explain why in the previous years the average pump prices of gasoline were still more
expensive compared with the price of E10 (Fig. 1).
Before E10 can effectively substitute gasoline, it must be equal or higher in engine
performance and lower in price. Existing and future engine technology should be able to
take this fuel up to induce consumers to prefer ethanol-blended gasoline. When this happens,
we expect to see gasoline demand to decline and consequently, its price to follow suit. In the
future, the increased share of E10 in the market should drive the transportation market away
from depending too much on imported crude oil, which hugely affects price of gasoline.
Hence, other objectives of the law will also be achieved i.e., increase rural employment and
income and mitigate harmful greenhouse gas emissions.
The results of the study imply a number of reforms for RA 9367 which policy makers
might consider. First, increasing ethanol content up to 24 %, a maximum blend, which still
requires no engine modification, must be put in place to ‘effectively’ substitute E10 to
gasoline. This must be coupled with the production and use of flexible fuel vehicle that can
take up as much as 85 % ethanol content or E85. Second, there is a need to strengthen
current government research, subsidies and tax incentives on ethanol use to expect continued
expansion on the use of ethanol. For example, the government can provide tax credits for
consumers to potentially offset the increasing cost of gasoline — an input to E10. But this
must be together with legislated increased ethanol content to avoid inadvertent subsidy on
Mitig Adapt Strateg Glob Change (2014) 19:1–13 13

gasoline consumption. And finally, regulatory mechanisms such as vehicle and fuel econ-
omy standards need to be institutionalized to enhance production and use of ethanol.
The limit of the study was it did not take into account the effect of the fact that not all gas
engine vehicles in the country can take up E10, due to limited data. It has also confined itself
into the gasoline market in the transportation sector as it did not specify enough the effect of
crude oil prices in the estimation being an exogenous variable that hugely determine the
price of gasoline. A possible extension of the study would be linking the gasoline market
(blended and unblended) into the economy wide market for fuel transportation, i.e. diesel
fuel, to see if a potential demand shift of diesel engine car owners to gasoline engine cars can
be expected in the long run.

References

Bhar R, Malliaris AG (2011) Oil prices and the impact of the financial crisis of 2007–2009. Energy Econ 33
(6):1049–1054
Borenstein S, Cameron AC, Gilbert R (1997) Do gasoline prices respond asymmetrically to crude oil price
changes? Q J Econ 112(1):305–339
Cantos, JAB (2012) Econometric analysis of the impacts of ethanol on gasoline prices in the Philippines.
Masters Thesis, UP School of Economics. University of the Philippines, Quezon City. Philippines
de Freitas LC, Kaneko S (2011) Ethanol demand under the flex-fuel technology regime in Brazil. Energy Econ
33(6):1146–1154
Department of Energy (2009) http://www.doe.gov.ph
Ozsezen AN, Canakci M (2011) Performance and combustion characteristics of alcohol-gasoline blends at
wide-open throttle. Energy 36(5)
Philippines Department of Energy (2008) http://www.doe.gov.ph/AF/Bioethanol.htm
Rajagopal D, Sexton SE, Roland-Holst D, Zilberman D (2007) Challenge of biofuel: filling the tank without
emptying the stomach?. Environ Res Lett 2(4): Art. No. 044004
Salvo A, Huse C (2010) “Is arbitrage tying the price of ethanol to that of gasoline? Evidence from the uptake
of flexible-fuel technology.” Working Paper 0093, Northwestern University Center for Study of Industrial
Organization
Szklo A, Schaeffer R, Delgado F (2007) Can one say ethanol is a real threat to gasoline? Energ Pol 35:5411–
5421
Tokgoz S, Elobeid A (2007) “Understanding the underlying fundamentals of ethanol markets linkage between
energy and agriculture.” American Agricultural Economics Association annual meeting, Portland, OR, 29
July–1 August
Wang M, Wu M, Huo H (2007) “Life-cycle energy and greenhouse gas emission impacts of different corn
ethanol plant types.” Environmental Research Letters 2(April–June) Article 024001, available at http://
www.iop.org/EJ/abstract/1748-9326/2/2/024001/
Wooldridge JM (2006) Introductory Econometrics A. Modern approach. MIT Press, Cambridge,
Massachusetts, second edition 2009
Wu et al (2006) “Fuel-cycle assessment of selected bioethanol production pathways in the United States,
Argonne National Laboratory, Nov. 7, p. 33 (http://www.transportation.anl.gov/pdfs/TA/377.pdf)
Reproduced with permission of the copyright owner. Further reproduction prohibited without
permission.