Our friends at ValvTect offer an explanation of how the addition of ethanol undermines octane and fuel efficiency:

There are three potential causes for "octane loss" and unfortunately none of them are linear.  

First: Ethanol separation.  In regular E-10 gasoline, ethanol accounts for about 3 octane numbers.  Should the gasoline phase separate, the gasoline on top of the water/alcohol mix will be about 84 octane.  Phase separation is not a linear function.  The fuel is either phase separated or it isn't.  As long as there is no phase separation there won't be any octane loss.  That is why ValvTect Marine Gasoline (VMGA) and ValvTect Ethanol Gasoline Additive (VEGA) are formulated to inhibit phase separation.

Second:  Oxidation.  Gasoline is susceptible to oxidation.  That is, after all, why we use it as fuel.  In the engine gasoline is rapidly oxidized; it combines with oxygen and is converted to carbon dioxide and water.  In the gas tank, on the other hand, this oxidation occurs as well; but very, very slowly and the reaction does not go completely to carbon dioxide and water.  In the fuel tank, the fuel only partially oxidizes and forms ethers, aldehydes, esters and ketones.  Left unchecked, these oxidation products proceed to form the gum and lacquers that make a mess of fuel systems.  They also don't burn as efficiently as the initial gasoline and can lead to octane loss... 

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