The federal government's key independent advisory body has recommended the axing of a controversial policy designed to boost ethanol use by NSW motorists because it increases petrol prices and reduces competition.

The Productivity Commission also says a mandate that 6 per cent of all petrol sold by major retailers in NSW must be ethanol may not have the claimed environmental benefits.

But the recommendation has been rejected by the NSW government as it prepares to launch an advertising campaign in support of its most recent attempts to encourage motorists to use E10, a blend of regular unleaded and up to 10 per cent ethanol.

Last year, the government legislated reforms including requiring a wider range of petrol stations to sell E10, establishing an online fuel price board and asking the Independent Pricing and Regulatory Tribunal (IPART) to regulate the wholesale price of ethanol in a bid to drive down its price.