Scoring the sweet stuff, or how US farm and biofuel subsidies combine into an amazing market mess

Written by dkoplow Posted: 09/12/2013 3:12 PM EDT

The headline in a recent issue of Ethanol Producer Magazine says it all:  "Colo. ethanol plant scores sugar feedstock for 6 cents per pound," as though the purchaser, Front Range Energy LLC, had just won the lottery.  While sugar is a regular feedstock at Brazilian ethanol plants, the US isn't exactly known as the world's most efficient location for sugar production.  The interlocking government interventions that made this simple headline possible are part of a fine ballet of ag support and protection policies -- though hardly a tribute to the market-based system that supposedly governs the US economy.  Here are the main components:

Sugar beet

1)  Restrict sugar imports to prevent low-priced foreign sugar from competing with domestic sugar farmers 

This is a baseline of US ag policy:  we have apparently restricted sugar imports in one way or another since 1789.  Foreign refined sugar prices have been half or less of those in the US for the recent period, with the quotas costing US consumers more than $3 billon per year in extra charges.

2)  Guarantee domestic sugar prices at high levels; put taxpayers on the hook to pay off producers if prices fall

This is nicely accomplished through the Commodity Credit Corporation (CCC), a federal body that is part of the US Department of Agriculture.  As its name implies, CCC extends credit to farmers, generally using their crop as collateral.  Unfortunately for the taxpayer, the same factors that often cause defaults to the CCC (primarily falling crop prices) also mean that the value of the taxpayer collateral is equally depressed and the taxpayer ends up eating the loss.

3)  Mandate that the feds take over the sugar, and then force them to sell into the biofuels market 

The ironically titled "Feedstock Flexibility Program" or FFP (7 USC 8110) restricts rather than enhances flexibility for the government creditor to recover as much of its capital as possible in the event of a default.  Defaults (or expected defaults) on sugar-backed loans from CCC trigger a mandated purchase of the surplus sugar stock by the federal corporation -- which is then required to sell the crop into biofuel markets. 

The ag economists among you are probably wondering whether selling food-grade material into fuel markets rather than as regular sugar would result in a much lower valuation of the collateral.  Well yes, yes it would.  But the whole point is to reduce the supply of sugar not only from abroad (accomplished by the import restrictions), but domestically as well.  It's not about selling the collateral for as much as you can get.  By diverting the sugar into markets that don't directly compete with food-grade sugar, prices in the food-grade segment can be further propped up.  In addition to helping US producers of sugar from cane and sugar beets, high prices help to keep corn syrup competitive as well.  Ag policies that help corn tend to have bipartisan, long-lasting political support.

The statute (section b(1)(A)) seems to require that the sales to biofuel producers not lose money for the government [emphasis added]:

For each of the 2008 through 2013 crops, the Secretary shall purchase eligible commodities from eligible entities and sell such commodities to bioenergy producers for the purpose of producing bioenergy in a manner that ensures that section 7272 of this title is operated at no cost to the Federal Government by avoiding forfeitures to the Commodity Credit Corporation.

But based on the Front Range Energy LLC purchase, it appears as though "avoiding forfeitures" takes priority over "no cost."  Thus, if the program buys sugar just before the producer fails to pay its government loan, but at the forfeiture price, this is viewed as "no cost to the Federal Government," and meeting the law's goal of avoiding forfeiture.  But from an economic perspective, the maneuver is mostly semantic.  Since the inventory is already marked down, there are no savings relative to the default scenario.  Further, the requirement to sell into biofuel markets rather than into the most opportune outlet at the time (or holding until prices recover) could well trigger higher costs to taxpayers than in the baseline. In fact, this is what even CCC expects:

FFP is expected to cost CCC an estimated $54.5 million more than using the least-cost surplus management option. (FR 45445, 7/29/13).

As noted in CCC's most recent amended rules for this program, controlling supply is a main driver:

FFP addresses sugar surpluses sooner than the current Sugar Program by permanently removing such sugar from the market for human consumption.

The July 2013 amended regulations move non-FFP sugar stockpiles as well into biofuel markets by disposing of "sugar held in CCC inventory in ways that do not increase the domestic supply of sugar for human consumption..." (FR 45442, V. 78, No. 145, 7/29/13).  Over time, this shift would be likely to increase the portion of sugar subsidies that end up supporting biofuels.

4) Run an auction with the one market you are allowed to sell to, but provide little publicity and an extremely short lead time 

Want to be sure whatever you are selling generates a low price?  Don't advertise very much, and give bidders only a week between the first announcement (of the very first sugar sale under this program) and the bid closure.  So, although USDA wanted 25.2 cents/pound for the 14.2 million pounds of table sugar it put up for sale, it received only 6 cents/pound from the winning bidder. 

The result?  CCC guaranteed the crop for $3.58 million; paid $3.58 million for it before a formal loan default; then sold it at auction for $854,100.  Total loss to taxpayers:  $2.7 million.

No worries if you are an ethanol producer and happened to be on vacation during the entire one week first bid window.  There is another 184 million pounds of sugar on auction, which based on current prices will trigger more than $33 million in additional taxpayer losses.

5)  Force consumers to buy your subsidized sugar ethanol at above-market prices for fuel

Given the many interventions thus far, it would not be realistic to think that government involvement stops once the feedstock hits the ethanol plant.  That is not the American way when it comes to farming. 

In fact, there is one additional big sweetener to this whole scheme worth noting.  Government rules, in the form of the Renewable Fuel Standard (RFS) purchase mandates, require consumers to buy ethanol in their fuel even at above-market prices.  The extra cost of these rules to the fuel chain can be approximated through the market price of RFS compliance credits, called Renewable Identification Numbers, or RINs.  There are different types of RINs to deal with a variety of special definitions under the RFS, and it turns out that sugar used in ethanol production is generally of much higher value in meeting the RFS than is ethanol from corn (corn remains by far the largests US feedstock for domestic ethanol production).

The FFP final rule (FR 7/29/13, p. 45442) notes that..."EPA has confirmed that ethanol produced from U.S. sugarcane would qualify for an advanced fuel RIN."  However, aside from any grandfathered supply, ethanol produced from sugar beets would only qualify for conventional RIN credit.

The incremental value of advanced (D5) RINs relative to conventional (D4) RINs from corn has been very large for most of the RFS compliance period (see this chart). 

 

To make Front Range Energy's "score" possible, we had to pay higher prices for sugar and for motor fuel in our role as consumers; and to guarantee and then write-off a big chunk of the value of our sugar crop collateral in our role as taxpayers.  And that's even before considering the environmental impacts of domestic sugar production, such as new Roundup ready sugar beets and long-term water pollution from cane production in Florida.