ethanol

Ethanol’s Broken Promise: Using Less Corn Ethanol Reduces Greenhouse Gas Emissions

It is now clear that the federal corn ethanol mandate has driven up food prices, strained agricultural markets, increased competition for arable land and promoted conversion of uncultivated land to grow crops. In addition, previous estimates have dramatically  underestimated corn ethanol's greenhouse gas emissions by failing to account for changes in land use.

It's an interesting time to watch biofuels markets.  A couple of years ago, with commodity prices spiraling, there was great concern that fuel markets were outbidding food and feed markets for edible biomass.  Now, reporter Judy Keen notes that the United States is facing drought in nearly 80 percent of the country's corn-growing area; and more of the country's landmass is facing drought than any time since 1956.

Back in 2006, biofuel proponents were touting the introduction of ethanol as a boon for domestic energy security.  National security was one of the central planks proponents used to advocate for continuing large and growing subsidies to the fuels.  The industry continues to highlight the energy security angle.  Here is the Renewable Fuels Association on energy security:

As a domestic, renewable source of energy, ethanol can reduce our dependence on foreign oil and increase the United States' ability to control its own security and economic future by increasing the availability of domestic fuel supplies. By displacing hundreds of millions of barrels of imported oil, the increasing reliance on domestically-produced ethanol is making available billions of dollars for investment in domestic renewable energy technologies.


Energy Security has More than one Parameter

There's a grain (sorry) of truth in this argument.  Being able to put ethanol into vehicles instead of gasoline provides a bit of competitive leverage against oligopolistic petroleum suppliers.  The leverage, however, is fairly limited.  The US Congressional Research Service recently concluded that

Despite the fact that ethanol displaces gasoline, the benefits to energy security from ethanol remain relatively small. While roughly 40% of the U.S. corn crop was used for ethanol in 2011, the resultant ethanol only accounts for about 7% of gasoline consumption on an energy-equivalent basis. Expanding corn-based ethanol production to levels needed to significantly promote U.S. energy security is likely to be infeasible.

Fuel substitution is only part of an energy security picture though, and it is important to look at the security issue  holistically.  Supply security also matters.  And, just as world events disrupt oil supplies causing price shocks and dislocations, so too can the supply of biofuels be disrupted.  Here's what I wrote on the issue six years ago (p. 58):

Biofuels do offer a diversification benefit, inasmuch as they may be less vulnerable to the same kinds of disruptions that threaten supplies of petroleum from politically unstable regions of the world. However, the cost per unit of displacement [i.e., subsidies per gallon of oil displaced] is very high, and there are likely many more efficient means to achieve the same end.  Moreover, the feedstocks from which biofuels are currently derived are also vulnerable to their own set of unmanageable and unpredictable risks, such as adverse weather and crop diseases.

It turns out that those "unmangeable and unpredictable risks" are not something that should be ignored.  The chart below is from a 2007 article by Bruce Babcock at Iowa State University, a frequent researcher on corn and biofuels issues.  He notes that corn harvests have regularly deviated from expected yields, and often by a large margin.  Shortfalls are particularly relevant with respect to biofuels markets that mandate particular consumption levels.  Responding to claims that crop innovation had made corn at a lower risk from drought than in the past, Babcock was skeptical:

It is an open question whether future supply shocks will follow the historical patterns. Many feel that current corn hybrids are better able to withstand hot and dry weather of the type seen in 1983 and 1988. This has yet to be demonstrated, though, as we have not had a severe drought since 1988. Dry weather in Illinois in 2005 and in the western Corn Belt in 2002 caused significant local yield losses, which suggests that corn crops remain vulnerable to drought.


 

 

 

 

 

 

 

 

 

 

 

 

 

 

Supply Shortfalls in the Face of Mandated Consumption

As crop production is threatened, food prices and crop futures rise. The higher prices send signals to all consumers that they might want to shift to other feedstocks or to figure out how to use the now more-expensive inputs more carefully.  This rationing process works best when all consumers of the affected commodity feel pressure to substitute or conserve.  Biofuel mandates mess up this process because they require diversion of a large portion of the corn crop into vehicle fuels -- even at very high prices.  In effect, the mandates hard-wire the markets so that transport uses for corn will outbid feed and fuel uses.

In an interesting review of corn market dynamics under the present drought, Darrel Good and Scott Irwin at the University of Illinois point out that compliance with the blending mandates does have some flexibility.  The rules allow some banking of prior year credits.  This carryover has been estimated at "at least 2 billion gallons" -- important, but still a small slice of the more than 13 billion gallons required for blending during the next mandate year.  Thus, when they estimated how markets would respond to rising corn prices, they assumed that carryover stocks of Renewable Indentication Numbers (commonly referred to as "RINs," and which are the market mechanism for tracking compliance with the RFS biofuel blending mandates) would be used first to reduce the need for buying actual (and expensive) corn.  This makes logical sense, but only solves part of the problem.  Good and Irwin further note that

without policy changes ethanol use after the stock of RINS is used up would become perfectly price inelastic.

Becoming "perfectly price inelastic" is economist terminology that means fuel markets will continue to buy the same amount of ethanol no matter how much the price of the fuel rises.  This is a big deal, because it means the residual demand for ethanol for fuel will outbid all other uses for corn during the period of scarcity:  food, animal feed, exports, everything.  And this will happen only because of the Renewable Fuel Standard subsidy, not because of the inherent economics of the product.

Good and Irwin point out that the ability to borrow credits from future years (up to 20% of the requirement) could theoretically be used to further reduce the need to buy actual corn for fuel markets.  However, they didn't see this strategy being widely deployed.  Borrowing for 2012/13 would mean the need to blend even more than the mandate for 2013/14 -- yet markets are already saturated with ethanol making incremental blending quite difficult. 

The drought brings into greater focus problems that have existed in biofuel markets for some time.  First, that biofuel feedstocks, like oil, are subject to supply disruptions and this volatility reduces the security element of the fuel.  Second, that the mandates result not only in market challenges but a moral one as well when the least important end-use from a societal stand point (fuel for cars) ends up diverting increasingly scarce supplies of corn or other biofuel crops from feeding people.


Ships Passing in the Night

Lest the mandated use of corn in cars rather than for food not cause enough heartburn, Tim Wise highlights another problem on his Triple Crisis blog.  While reducing carbon impacts was an early (though not always accurate) selling point of biofuels, current policies have resulted in Brazil and the United States shipping each other ethanol at the same time.  Here's Wise:

Why would the United States, which now devotes 40% of its corn crop to the production of ethanol, import more  than 4 billion gallons of ethanol from Brazil? And why would Brazil at the same time import a projected 2 billion  gallons from the U.S.? Couldn’t we just save all those transactions costs and shipping-related greenhouse gas  emissions by keeping our ethanol and cutting our projected ethanol imports from Brazil in half?

Not if your goal is to game the U.S. biofuel mandate.

The driver is the fact that corn ethanol and sugar ethanol are fall into different categories of the RFS.  Sugar-based fuels, because they supposedly have a lower carbon footprint, fall into a more constrained, and therefore more valuable, category of RINs.  Wise notes that

...the ultimate perversity is the ethanol-for-ethanol trade between the U.S. and Brazil. Under the FAO-OECD’s baseline scenario, Brazil would import 2 billion gallons of corn ethanol from the United States. Why, if it’s a major ethanol exporter and it produces more environmentally sustainable ethanol? To make up for the domestic shortfall created by its exports to the U.S., and to meet its own rising demand from its expanding fleet of flex-fuel cars. They’ll take our low-grade corn ethanol if they can get a higher price for their sugar-based equivalent.

And so it goes.


Just Pass the Wine

The inanity of it all is a bit mind-boggling.  But then I remember it has always been so in this nook of our global marketplace.  My first introduction to ethanol issues was in 1989 when I worked on an ethanol-related US trade case.  It turns out that Europe was producing too much wine due to their complex and wide reaching system of agricultural subsidies.  Wine can also be used to make ethanol fuels, and even then the US had generous subsidies for blending ethanol with gasoline.  Alas, the ethanol-from-wine couldn't come straight to our shores because then we'd have been flooded with supplies from around the world, and that would have hurt US corn farmers and processors.  Thus, a tariff (which ended only last year) was in place to render most imports (including European wine alcohol) far less competitive. 

To solve the problem, the wine was instead shipped first the Carribean basin, which due to a regional economic development plan passed by Congress earlier, had special tariff-free access to US markets.  But to comply, some value-added had to be done to the fuel in the Carribbean -- it couldn't just be transhipped.  So it was dewatered there, and entered our markets tariff-free where it was blended with our gasoline supplies to "green" our transport fleet.

How much easier it would have been if they'd just offered us the wine.

Earth Track Blog Post

Below is an article on the end of VEETC titled "Looking at Life With an Ethanol Subsidy," published in Farm Futures on December 28th.  In only a few short paragraphs, it captures so much of the industry spin on these issues over the years that is provided a great framework for calling them out.  A link to the article is here.

The ethanol industry is probably not caught unawares by the end of the Volumetric Ethanol Excise Tax Credit, but it's quiet expiration as 2011 winds down - under the hubbub of job creation bills and debt ceiling limit raising - will not go unnoticed by the industry.

The end of VEETC also brings along an end to the 54-cent-per-gallon tariff on imported ethanol, which may not be an issue given that Brazil is buying plenty of U.S. ethanol to burn in its cars (the country's vehicles are predominantly flex-fuel in design and they burn a lot of ethanol).

It will be interesting to see how the Brazil-US trade plays out over time.  The end of the tariff should make it easier to import sugar ethanol from Brazil, and over the longer-term, ethanol production from sugar cane in a tropical region is expected to be more efficient than US corn.  As the RFS becomes more binding (expected as a byproduct of the elimination of VEETC), it could well start pulling fuel flows back from Brazil to the US, as has been the historical norm.  There has been quite a bit of controversy on whether US exports have tapped the blender's credit before heading offshore, as well.  Industry said no; others disagreed.  That debate will now end, as nobody will get the blending credit.  If we see reversals in the direction of trade that are both rapid and large, we'll know that exporters were, indeed, getting the credit in the past.

What many consumers don't realize is that the tax credit didn't go to ethanol plants, it went directly to oil companies as they splash blended ethanol into the truck to head for the local gas station. As the tax credit expires, fuel providers will raise their prices to cover, and consumers may be surprised. It doesn't mean less ethanol will be used, since the biofuel is a mandated oxygenate in many states - at the 10% level.

The corn and ethanol industries love to say that the tax credit went to oil companies.  This is the point of market incidence, where the credits were paid -- like PayPal collecting funds related to a sale on Ebay that will ultimately be forwarded to another party.  This is by no means necessarily the point of economic incidence -- i.e., which market player ultimately ended up with the financial benefit of the tax credit.  The fact that the corn and ethanol industries long fought the end of VEETC, while the oil industry didn't, says quite a bit on which party was more likely to be benefitting economically from the credit.  Further, the article's claim that prices will rise to cover the loss of VEETC also indicates that it was ethanol getting the subsidy, not the petrol part of the fuel mix. 

The fact that ethanol remains mandated (both by oxygenate rules in some states as the article mentions and by the Renewable Fuel Standard), means that we aren't likely to see a sharp loss in competitiveness for ethanol and declining market share following the end of the blender's credit.  Consumers are still required by law to buy the stuff after all, even at higher pump prices.  We are merely seeing a subsidy shell game:  lower tax subsidies (borne by taxpayers) shifted to higher prices on the tradable RFS credits, called RINs (borne by fuel consumers). 

Corn growers have supported the end of the credit as a way to help reduce the federal deficit, but as one corn group notes the oil companies "didn't follow suit and offer up their own century-old petroleum subsidies as a budget-saving measure."

Yeah... A large subsidy exists for more than 30 years, is renewed multiple times, including during a bloody battle in 2010, and the corn growers claim the loss of VEETC was voluntary.  The article was mere text.  But if it had been video, I doubt even they could have put forth this claim with a straight face.

None of this is to go against the corn growers' argument that fossil fuel subsidies should be eliminated, of course.  They should be, and hopefully will be.  But let's be clear:  VEETC didn't die because the corn growers were taking one for the team; oil and gas subsidy elimination will no doubt require an ever bigger fight.  Second, the end of VEETC by no means ended subsidies to ethanol.  Hence the title of the article referring to the end of "an ethanol subsidy" rather than the end of "ethanol subsidies." 

In my view, the successful elimination of VEETC had two main pillars.  The first, and probably most important, was the splitting of the farm lobby as surging grain prices led the feed industry and food producers to have interests that diverged sharply from the fuels and corn groups.  This led to the establishment of a new set of trade associations, new patterns of political funding and pressures, and some interesting political alliances with environmental groups (concerned about environmental impacts of scaling biofuels on land and habitat) and development groups (worried about domestic SUV owners outbidding poor residents of the developing world for the caloric content of grains).  Congressmen who might previously have had misgivings about the support for corn ethanol now had cover to begin taking positions against continuing the policy. 

The second pillar allowing the end of VEETC is the recognition, even by the industry, that the vast majority of subsidies that VEETC had provided will remain through higher RIN prices under the RFS, and that the industry will not face a shake-out from subsidy removal because the subsidy isn't really disappearing.  Some producers will probably be worse off, but it won't be industry-wide.

The math on oil company economics of ethanol use are pretty clear. In a press release from the Illinois Corn Growers Assocation, Jeff Scates, president, notes that for the last four years ethanol has been less expensive than gasoline so when oil companies use ethanol "they're already making a gallon of gas cheaper to produce. The VEETC was worth about 4.4 cents per gallon at the 10% blend. That's the price advantage that's lost starting January first. It's not the ethanol that might make gas prices go up, it's the loss of the VEETC."

Aside from some adjustments to these numbers that might be needed to reflect ethanol's lower energy content, the article seems to be acknowledging that any cost advantage ethanol held to conventional gasoline was due to a tax subsidy.  Oops.  To me that seems to say that the requirement to use ethanol is making the price of gasoline go up.

It's the end of a 30-year ride for VEETC, and the ramifications are not completely known. Industry groups report that ethanol plants will go on, but how consumers react to a 5-cent gas price rise on Jan. 1 remains to be seen.

With the fiscal mess the country is in, it is high time to see the end of many more "rides" like this one.  On the specifics of VEETC, I'm not expecting riots come January 1st.  Changes on this scale are in the noise of normal shifts in the price of a gallon of gas.  More important policy-wise is ensuring that if the mandates stay in place they are accurately integrating environmental impacts, and that the environmental thresholds fuels must meet to get this subsidy become more stringent over time.  Ideally, though, we see an end to balkanized transport subsidies and force all methods for reducing gasoline per vehicle-mile travelled to compete on equal footing. 

UPDATE, Jan. 3, 2012

A few more quips on the VEETC expiration.  Here's Matt Hartwig of the Renewable Fuels Association talking of the industry's magnamity in the New York Times:

“We may be the only industry in U.S. history that voluntarily let a subsidy expire...The marketplace has evolved. The tax incentive is less necessary now than it was just two years ago. Ethanol is 10 percent of the nation’s gasoline supply."

In response to a question about how the loss of the subsidy might affect prices and supply, Mr. Hartwig said: “We don’t expect the price of corn to fall or rise just because the tax incentive goes away. We will produce the same amount of ethanol in 2012 as in 2011, or more.”

Gee -- loss of a big tax subsidy, yet no change in the markets for corn or ethanol?  How is that possible?  After all, Scientific American noted that for the first time in 2011, more corn was being used for fuel than for feed to domestic animals (it passed human consumption long ago).  Hartwig knows, of course, that his markets are protected by the mandates and only the form of subsidy has changed.  And so the spin continues.

NRDC's Sasha Lyutse was also irked by the industry's claims that it was taking the high ground on subsidies.  She compared industry statements from a year ago (when they had a chance to keep VEETC alive) with their current stoic communalism:

It’s actually fairly amusing to take a page out of Jon Stewart’s book and contrast industry statements from 2010—when corn ethanol lobbyists were issuing dire warnings that equated ending the VEETC with “pushing the industry off a cliff”—with statements over the last few months, as corn ethanol proponents pulled a sharp 180 and started telling anyone who’d listen just how much they didn’t need or want the VEETC.

Here’s Renewable Fuels Association President Bob Dinneen in July of 2010:

“Now is not the time to add uncertainty and complexity to the energy tax debate. Because the EPA has failed to act to allow higher level ethanol blends, margins in the industry are razor thin. Losing the tax incentive now will shutter plants and cost tens of thousands of jobs.”

And here’s American Coalition for Ethanol Executive Vice President Brian Jennings on that same day:

“If Congress fails to extend ethanol tax incentives beyond 2010, more U.S. jobs will be lost and energy independence will be reversed, two dangerous consequences that America cannot afford.”

Compare that to the industry’s current spin, like this statement from Poet CEO Jeff Broin just a few weeks ago:

"Ethanol is now able to compete with gasoline without a tax break…Today, ethanol is so competitive that we have become a major exporter, even to Brazil."

And the National Corn Growers Association last month:

“VEETC expires about a month from now, and corn growers and the ethanol industry have long agreed to let it expire and have since stopped fighting for its renewal...Frankly, we left this game last quarter because there are other, smarter ways to support ethanol, especially in today’s deficit-prone political world.”

You’d almost think someone forced them to spend millions lobbying for a VEETC extension!

 

Earth Track Blog Post

Lots of action on the biofuels front to talk about:  VEETC near death?  Corn wiggling its way into advanced ethanol and biodiesel mandates.  E15 gets a cool new warning label, but auto makers steer clear.

1)  Death of VEETC? 

A group of Senators has introduced legislation to kill the ethanol blenders credit and the import tariff some months before they are intended to expire anyway.  The payoff to the industry for going along:  nearly $700 million of the savings applied to extend the small producer production tax credit and tax breaks for blender pumps.  Not a perfect bill, but given that the excise tax credit may not really be allowed to die in December this year as planned (DC insiders were sure it would die last year too), perhaps the bill is a reasonable trade-off for certainty.  The tax breaks for refueling equipment are not limited to ethanol blender pumps, though are likely to favor them given not much else in the way of alternative fuels is flowing into gas stations at the moment.  If other infrastructure starts tapping into these breaks (electric vehicle recharging stations, for example), I'd expect the tax losses to Treasury to rise. 

Thankfully the bill does not provide subsidies to an ethanol pipeline, something that would increase the barriers to entry for better substitute fuels.  And, while the demise of VEETC would have deficit reduction benefits, as I've noted in earlier posts the subsidy to the biofuel industry will remain -- albeit in the form of higher fuel prices due to consumption mandates rather than the tax credits.

The Wall Street Journal characterizes the payoffs to the ethanol industry this way:

Their obvious political calculation is that the $668 million gratuity the Senators felt they owed this ward of the state will become as inviolable as the tariff and blenders credit were until now, and grow over time. We'll take this offering to St. Jude, the patron saint of lost causes we've invoked for over 30 years in opposition to ethanol. We hope it's a down payment on a non-insane U.S. energy policy.

If only the Journal would take an equally hard-line on massive subsidies to nuclear energy; St. Jude isn't just visiting ethanol plants.

2)  So "Advanced" biofuels is still really just corn?

Since producing ethanol from corn is a stable technology, justification for billions in subsidies to corn ethanol has often rested on claims that this work is a necessary stepping-stone from what we know to more complex, advanced biofuels.  Here is MIT researcher Tiffany Groode back in 2007:

I view corn-based ethanol as a stepping-stone.  People can buy flexible-fuel vehicles right now and get used to the idea that ethanol or E85 works in their car. If ethanol is produced from a more environmentally friendly source in the future, we'll be ready for it.

Corn ethanol did fill most of the 10% ethanol capacity in existing fleets, turning into a bit more of the proverbial millstone than a stepping stone.  More expensive cellulosic fuels will have an even more difficult time trying to enter the market as a result.  But there is also growing evidence that these "advanced" fuels may be in large part corn as well.

Corn for Cellulosic Production

DOE's first loan guarantee for "advanced" biofuels was announced last week.  It provides $105 million in support for the nation's first commercial scale cellulosic plant.  It's backer, POET, has patriotically named the plant "Project Liberty" because it will supposedly free us from the shackles of foreign oil.  The firm calls the plant "pioneering."  Indeed, DOE notes that "Unlike many conventional corn ethanol plants, Project LIBERTY will use corncobs, leaves and husks..."  So much for breaking the corn cycle:  the subsidies will merely increase the returns to converting corn crops in their entirety into fuel.

An interesting recent paper by Juan Sesmero at Purdue notes that corn stove is expected to meet 25% of the advanced biofuels mandate under USDA and EPA projections.  Further, he notes that the short-term economic returns on stover harvest (see page 18) for fuel quickly create pressure to harvest stover at rates as high as 80% of available biomass, well above the 30% sustainable yield rate.

Corn for Biodiesel Production

What about the biodiesel side?  Biodiesel has a carve-out in the Renewable Fuels Standard to ensure that producers survive with an otherwise uneconomic product.  An interesting article in Biodiesel Magazine indicates that corn is also playing an increasingly big role in tapping into biodiesel subsidies.  Long-time industry journalist Ron Kotrba notes that in 2010, roughly 10% of the biodiesel mandate was filled by corn oil.  35% of ethanol producers already extract corn oil in their processes, a figure expected to double in the next couple of years.  Some of the oil appears to be inedible (thereby not competing with other uses), though the article also notes that oil production can degrade the feed quality of dried distillers grains.  This means there are clearly some fuel versus food (or at least feed) interactions here.

David Winsness, representing one of the firms developing oil extraction solutions, expected to see corn oil from ethanol fill 680 million gallons of the 1.28 billion mandate in 2013.  This would mean king corn will comprise more than 50% of the biodiesel mandate as well.  More subsidies to corn; and a high enough rate of biodiesel subsidy capture by corn to call into question the very purpose of having a segregated mandate for biodiesel at all.

3)  Caveat Emptor on E15: Use it incorrectly and void your auto warranty

Try to fill up your gasoline car with diesel fuel by accident and the pump won't fit into the hole of your gas tank.  After a bit of fidgeting and head scratching, most people will determine their error and go to the right pumps.  Not so clear with E15, the ethanol industry's short-term salvation for building too much subsidized production capacity for what the existing vehicle fleet can absorb.  Here, we've got a new, EPA-approved warning label.  e15 labelIt is orange, and it does say "ATTENTION" in all capital letters -- an indication to look and listen.  But let's say E15 looks cheaper (at least on a volumetric basis), or you don't speak English well, or you are in a rush.  How many of you have put lower octane fuel in your vehicles that clearly say 91 or higher to save money, assuming it won't make much of a difference if you do it once in awhile?   

With E15, filling improperly might make a difference.  All of the major auto makers have stated that using E15 in the wrong vehicle will void your warranty.  As Consumer Reports notes, most of these older vehicles are out of warranty anyway.  However, there are concerns about how the higher blend might affect new cars still under warranty; and for owners on the impact of the higher blend on maintenance and repair costs.  The National Petrochemical and Refiners Association is concerned about performance problems of the higher blends if they are used improperly small engines, boats, or snowmobiles resulting in engine damage or stranding.  NPRA also notes that the ethanol industry has refused to warranty against engine damage of any type from the higher blends.  This is perhaps an indication that they are less sure than their press releases that E15 use will be trouble-free.  Further, retailers may be liable for a variety of problems associated with E15, including potentially higher air emissions than allowed (E10 gets some waivers that may be insufficient for E15).  This, in addition to the conversion costs at gas stations for a limited market and higher customer confusion, may ultimately be what curbs the ethanol industry's push to have us all use more of their product whether we want to or not.

Earth Track Blog Post

In the area of fixed income, one shouldn't be betting against Bill Gross of Pimco.  The man is a walking, talking fixed income encyclopedia and routinely makes astute calls on bond trends and pressures.  In March his total return fund (PTTRX) went to zero on US Treasuries.  In April, he supposedly went short (update here).  Others may follow.  The issue?  Ballooning deficits and a perception of a Congress unable to stem the tide.

Enter the world of subsidies, where two of the easiest subsidy reforms are running into friction:  killing the volumetric ethanol excise tax credit (VEETC) and eliminating a small number of the subsidies to oil and gas.  If the Congress is so adrift on fiscal accountability that it can't even kill these subsidies, lopping a good $10 billion or more per year off the federal deficit, perhaps we should all start to short Treasuries.  

This post focuses on VEETC; I'll deal with the oil and gas subsidies, and the various proclamations of gloom and doom from the American Petroleum Institute should their beloved percentage depletion allowance disappear, in a future post. 

Let the volumetric ethanol excise tax credit die 

In the life of a Congressman, it is hard to imagine too many opportunities where one can do nothing, save billions per year, and barely cause economic dislocations.  Not extending VEETC is one.

  • After VEETC, the RFS picks up the subsidy slack.  VEETC almost entirely duplicates the economic protection provided by the renewable fuels standard (RFS).  The RFS is a purchase mandate which forces markets to buy -- at above market prices if need be -- a variety of biofuels.  Right now, the vast majority of what must be purchased is first generation corn ethanol.  The implication of this overlap is important:  despite industry whining to the contrary, if you kill VEETC you are not suddenly pulling the rug out from under the industry's operations.  Far from it.  You are merely switching the form of subsidy from taxpayer financed tax credits to consumer-financed above-market prices at the pump. Tax credits disappear though, and this shift saves taxpayers $6 billion per year and rising, reducing the deficits.  Price premiums on RFS-eligible fuels rise (as reflected in the trading price of the RINs, the tradeable units of account for compliance with the RFS), so almost no ethanol producer goes out of business.  Heck, even the industry acknowledges the policy overlap.  
  • You can kill it without a vote.  VEETC will expire on its own at the end of this year.  No Congressman need to come out publicly to kill it and no political cost for doing so need be incurred.  Silence here really is golden.
  • Farm state losers from ethanol policy are growing.  Old arguments that ethanol subsidies universally helped farmers no longer apply.  Rising corn and other commodity prices have driven up feed prices and marginalized much animal production.  With roughly 40% of the nation's corn crop directed towards mandated fuel markets, the tensions are rising.  There is no longer a farm-state consensus on what the properly policy should be.  This gives politicians of all stripes the cover to let VEETC die.
  • Greener fuels benefit from having VEETC gone.  The RFS at least attempts to differentiate environmentally-harmful biofuels from others.  Not so for VEETC:  the blenders credit could still be taken even if the ethanol were made from a special mix of these threatened and endangered plants, from liquidating Pacific Lumber's redwood stands (which are now, thankfully, sustainably managed), or from corn produced unsustainably on erodible land.  But liquid biofuels were always sold to the public as green fuels, and killing VEETC is a good way to move in that direction.

So when we kill VEETC, were are not really taking away dessert from the farmers.  Right now, dessert comes in the form of a big slice of chocolate cake (VEETC) plus a dab of vanilla cake (RFS RINs).  After the demise of VEETC, there will be no more chocolate cake, but the slab of vanilla will be much bigger.  Alas, the staunchest ethanol supporters, such as Senator Charles Grassley, seem to like big pieces of both chocolate and vanilla best.  Perhaps they are worried this would lead to an all out attack on all of their other subsidy programs.  But when bond experts begin shorting Treasuries, it is time to put the interest of the country a bit higher on the agenda of what, after all, is supposed to be a national body.  Of course, that agenda does need to include slashing all sorts of other subsidies that now riddle our tax code; but doing the easy ones should be...easy.

Grassley's compromise -- to reduce VEETC a little bit and to drop it even more when oil prices are high -- isn't really a compromise.  In fact, the RFS mandates and the tradable RINs on those mandates already do this automatically.  When oil prices are high, demand for ethanol is high as well, and RIN prices drop to zero or nearly so.  When oil prices are low, they do the reverse.  In all markets, the mandates provide a floor to investors that has greatly reduced the financial risk and financing cost to build new plants.  There is no need for the parallel system.

The very fact that Grassely is coming out with this proposal, and that both Growth Energy and the Renewable Fuels Association are at least posturing to support it, indicates how very weak the industry position really is.  Note, however, the final paragraph in the Reuters story:

The Grassley bill would also provide incentives to help the ethanol industry transform with new infrastructure to get biofuels to market. So-called blender pumps which allow customers to chose the blend of ethanol they want in their cars would benefit.

This is the other fallback position of the industry.  We'll give up our tax credit (that is already duplicated by the RFS) and in return, you'll help us pay for infrastructure we want.  Unfortunately, that is infrastructure that the market demand doesn't seem to think is worth buying on its own.  It is infrastructure that allows consumers to boost the ethanol blends in their cars above the allowable limit at the mere spin of a dial.  And it is infrastructure that will further lock in ethanol fuels over "drop-in" biofuel formulations such as biobutanol, though the drop-in fuels don't need new vehicles, pipelines, and refueling pumps at all. 

VEETC should be allowed to die, with no extensions and no side-payments.


Related document:  Biofuel Subsidies: An Overview, presentation at the Biofuels Policy Forum, April 14, 2011 in Washington, DC.


Earth Track Blog Post

During the early part of 2010, when the volumetric ethanol excise tax exemption (VEETC) looked like it was heading towards elimination, ethanol industry contortionist Bob Dinneen of the Renewable Fuels Association worked hard to paint the subsidy as vital to all things American.  In yet another RFA-sponsored study by the industry's favored economist John Urbanchuk, RFA set out to quantify the bad things that would happen if VEETC expired.  They came up with quite a list, summarized by Ethanol Producer Magazine:

If VEETC is allowed to lapse, the study said, the price to producers would be reduced by 27.4 percent, resulting in a nearly 38 percent cut in supply by producers...

If the VEETC is eliminated, the immediate impact on the industry is expected to be severe," the study said. "A significant amount of capacity would likely go offline quickly. Some of that capacity may come back online as prices rebounded to an equilibrium point, but most of the lost production would not come back.

In Dinneen's own words:

Failure to provide the kind of assurance investors require to continue building out this industry by extending the tax incentives would be shortsighted, relegating future generations to a reliance on both foreign oil and foreign renewable fuels.

With such dire outcomes, how could Congress even consider stripping away the multi-billion dollar tax break? 

The manner in which the RFS and blending subsidies interact, however, paints a very different picture of the likely impacts from elimination.  The RFS sets a mandated consumption floor for favored fuels, in good times or bad, high corn prices or low.  This is great protection if you are an ethanol producer, though quite bad if you happen to be a member of the urban poor in the developing world trying to buy corn for food.  Because the RFS creates a price-insensitive mandate, the rising feedstock prices would not divert supply from fuel to food markets as quickly as without the mandate.  This increases the likelihood of rich world fuel markets outbidding developing world urban poor looking to buy corn to eat.  Not a great dynamic. 

But back to US fuel markets though.  The RFS generates a market-clearing price for providing a pre-set number of RFS-compliant gallons.  With a few exceptions (such as biofuels so environmentally-challenged they can't even meet the weak RFS2 ghg reduction standards), these are the very same gallons eligible to meet the RFS2 mandates. 

So how would the policies overlap?  For a given production cost structure, gallons earning a 45 cpg tax credit are able to remain in production at a lower RFS credit value than would be possible for them to do without the tax credit.  (The RFS credit value in the US is referred to as the RIN value, which is short for "Renewable Identification Number," the accounting units the program uses for RFS-compliant gallons).  Pull the tax credit and the equilibrium RIN prices will rise more or less the same amount.  Increase the credit and the equilibrium RIN prices are likely to fall in response.

And, despite the claims of Urbanchuk and Dinneen, this is exactly what seems to be happening.  Here's an article on what's happening in the biodiesel sector, from Biodiesel Magazine in November 2010:

Although the U.S. biodiesel industry has struggled since the lapse of the $1 per gallon tax credit, renewable identification number (RIN) prices are currently trading high enough to fill that void. One factor that seems to be contributing to the relatively high price of RINs is the volume requirements mandated by the U.S. EPA under the renewable fuel standard (RFS2)...

According to Sam Gray, a renewable fuels trader with VICNRG LLC, 2010 biodiesel RINs hit an all-time high on Dec. 8, trading at 96 cents per RIN. Since each gallon of biodiesel that is produced generates 1.5 RINs, that equates to $1.44 per gallon, which more than offsets the lost value of the expired $1 per gallon biodiesel tax credit. [Emphasis added]...

Current market conditions seem to be indicating tight biodiesel supply in 2011, leading to relatively high RIN prices, but McMartin and Gray agree that this will change if the biodiesel tax credit is reinstated. "If that $1 comes back, there is no way RINs can remain high, the market just wouldn't allow it," Gray said. "The market will correct that, so if the dollar comes back, you are going to see a large percentage of that dollar proportionally wipe away the 2010 and 2011 RIN value."

The policy take-away here?  The very least Congress can do here is kill the blenders' credits permanently.  No transformation of the credits into new or bigger subsidies, such as to ethanol refueling infrastructure and pipelines as industry group Growth Energy has advocated; just kill the blenders credits because doing so will save taxpayers lots of cash, and will have virtually no effect on market structure anyway.

Earth Track Blog Post

Last April when dried distillers grains DDGs started showing up in far flung markets, the industry touted it as an example of their global competitiveness.  I was thinking subsidy arbitrage was more likely.  Seems like the subsidies are closer to the truth.  Philip Brasher summarizes the pending trade case launched by China for dumping DDGs.  He notes that the case is likely retaliation for a case the US launched against China for subsidies to renewable energy industries such as wind and solar.  It is likely that both the US and Chinese cases have merit, and that the existing subsidies do, indeed, result in substantial distortions in trade patterns.  It is also likely that politics, rather than economics, is more likely to drive their resolution.

Earth Track Blog Post

The march to E15-ity and beyond continues, with DOE submitting vehicle tests for how older cars performed with the higher blends of ethanol.  EPA allowed blends up to 15% for model 2007 and later vehicles in October 2010, and is expected to rule on earlier models (2001 and later) this month.

A few elements of this whole issue continue to puzzle me.  First, with DOE a strong proponent for ethanol blends for so long, was there no more neutral party to test the impact of the blends on vehicles?  Second, Reuters notes that EPA delayed its decision on later model cars "after the Energy Department said it needed to redo several tests because some of the cars were not properly prepared." While Reuters says that "the additional testing was not directly related to the E15 fuel," I could not locate information from DOE on what exactly the proper preparation was related to.  I wonder if this argument would work when my kids take their SATs?

In related news:

  • Domestic production of ethanol, the vast majority of it from corn, reached an all time high of 27.4m barrels in October 2010.  This underscores the industry pressure to boost mandated consumption of ethanol fuels as much as possible.  There was no imported ethanol that month, though exports of the subsidized fuel were way up year-on year.  It's simple subsidy arbitrage. 
  • Fuel ethanol now using nearly 40 percent of the US corn crop.  The larger the share of corn absorbed to make fuel ethanol, the more important the many subsidies to corn production become to the economics of fuel ethanol.  These include large subsidies to irrigation, corn production, and poor control of nutrient runoff of corn fields that are heavily polluting the Gulf of Mexico.
  • The US auto industry has joined a growing array of affected parties suing the government on the E15 rule.  Since the auto makers get not a penny from the fuel you put in your car, one would think that perhaps there are real engineering and performance issues they are concerned about.  As far as I know, neither Bob Dineen or Matt Hartwig at RFA have taken up my 2009 suggestion to put their personal assets as collateral should the higher blends they are pushing so hard for do end up damaging the vehicles -- among the most expensive assets most Americans own.  It's simply aligning interests; and if the risks of damage are as low as they say, it should be an easy bet for them to make.   
  • The final rule for the Biomass Crop Assistance Program (BCAP) was released a few months back.  BCAP provides subsidies to farmers for producing feedstocks they convert into "environmentally-preferable" second-generation cellulosic ethanol.  To be effective, BCAP subsidies need to outbid the subsidies to farmers already get for current production patterns, such as land used to produce corn and corn ethanol.  It's an ironic policy twist that has the government bidding against itself.  However, the final rule does not ensure that subsidized production is actually done in a sustainable manner.  In fact, only intense lobbying protected the bark and mulch industry from losing feedstock to subsidized fuel production. The subsidization of energy conversion undermining other uses of raw materials is not a new issue.  The soap and detergent industry was harmed by subsidies to biodiesel undermining their purchase of fats and oils.  Similarly, widespread subsidies to energy generation in basic industries such as paper and steel, and to landfill gas and waste-to-energy facilities all undermine the markets for recycling secondary materials since the recovery of the embedded energy these materials contain becomes less valuable.
  • Fox News rags on Al Gore for reversing his position on ethanol, now recognizing they are very much a mixed bag environmentally. Would I have preferred Gore do this some years ago?  Sure.  But I'm glad he is doing it now.  And I would welcome a similar reversal by Fox News on nuclear power, recognizing that it, too, should not be a kept industry of the federal government existing merely due to its access to the flow of federal support.
Earth Track Blog Post

Spineless subsidies part 1:  Ethanol

Ethanol blenders credit moves forward towards extension at current rates in the Senate.  Even more ludicrous since even without the excise tax credit subsidy we are still forced to buy the stuff at above market prices under the federal Renewable Fuel Standard.

Chuck Grassley makes a good point when he argues that you can't treat ethanol and oil subsidies differently:

The fact is, it's intellectually inconsistent to say that increasing taxes on ethanol is justified, but it’s irresponsible to do so on oil and gas production.

Grassley, a strong supporter of everything corn, uses this logic as a justification for keeping all subsidies.  Of course, the logic is even stronger in the other direction:  get rid of all of the subsidies -- to oil and gas as well as to ethanol.  Large fiscal and environmental benefits.  Such broad-based reform is difficult, to be sure.  But there have been successes.  New Zealand, for example, got rid of a wide swath of sectoral subsidies. 

Domestic producers will see little change in their subsidy capture once the Renewable Fuel Standard mandate premiums rise to offset the decline in excise tax credit subsidies.  Thus, Grassley's arguments about domestic energy security seem a bit hollow.  What then?  Perhaps it is the fact that without VEETC, producers can't export taxpayer subsidized ethanol to other countries.  Robert Rapier did a nice write-up of this issue on his R Squared blog.

Spineless subsidies part 2:  Nukes

In the House, legislation kicking in another $7 billion in loan guarantees for new nuclear reactors has passed.  It's another "opportunity" for taxpayers to participate in building what industry regularly claims to be a low-cost energy resource over the long-term.. Seems like the massive bailouts of the last two years have made people forget that a $7 billion investment into a private firm is hardly the norm throughout the history of the United States.

Think the money is safe?  I don't.  In other nuclear industry news:

  • The Oyster Creek Plant in NJ will close early rather than properly manage its water use (virtually every one of the billions of gallons of water used per day at reactors across the country is free).  
  • The EIA's capital cost estimates for new nuclear plants are up 37% since last year -- despite a recession that has dampened construction costs generally and reduced pressure on the nuclear power supply chain.
  • Westinghouse has provided its Chinese partners with key technical documents on its designs.  They, and all of the other vendors competing for market share in the heavily state-subsidized Chinese nuclear power sector, fully expect their IP to be appropriated and applied by domestic Chinese competitors in short-order.
  • Key nuclear plant owner Exelon acknowledges natural gas will be their first choice to fill new generation needs (page 1) and that not much new generation is needed right now anyway (page 2).  And, despite ignoring many of the embedded subsidies to the nuclear fuel cycle, Exelon's new ghg abatement curve is still placing new build nuclear well behind many other options (page 6).

 

Using Biofuel Tax Credits to Achieve Energy and Environmental Policy Goals

The federal government supports the use of biofuels—transportation fuel produced usually from renewable plant matter, such as corn—in the pursuit of national energy, environmental, and agricultural policy goals. Tax credits encourage the production and sale of biofuels in the United States, while federal mandates specify minimum amounts and types of biofuel usage each year through 2022. Tax credits effectively lower the private costs of producing biofuels relative to the costs of producing their substitutes, gasoline and diesel fuel.