Taxpayer Supports for Corn Ethanol in Federal Legislation April 2013

Since its creation of the domestic market for corn ethanol after the energy crisis of the 1970s, the federal government has nurtured and maintained the ethanol industry with a steady stream of subsidies. Originally sold as a way to achieve energy independence and reduce greenhouse gas emissions, ethanol has been a favorite of many lawmakers: ethanol producers have received favorable treatment under the tax code, tariff protection from foreign competition, and even a government mandate for its 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.

Natural gas fracking well in Louisiana

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.