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.