A free-market energy blog
Random header image... Refresh for more!

Biofuels as America’s Biggest Loser (with apologies to NBC)

Biofuel mandates in the U.S. suffer from a high-octane blend of politics and special interest agendas that have corrupted physical science, economic analysis, and the policy prescriptions alike. This is the predictable outcome when process and policy are de-linked from basic economics and marketplace realities. Unintended consequences and distortions always result.

Historian, professor and author Burton Folsom in his book, The Myth of the Robber Barons, makes an important distinction between “market entrepreneurs” and “political entrepreneurs.” Market entrepreneurs compete by utilizing their own funds, resources and private investment in an effort to create and market a superior product. Political entrepreneurs, on the other hand, fund their business models off of government subsidies, federal protections and vote buying.

This is a useful distinction to keep in mind when evaluating the perverse outcomes of the subsidized U.S. ethanol industry where the participants consist mainly of political entrepreneurs.

Baker Institute (Rice University) Study

Corn-based ethanol and other U.S. feedstock biofuels programs are not supportable on economic, environmental nor logistical grounds. That is the conclusion of a recent comprehensive study by Rice University’s James A. Baker III Institute for Public Policy, Fundamentals of a Sustainable Biofuels Policy. This report was previously cited by Ms. Caroline Boin in her recent post, in which she correctly labels the U.S. biofuels program a “scam” and little more than a sop to farm lobbies and corporate agri-business interests. In short, the Baker Institute study represents a clear indictment of the nonsense that passes for federal energy policy.

One key recommendation from the study is that Congress reconsider its biofuels volume mandates outlined in the Energy Independence and Security Act of 2007.

EISA called for production targets of 9 billion gal/year of biofuels in 2008 increasing to 36 billion gal/year by 2022. Corn ethanol is capped at 15 billion gal/year of this total but even that will be nearly impossible to reach due to significant logistical and commercial barriers that exist (aside from the fact that virtually no environmental benefits are derived from ethanol).

The Baker study identifies multiple reasons to question achievability of mandated volumes, claims of energy independence and alleged environmental benefits cited by ethanol advocates. A few are outlined below.

Subsidies, Tax Credits and Protectionism for Ethanol “Political Entrepreneurs”

Ms. Boin previously highlighted the study’s revelation that a whopping $4 billion in 2008 subsidies were required to replace a miniscule 2% of U.S. gasoline supplies. The first logical reaction is how a program could deliver so little bang for the buck, especially when “energy independence” is supposedly one of its cornerstone objectives.

Part of the answer to this embarrassing substitution level can be linked to previous Congressional and EPA miscues. Many readers may recall the introduction of MTBE (methyl tertiary butyl ether) in the late 1990s as an EPA-approved additive to gasoline. It was approved to blend with gasoline in order to attain new federally mandated specifications to oxygenate gasoline in order to meet more stringent air quality standards. MTBE turned out to be fraught with detrimental environmental effects. It was determined to be easily soluble in water and toxic. Its eventual presence in groundwater systems raised red flags and its use was abandoned under threat of product liability lawsuits.

Thus, a large portion of current ethanol production must go to replace MTBE as an additive. The Baker Institute study notes that in 2009 the U.S. produced ethanol at a run rate of about 10.4 billion gallons annually, mainly from corn. However, about 6 billion gallons per year are needed to replace MTBE as a blending agent, leaving only about 40% of annual production to displace gasoline. Further, even this meager substitution level is overstated. Why? The study points out that ethanol has a lower energy content than traditional gasoline, requiring more fuel to travel an equivalent distance. Thus, there is no gallon-for-gallon substitution ratio of ethanol to gasoline. Therefore, ethanol is only displacing about 185,000 b/d of gasoline compared to an average 9 million b/d demanded. Ethanol fails on the “energy independence” argument.

To fully appreciate the total subsidized cost of ethanol, one must take into account both federal tax credits provided to blenders and tariffs imposed on imported sugarcane ethanol. Blenders originally received a $0.51/gal. direct tax credit which was reduced to $0.45/gal in the Food, Conservation, and Energy Act of 2008. According to the study, about $3.2 billion in tax credits were provided to blenders in 2007. This meant that an incredible 76% of all funds allocated by the federal government for all renewable energy projects went to gasoline blenders to support the introduction of ethanol into the transport fuel market.

Regarding tariffs, it is widely known that sugarcane based ethanol is superior in terms of energy content and on average 30% cheaper to produce. Brazil is the world’s largest sugarcane producer and produces large amounts of ethanol for both domestic consumption and export. Brazil is now the world’s largest exporter of ethanol.

Too bad the U.S. doesn’t see much of Brazil’s surplus. The basic economic concept of comparative advantage alone would dictate that the U.S. end its corn-based ethanol program immediately and import sugarcane ethanol, saving our economy billions of dollars. Instead, the inefficient and economically and environmentally damaging corn ethanol program is subsidized then protected from more desirable product. This is the triumph of politics over economic common sense.

The current tariff on imported sugarcane ethanol is $0.54/gal. plus an additional 2.5% ad valorem tax. Given the advantageous production cost differential between sugarcane ethanol vs. corn ethanol, the tariffs ensure corn ethanol gets the priority. It also ensures the U.S. economy and taxpayer become poorer so farm-related special interests can thrive.

Logistical Barriers

Now that our government has heavily subsidized and protected ethanol as a fuel source, its use should be fairly ubiquitous, right? Wrong. When one creates a distorted “market” the unintended consequences and miscalculations are sure to be plentiful. In addition to an inability to meet mandated production volumes outlined above, transportation costs, supply bottlenecks and other logistical impediments keep many states from being able to increase their ethanol consumption.

Since production of ethanol is concentrated in the Midwest, distribution systems to other parts of the country, especially the coasts, where most of the nation’s gasoline is consumed, are not developed. As a result, the study points out that the majority of states in areas farthest from the Midwest have not achieved recommended 10% ethanol content levels. In fact, as of 2008, not one region of the country achieved the average of 10% ethanol motor fuel use. Removing tariffs on sugarcane-based ethanol could solve this deficiency, especially at the coasts of the U.S., where the major ports located.

The study notes that gasoline is transported very cheaply around the U.S. via pipelines from refineries to local distribution centers where trucks are loaded for short-range delivery to local stations or directly to industrial consumers. The study points out there are an estimated 160,868 miles of liquid petroleum pipelines for transport of traditional fuels. The extensive system means traditional gasoline can be transported for pennies per barrel. By contrast, zero ethanol is shipped via this same economical system in the U.S. due to fuel quality and pipeline integrity concerns. Instead, ethanol transport is handled by rail (60%), trucks (30%) and barge (10%) further adding to the cost of delivered product.

In addition, aside from the major distribution infrastructure deficiencies, our federal policy geniuses failed to consider an even more basic impediment to exceeding 10% ethanol-blended fuels: Automobile manufacturers will not extend warranties on engines or parts in vehicles that use more than 10% ethanol content in fuel. The only exception is flex-fuel vehicles (FFV) designed to run on E-85 (85% ethanol content). Unfortunately, FFVs represented only 3% of the car fleet as of March 2009. Oops.

Environmental Benefits Lacking

Alleged environmental benefits of ethanol are mostly unfounded. Studies reveal that the production and use of ethanol are not carbon neutral, whether corn-based or other cellulosic fuels are used. As noted earlier, evidence shows that existing biofuels provide no performance improvement over traditional gasoline and once land use changes are taken into account, there is no basis to support ethanol on environmental grounds. In addition, the amount of acreage required to be devoted to growing corn in order to meet volume mandates carries its own negative environmental impacts including groundwater contamination from fertilizer runoff which threaten ecosystems and fisheries along the Mississippi River and the Gulf of Mexico.

Conclusion

Ethanol production is economically unsound and makes the U.S. poorer as a result. It is arguably one of the most heavily subsidized energy programs of all times. The huge diversion of funds and resources to protect and prop up an industry that on balance degrades the environment, does not make us less dependent on foreign energy, and cannot deliver on volume mandates is a dysfunctional energy policy.

In private industry, when few to zero of one’s stated objectives for a major project are achieved, while burning through an organization’s resources, you are typically fired. But under the perverse incentive system of government, lacking accountability and with few repercussions for failure, even when documented on a massive scale, it’s more likely one will receive a budget increase to implement new mandates to “correct” the previous failures.

Albert Einstein is credited with stating; insanity is doing the same thing over and over again and expecting a different result. U.S. biofuels policy is eminently qualified as insane.

——————–

William Griesinger (B.S., Indiana University; MBA, Ball State University) is a director with BlueCrest Capital Finance in Chicago. His background includes all facets of business development, loan structuring, credit underwriting, transaction approvals and legal documentation, portfolio management, and loan work out and restructuring experience within the corporate banking, commercial finance and technology finance industries. Energy is one of his primary sectors of interest.

Mr. Griesinger’s public-policy interests include tax policy, education, energy, and the environment. This is his first blog at MasterResource.

10 comments

1 Jason Barton { 03.25.10 at 12:12 pm }

Hi Bill,

Thanks for your thoughts. As always, it’s great to hear from you.

The distinction made by Folsom between market and political entrepreneurs is an insightful and important one. It’s always interesting to me when people talk about ‘demand for ethanol,’ when, really, there would be almost no demand for ethanol without government mandates, both in the U.S. and here in Brazil. I’ve also often wondered about the validity of purported benefits of ethanol production, both in terms of their environmental merits and their benefits to rural economic development.

My approach, however, is not to question the wisdom of Bush’s 2007 Energy Independence and Security Act, the law that establishes the Renewable Fuel Standards and biofuel use mandates you discuss in your post, but to focus on the question, if we’re going to meet these mandates, if and how Brazilian cane ethanol might fit into this picture in ways that are beneficial to Brazil?

The report by the Baker Institute and Rice U. also provides great food for thought. A source not cited there is the article by Eaves and Eaves (Renewable corn-ethanol and energy security,” 2007) which points out that, with the immense fossil fuel demands of corn production, corn ethanol will do little or nothing to reduce our dependence on fossil fuels or imported sources of energy.

As for your question about if or when the tariff on imported ethanol might be reduced, that’s anybody’s guess. Many Brazilians in the industry here point to the entrance of major petroleum companies BP and Shell into the Brazilian ethanol market as an indication that this tariff may indeed soon be lowered. These companies, they claim, have at least as much power as the influential corn growers’ lobbies, and so may be able to weigh in, especially in light of the EPA’s recent RFS2 announcements approving Brazilian cane ethanol as an “advanced biofuel.”

Keep in touch, and keep me posted on your work!

Cheers,
Jason

2 Alan F { 03.25.10 at 2:07 pm }

Not only in America as I look at such a waste once a week here in good old Saskatchewan. A multimillion dollar biofuel waste of stainless steel and real estate that is now and likely forever attached itself to the government/tax paying public teat. Its entire feasibility was based upon $140+ dollar a barrel oil and the premise that each and every one of us likable/gullible Canadians would place buying expensive green tech before that of purchasing ALL ELSE necessary to sustaining our polite existences! Go green eh?

3 Consumer Energy Alliance { 03.25.10 at 2:37 pm }

There is no one quick-fix for weaning ourselves off of fossil fuels and we will have to focus on the policies which ensure a balanced combination of alternative energy sources, including wind, hydro, solar and biofuels, while also maintaining access to traditional resources, including oil and natural gas. The hard reality is that we also need to reduce our energy consumption through greater efficiency and conservation efforts, not just replace it with something else. CEA believes that biofuels have great potential to contribute to America’s overall energy resources.
Want to learn more about balanced energy for America? Visit http://www.consumerenergyalliance.org to get involved, discover CEA’s mission and sign up for our informative newsletter.

4 Jon Boone { 03.25.10 at 8:52 pm }

The Consumer Energy Alliance statement here does nothing but shill for a disturbing concept, namely that “every little bit of ‘alternate’ energy” helps our electricity portfolio and is good for consumers. Nonsense. Wind technology in particular is demonstrably dysfunctional, reducing productivity and efficiency all around, making everyone and everything around it work much harder just to stay in place, while costing consumers more as they get less. As for corn ethanol, which reduces efficiency and performance while threatening the integrity of machine engines, lessening the food supply, and depleting millions of acres soil and siphoning off a sea of water–for shame. These are hardly alternate energy sources, demonstrably so, since they haven’t shut down any conventional source of power–and they aren’t going to do so, ever. What they both represent is bunco.

5 B.T. { 03.26.10 at 11:42 am }

That there are “Political entrepreneurs” who “… fund their business models off of government subsidies, federal protections and vote buying.” should be no surprise. It has always been so.

“There are two methods, or means, and only two, whereby man’s needs and desires can be satisfied. One is the production and exchange of wealth; this is the economic means. The other is the uncompensated appropriation of wealth produced by others; this is the political means.” – Albert Jay Nock, “Our Enemy, the State”, 1935.

I’m quite sure that Nock was well acquainted with Frederic Bastiat’s “The Law” (1850), as well. One of the key themes of this work is the subverting of the economic means by the political, which we are reaping the results of today, in spades.

None of this is new. Alas, we have such a dumbed-down, government-schooled (not a disparagement of any one in particular, just an observation – I was, myself, a public school attendee), electorate that they cannot see that this perversion of justice stands against their own self-interests. No side in today’s politicized debate seeks to restore true justice to its preeminent place in the social order, but each seeks to bend law to serve it’s own political interests. It’s become Institutionalized Plunder, no matter who sits in the seats in Washington, District of Criminals – as Bastiat so eloquently stated it 160 years ago.

If it cannot be stopped, there is only one outcome …. collapse.

6 Robertg { 03.26.10 at 7:56 pm }

Biofuels were pushed by environmental groups. That should have been a giant red flag to all that the claims were not true. Face it after the global warming scam I can’t believe anybody would believe anything any environmental group ever says again.

7 Ron { 03.29.10 at 12:33 am }

In answer to those people who blame environmental groups for bad biofuels policies, I suggest they look at the legislative history of biofuel policy in Brazil, Canada and the United States. Behind every mandate and subsidy — particularly in the early days, and now with attempts to extend the blenders’ credit for ethanol in the United States through 2016 — you will find powerful agri-business interests (e.g., Archer Daniels Midland), oil companies (e.g., Shell, Suncor and Huskey in Canada), political entrepreneurs (e.g., Vinod Khosla in the United States, Kenneth Field in Canada) and of course the farmer lobby itself.

That some major environmental groups (some in the Sierra Club, but by no means all) bought into the hype is unfortunate, and in the 1990s and through about 2006 they certainly were chearleaders for biofuels — often for cynical reasons (e.g., because they thought it would enjoin the powerful farmers’ lobby in their fight against climate change).

But reality, as it often does, hit the environmenta movement in the face. With mounting evidence of the environmental downsides of biofuels, their extremely poor cos-effectiveness in reducing greenhouse-gas emissions, and their link to higher food prices, environmental groups have, for the most part, dropped biofuels like a hot potato. Environmentalists should at least be given credit for changing course in light of new information, though I would agree that many of the so-called unintended consequences of biofuel policies could have been predicted from the start.

8 Ron { 03.30.10 at 11:13 am }

A bipartisan bill (Pomeroy-Shimkus) has been introduced into the House of Representatives that would: (a) extend the current $0.45/gallon Volumetric Ethanol Excise Tax Credit (VEETC) for another five years; (b) extend the $0.10/gallon Small Ethanol Producers Tax Credit for another five years; (c) extend the $0.54/gallon tariff on imported ethanol for another five years; and (d) extend the $1.01/gallon Cellulosic Ethanol Production Tax Credit for another three years. These tax incentives and the tariff are all due to expire at the end of this year.

Said Rep. Earl Pomeroy (Democrat, N.D.): “At a time when our economy is struggling, we cannot afford to let these tax incentives expire and stymie the growth we have seen in our ethanol industry.”

Said Bob Dineen, President of the Renewable Fuels Association (RFA): “Allowing the tax incentives for ethanol to expire is simply not an option.”

Said Tom Buis, chief executive of Growth Energy: “Without the tariff, American taxpayers will be allowing foreign-subsidized ethanol to subvert American companies and American workers.”

I think I’m going to barf.

9 Chris { 03.31.10 at 2:49 pm }

The oil & gas industry can only blame themselves for having to use ethanol in gasoline. Few of you recall how the refiners wanted MTBE out of gasoline (it hurt profits since a good portion was coming in from Saudi Arabia or chemical companies on the US gulf coast). Instead of DEFENDING the use of MTBE, they opened the door for the farm lobby to put ethanol in gasoline. MTBE is used extensively in Europe (and elsewhere) with NO problems. MTBE is the finest gasoline additive known to man: sulfur-free, high octane, low vapor pressure (for gasoline), oxygenate, etc. We would still be using MTBE today if the program to fix/replace outdated (i.e., prone to leaking) storage tanks occurred in the 90′s instead of the early 2000′s timeframe. If you don’t believe me, read the Oil & Gas Journal editorials from that time period. Absolutely disgraceful.

10 Green Energy Proving Venture Capitalists are Smarter Than Government Bureaucrats. « AUSTRIAN ECONOMICS ADDICT { 09.30.12 at 9:37 pm }

[...] subsidies are running out (read about wind here), corn ethanol is literally eating your seed corn (read about ethanol here), and electric ears were discussed above. At what point do we quit putting our faith in all-knowing [...]

Leave a Comment