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.

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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.

Despite pushing up food prices and having unintended consequences for the environment, the U.S. Environmental Protection Agency (US EPA) recently reiterated its support for ethanol. President Obama also promised continued investment in advanced biofuels in his recent State of the Union address.

Bad Economics

A leaked paper on the 2007/2008 food crisis by the World Bank Development Prospect Group estimated that U.S. and European Union biofuel production was responsible for 75% of the price rises–a far cry from the 3% estimate by USDA.

Biofuels from crops like corn, sugar, and palm oil have more than tripled since 2000. In accordance with its 2007 energy bill, America is targeted to increase biofuels production to 15 billion gallons by 2012 and 36 billion by 2022, up from the current 10.6 billion. Of that 36 billion, ethanol is capped at 15 billion gallons.

Just last month, US EPA announced that despite doubts as to its energy and environmental record, they would still support further ethanol production. The new guidelines will allow for the production of an additional 2 billion gallons of corn ethanol and potentially much more.

These subsidies are about political pandering, not cutting greenhouse gases.

The EPA admitted that a considerable amount of current ethanol production would, as a result, fail to meet the 20% reduction criteria. It is difficult to see on what grounds these subsidies to biofuels can be justified–if not outright agricultural protectionism.

We should also bear in mind the other renewable or carbon-mitigating technologies that are being sidelined as massive hand-outs are given to biofuels. There is a real risk that resources, skill, and time are being diverted from potentially promising technologies to subsidize biofuels.

A recent report by Rice University (Texas) found that the U.S. spent US$4 billion on biofuel subsidies in 2008 to replace a mere 2% of the US gasoline supply. It estimates that this costs taxpayers about US$82 per barrel, or US$1.95 a gallon more than the retail price of petroleum fuel. By 2022, US biofuel subsidies will have totaled US$400 billion, according to environmental pressure group Friends of the Earth.

The EU is no better, however, giving around €3.7 billion (US$5.2 billion) in biofuel subsidies in 2007, aiming to replace 5.75% of transport fuel by the end of 2010.

The condition underlying the increase is that future ethanol production must have emissions 20% lower than gasoline. The US EPA says that this could increase farm incomes by $13 billion by 2002 and reduce oil consumption as well as greenhouse gas emissions.

However there are good reasons to remain skeptical of the US EPA’s projections. The new rules requiring 20% lower emissions compared to gasoline only apply to future ethanol production – 13 billion gallons already or soon-to-be produced are exempted.

The US EPA admitted that a considerable amount of current ethanol production would, as a result, fail to meet the 20% reduction criteria. It is difficult to see on what grounds these subsidies to biofuels can be justified – if not outright agricultural protectionism.

Environmental Waste

On top of wasted taxes and higher food prices, biofuels make little environmental sense. Specifically, production in the U.S. and the EU can release more emissions than it avoids. Nobel-Prize-winning chemist Paul J. Crutzen estimates: 

For rapeseed biodiesel, which accounts for about 80% of the biofuel production in Europe, the relative warming due to N₂O [nitrous oxide] emissions is estimated at 1 to 1.7 times larger than the quasi-cooling effect due to saved fossil CO2 [carbon dioxide] emissions. For corn bioethanol, dominant in the US, the figure is 0.9 to 1.5.

Although the United Nations Food and Agriculture Organization sees little chance in the near future of another “concurrence of so many factors” that caused the food crisis, there is no room for complacency. Food prices are taking a long time to fall (corn is still 50% above its 2003-2006 average), while the number of hungry people recently topped one billion. This is a worrying trend as there has been an increase in both the absolute number and the percentage of hungry people, reversing decades of progress.

Ethanol already takes up 27 million acres out of the 90 million acres of corn in the USA:  from 2006 to 2008, the World Bank’s Food Price Index doubled.

If biofuel was about the environment, the U.S. would not impose tariffs on environmentally-friendly ethanol from Latin America and the Caribbean. Likewise, new EU tariffs are clearly aimed at American producers who send 95% of their biofuel exports to Europe.

Another environmental problem is the fear that natural habitats will be converted to farmland to take advantage of biofuel subsidies. The diversion of existing U.S. cropland to biofuels has shifted soybean production to South America and Indonesia, encouraging deforestation. On several occasions, ethanol supporters in Congress and the Senate have tried – and failed – to stop it from taking into account international land-use changes when assessing ethanol.

Nor do biofuels save energy. Some varieties require as much to grow, transport and process as they release when you burn it.

Bad Prospects

And according to United Nations Conference on Trade and Development, at oil prices below $70 per barrel (the recent range is US$70-85), corn-based ethanol struggles to compete without subsidies.

The U.S. and the EU claim “second-generation” biofuels from plant cellulose or waste will help achieve their stringent self-imposed “renewables” targets but this is a nascent industry that has yet to deliver value for money. Yet the USDA has already issued new guidelines to encourage farmers to grow crops for “next-generation” biofuels. The EU said it would reconsider biofuels following the food crisis. But there is powerful pressure from farm lobbies in both places.

Conclusion

Agriculture faces many difficulties, from how to establish land rights to how to disseminate technology or adapt to climate change. But the biofuel problem is a no-brainer.

Creating an artificial market with subsidies is no way to reduce emissions, save rainforests or feed the poor. Biofuel subsidies are just a Green handout to farm lobbies in rich countries:  it is time to end them.

Caroline Boin is a Project Director at the International Policy Network, London, a London-based independent think-tank working to promote economic development via free markets and free trade.