Tuesday, November 20, 2012

EPA Unwavering in Support for Ethanol, Despite Drought

Last Friday the US Environmental Protection Agency (EPA) rejected the petitions of a bi-partisan group of state governors for a waiver of the federal ethanol mandate, resolving one of several energy-related issues that had been deferred beyond the presidential election.  The waiver requests filed in August cited the harm that the Renewable Fuel Standard (RFS) is causing to the poultry, dairy and livestock sectors and related businesses--and by extension to consumers--by increasing competition for corn during a severe drought that has sharply constrained supply.  The EPA's detailed response made frequent references to the "high statutory threshold of severe harm to the economy" required for a waiver of the RFS, and to the output of a model simulating the market for corn and ethanol. It also included the extraordinary assertion that, "the RFS volume requirements will have no impact on ethanol production volumes in the relevant time frame, and therefore will have no impact on corn, food, or fuel prices."  If that were true, then it's not obvious why the mandate should exist at all.

In rejecting pleas for relaxation of the ethanol standard, the EPA appears to be relying on two key facts.  First, wholesale ethanol prices remain lower than wholesale gasoline prices, despite corn prices that are high enough to force many ethanol producers to cut back output.  I'd attribute that mainly to weak US gasoline demand and the much-discussed impact of the "blend wall" in limiting ethanol to 10% of the gasoline pool, rather than as a sign of an unaffected market.  The agency is also relying on the availability of "paper ethanol" in the form of Renewable Identification Number (RIN) credits from past over-blending of ethanol by refiners and other gasoline blenders.  The EPA's estimate puts the number of available RINs at the equivalent of 2-3 billion gallons, or around 20% of this year's 13.2 billion gallon conventional ethanol requirement. As a result of these factors, EPA can claim with some justification that ethanol prices are not harming motorists at the gas pump at this time.  That's small consolation to the petitioners.

EPA's assurances to those in the poultry, dairy and livestock value chains are based on much thinner evidence--in fact, on none at all, unless you count as evidence a model that predicts corn prices would only fall by $0.58 per bushel if the ethanol mandate were eliminated entirely.  Simulations are useful but still aren't reality. The output of a model is only as good as its assumptions and algorithms, and when that output defies logic, it calls for the application of good judgment, particularly when the result happens to align so neatly with the internal concerns about the long-term implications of a waiver that are evident in the agency's response.  I can't help concluding that an agency whose management possessed greater depth and breadth of experience outside of government--especially in the business sector--would have given more weight to the struggles of the dairies, ranchers, meat-packers and others who are being squeezed by a mandate that is projected to consume 42% of this year's corn crop and is very likely inflating the cost of the Thanksgiving meal that many of my US readers will eat on Thursday.   This administration's lack of outside experience has been a glaring shortcoming that the President could easily remedy as turnover creates openings at the start of his second term. 

I can't say that I'm surprised by the EPA's ruling on the waiver requests.  I also can't help wondering whether it provides any indication of how the administration is likely to deal with the other issues that were deferred until after the election.  Yet even if we can't read anything else into this decision, it's clear that the Renewable Fuel Standard enacted in 2007--before the financial crisis and recession--is in serious need of reform.  If its language doesn't require the EPA to adjust the ethanol mandate in light of a drought that will result in the smallest corn crop since 2006, when US ethanol production was 65% lower than last year, then the law simply didn't incorporate sufficient foresight about possible future events.  Together with its unrealistically ambitious cellulosic biofuel standard, the provisions of the RFS increasingly seem to relate to some other, parallel universe, rather than the one in which we live.  


Anonymous said...

The EPA is not the only group to have come out with the conclusion that waiving the RFS would have small effects. Purdue University and Iowa State University both released notes showing that a waiver would have a 5.6% and 7.4% price reduction effects, respectively, so long as the EPA allowed the continuing use of RIN credits from previous years.

I cannot find my link to the Purdue Study, but the Iowa State study is here:

As a meta-note, I cannot understand how one can epistemeologically call the USDA's reliance on a forecasting model "[no evidence] at all" when it defies your own intuition, but then bank on that same level of evidence - in fact, less - to justify a waiver. I understand that you are a policy commentator and should not be going into detail in this post, but saying "I disagree with this model's conclusions, therefore the model must be flawed" is a very weak argument; even a reference to disagreements in the details too arcane to discuss in this post would be stronger.

Geoffrey Styles said...

I don't normally respond to anonymous comments, but this one raises a point that I had considered exploring at greater length in the post, and an important one. It starts with a basic distinction between facts and analysis. A model is not a fact; it is analysis, and the accuracy of that analysis can only be inferred after the fact, when enough facts have accumulated against which to compare its output. (By then it may be too late for those who were asking for relief.) That doesn't make it useless, but it does render it less useful in a situation like this than the other, actual evidence available to the EPA.

The petitions of the governors, at least the ones I read, referred to specific harm to specific sectors of their states' economies. Rather than relying on a model of these interactions, a more pragmatic-minded EPA might have assembled data on the changes in profitability, employment and other metrics of the various sectors affected. In order to separate effects that were related only to the drought but not to the competing appetite of ethanol plants for a shrinking corn supply, it could have looked at other sectors in those states that were affected by the drought but not reliant on corn or other crops used in biofuels. The Iowa State model could have been used in conjunction with such data and analysis to provide additional insights, but relying on it alone to render judgment on the impact of the RFS suggests an unhealthy degree of detachment from actual events, particularly when there's a good chance that your policy is compounding the harm to people who are already suffering from the drought.

As for the argument that illogical model outputs suggest flaws in the model, isn't that a routine basis of testing models? When the output doesn't make sense, it's time to start digging through the assumptions and algorithms to see why the result is so counterintuitive. In some cases you find that the model is capturing a crucial relationship that wasn't obvious, but as often as not, in my experience, it suggests that the modelers missed something important.

You referenced RINs, and the EPA could have made much make more of this in their response. In my view as a former trader, one of the strongest arguments they'd have had for rejecting the waiver requests relates to the integrity of the RIN program. Who would buy a RIN if they thought that the first time it was really in demand the EPA would waive the requirement that lends them value in the first place? Of course this is a very Wall St. vs. Main St. kind of argument, in terms of trading off harm, and it reflects a high-profile risk that any RIN buyer implicitly takes on and must factor into his valuation, so perhaps I shouldn't be surprised it wasn't the main plank of the response.

Anonymous said...

Thank you for your response. I have been a loyal reader for nearly two years (via RSS) but dislike posting using any publicly known online ID because I like to keep informal discussions and my professional relationships separate.

The way I read your clarification, what you are describing as the EPA's ideal course is not necessarily a repudiation of the model per se but a deeper economic impact analysis coupled to the EPA's price model. It may well have shown that a small reduction in price would have had a major effect on employment and profitability of other industries; it all depends on relative elasticities in various industries, for which I am sure there is substantial literature. I can't fault a desire for a deeper analysis with more emphasis on the economic fundamentals, especially if, as you say, the USDA essentially looked at the price decrease output of their model and callously said "no big deal."

You are indeed correct about the testing basis of any model that displays counterintuitive results. In this case, however, my contention is that others' intuition may not have been the same as your own - i.e., that reasonable people may disagree. The two corroborating studies from Iowa State and Purdue at least lend some credence to the USDA's conclusion, for example.

My own recent reading in the agricultural economics literature suggests that the dynamic effects of an RFS waiver would not result in a sharply lower maize price. A waiver would result in a lower overall maize crop in the US because of reduced discretionary fertilization and field maintenance in response to lower futures pricing, to name one example of such a dynamic effect.

Thank you for the point about
RINs. Since I approach the biofuels/biochemicals industry primarily from the process engineering perspective, that is the kind of insight I read you for.

Geoffrey Styles said...

The complexity here is daunting. I could see how a lower RFS could result in less planting or lower yields, though with regard to folks differing about what looks like a reasonable output, it might be useful to keep in mind that some of the highest non-drought corn prices have coincided with the growth of ethanol production, despite planting more acres and getting higher yields. For example, the Dec. 2012 corn futures contract never settled below $4 since inception in mid-2009, and the eyeball average is well north of $5, even last year. Compare that to typical prices in the $3's only a few years ago, despite higher natural gas prices (hence higher fertilizer prices). A simple regression of corn prices vs. ethanol production might have shed some light on the impact of the RFS.

see: http://www.cmegroup.com/popup/mdq2.html?code=ZCZ2&title=December_2012_Corn&type=p#link=monthly

And thanks for your explanation of your desire for anonymity.

pelinoc said...

It seems to me that the arguments around corn, ethanol, government programs, and the broader agriculture business are complicated, and it is difficult to see through a thicket of claims and counterclaims. In this year of drought, when different groups are trying to protect their own interests, the stakes are particularly high, and nobody seems that interested in facts.

For example, if you examine the record of US corn acreage and ouput (available on the USDA site), you will see a substantial increase in both, on average, between the 90s and the 00s. In fact, every year since 2007 more than 85 million acres have been planted, a level of planting that was not achieved once between 1950 and 2006. On the output side, in the 90s between 6.3 and 10.1 billion bushels were produced annually, while since 2000 the numbers have been between 8.9 and 13.1 billion.

The obvious and substantial growth in the corn market can likely be attributed to corn farmers' response to demand from ethanol producers.

This year was a drought year, and the average output per acre is expected to be only 122 bushels. That is the lowest level since 1995, another drought year.

If ethanol had never developed as an industry, and there were many fewer acres of corn planted (as you would expect from the data), and there was a drought year, prices would have been much higher than normal, and the same corn users (dairy, cattle, chicken, etc.) would have been crying for help. The only difference would have been that they would not be complaining about ethanol.

In 1995, when there was a serious drought, corn prices were 40% higher than the year before. No doubt all those agricultural interests cried out for help (though I have not tried to research that). This year, prices have gone up by only 25% from last year. Yet the ethanol industry is being blamed, when they obviously were not around to be blamed back in 1995.

None of this is a defense of ethanol, because you can agree or disagree with that industry and the government programs that support it on many other grounds. But let's at least separate some of the issues that are truly at stake from those that are incidental.

Geoffrey Styles said...

I've looked at a lot of that data, too. When corn prices spiked 40% in 1995, they did so from a lower baseline, so I suspect comparing that to this year's 25% is a bit of apples and oranges. I agree wholeheartedly that this entire issue is complex, with many competing interests. When you boil it down, my main complaint is that rather than wading into that complexity and looking carefully at the wealth of data that observers like us could think to examine, they seem to have punted to a model that can't possibly capture all that complexity. It's possible that after examining everything both of us have suggested, the answer would be the same. But while disappointing, a rejection of waiver request derived in that manner would at least satisfy more in thoroughness and resolve a lot more doubts.

In the course of writing this response, it also occurred to me that the fundamental error of the drafters of EISA 2007's RFS may have been in leaving the adjudication of RFS waiver requests to the EPA, which surely has a conflict of interest. An external panel (external to EPA and including experts external to government) would have been a better choice.

Ed Reid said...


I'll bet you would be uncomfortable assigning the fox to guard the turkey house as well.

Happy Thanksgiving