Is An Ethanol Compromise on the Horizon?

• The RFS ethanol mandate increasingly benefits farmers and ethanol producers at the expense of motorists, small-engine users, food producers and restaurants.
• Repeal of the RFS looks unlikely, but equitable reforms addressing the needs of all affected groups are possible, if Congress is willing to compromise.

Earlier this month, National Journal hosted an event on the “Biofuels Mandate: Defend, Reform, or Repeal” from Washington, DC. I encourage you to skim through the replay. The session highlighted a wide range of views concerning the US Renewable Fuels Standard (RFS), including those of the corn ethanol and advanced biofuels industries, poultry growers, chain restaurants, environmentalists, and small engine manufacturers. Although these broke down pretty sharply along pro- and anti-RFS lines, I thought I detected hints of the kind of compromise that might resolve this issue. I’d like to focus on the elements of such a deal, rather than rehashing the positions of all of the participants, with one necessary exception.

The most disappointing contributions to the discussion occurred during the interview with Representative Steve King (R, IA) by National Journal’s Amy Harder. If we accept Mr. King’s perspective, we should embrace the RFS as being as relevant today as when it was conceived, with no changes required. That flies in the face of the serious market distortions now manifesting in the “blend wall” at 10% ethanol content in gasoline.

Among other things, Mr. King claimed that a 2008 reduction of $0.06 per gallon in the now-expired ethanol blenders tax credit brought the expansion of the corn ethanol industry to a standstill. The industry’s own statistics tell a very different story, with US ethanol production capacity having grown by a further 86% since that point.

Rep. King also characterized “food vs. fuel” concerns as a bumper sticker issue, with no basis in fact. That issue might be controversial, but it is far too substantive to dismiss so cavalierly. The latest evidence of that is a vote by the European Parliament to cap the contribution of conventional biofuel — ethanol and biodiesel derived from food crops — at 6% of transportation energy out of a 2020 target of 10%, based on concerns about sustainability and competition with food. It seemed fairly clear that the Congressman views the RFS more as a farm support measure than an energy program.

The only one of Mr. King’s comments that seemed to find traction with the other pro-RFS panelists was his odd suggestion that without a mandate for biofuels, the only federal mandate in place would be one for petroleum-based fuels. Certainly, gasoline and diesel have advantages in terms of infrastructure, energy density and the legacy fleet, but he appeared to have something else in mind. From the way others picked up on this, perhaps it was his earlier reference to the tax benefits that conventional fuel producers have long enjoyed. This is the first and easiest element on which to compromise.

If ethanol producers and advanced biofuels developers are convinced that fossil fuels get a better deal from the federal government than the one they have under the RFS and the $1.01 per gallon producer tax credit for second-generation biofuels, it would be a simple matter to replace these programs with the same incentives received by oil and gas producers and petroleum refiners. After all, the biofuel industry already benefits from the Section 199 tax deduction that accounts for a third of budgeted federal tax benefits for the oil industry, and it shouldn’t be hard to devise an accelerated depreciation benefit analogous to “percentage depletion” and the expensing of intangible drilling expenses. Combined, the value of these tax benefits is about 1.3¢ per equivalent gallon of oil or natural gas produced this year.

Other concerns came across clearly. Despite the endorsement of 15% ethanol blends by the Environmental Protection Agency, blending more than 10% ethanol in gasoline creates serious risks for the US’s 500 million existing gasoline engines, large and small. The scale of corn diversion necessary to go beyond 10% is also distorting the US agricultural economy and food value chain, all the way to the restaurants in our communities. However, those engaged in developing new biofuels that don’t rely on edible crops, or that are fully compatible with existing infrastructure and engines, are legitimately worried that the repeal of the entire mandate would strand the significant investments in new technology that have already been made, and possibly smother their industry just as it nears its first commercial-scale deployments. All these points of view struck me as eminently reconcilable within a reformed RFS that recognizes that most of the assumptions of the 2007 mandate are no longer valid.

The starting point for reform of the RFS should be a 10% cap on ethanol from all sources in mass-market gasoline — excluding E85 — combined with measures to give ethanol from non-food sources priority within that cap over ethanol produced from corn or other food crops. The advanced biofuel targets of the RFS should also be scaled back significantly to reflect the reality that the 2007 targets were wildly optimistic. Ideally, they should be adjusted each year based on the previous year’s actual output. In return, the current producer tax credit for cellulosic and other second-generation biofuels could be extended beyond its scheduled expiration at the end of this year, and then phased out over a reasonable, predictable period, perhaps tied to cumulative output.

Finally, since few on the panel seemed impressed by the EPA’s exercise to date of its statutory power to adjust the RFS to fit changing circumstances, that authority should be transferred to another agency, along with clearer guidelines on when adjustments would become mandatory.

I’d be the first to admit that the reforms I’ve outlined above fall well short of the outright repeal of the RFS that many, including myself, would prefer. That’s the essence of compromise. Having just experienced a government shutdown and debt ceiling crisis brought on by the clash of two intransigent positions, this might be preferable to an impasse that leaves an unsustainable status quo untouched. And if the assessment of Representative Welch (D-VT) concerning the appetite of the Congress to take up this matter is accurate, something along these lines might just be achievable.

Reform of the RFS would leave in place for a while longer the outlines of a mechanism that one of the session's panelists accurately described as a Rube Goldberg construction. Short of a guarantee to bail out everyone who invested in biofuels production or research on the basis of the RFS that Congress put in place in 2007, should they fail in a post-repeal market, I’m not sure there’s another course that would be sufficiently equitable to all parties involved.

A different version of this posting was previously published on Energy Trends Insider.