Given the remarkable longevity of the tax credit for ethanol blended into gasoline, it seems fitting that it would take a problem on the scale of the massive US deficit and $14 trillion federal debt to trigger its demise. Yet despite a widely-publicized Senate vote in June and the announcement of a key compromise among three Senators last week--two from the corn belt and one from the West Coast--it remains unclear just when and how the cancellation of this subsidy will become law. And because the fate of the subsidy is linked to that of the parallel tariff and duty on imported ethanol, the US ethanol industry faces not just the prospect of a more challenging market by year-end, but one that could include competition from foreign suppliers with special advantages under US renewable fuels regulations. Some producers may end up wishing they hadn't expanded output quite so fast.
I've followed the ethanol subsidy for much longer than I've been blogging about it. As I was reading a two-part assessment of the changing ethanol situation in Biofuels Digest it occurred to me to take the dusty report from my long-ago M.B.A. project off the shelf. Its topic was the market for "gasohol", gasoline blended with up to 10% ethanol, on the West Coast in the early 1980s. At the time, blenders received roughly the same tax credit as today's $0.45 per gallon of ethanol blended, thanks to the 1978 Federal Energy Tax Act and the Highway Tax Act of 1983. That benefit was a lot more generous in then-current dollars than now, but much smaller in aggregate. In the intervening decades, gasoline with ethanol has expanded from around 2% of the market to nearly 100%. In much of the country it is now harder to find gasoline without ethanol than it was to find gasohol back then.
That's only one indication of the tremendous success this industry has enjoyed, due almost entirely to government policies like the Volumetric Ethanol Excise Tax Credit and the national Renewable Fuels Standard (RFS) established in 2005. In fact the eventual demise of the ethanol tax credit was virtually guaranteed by the passage of an even more ambitious RFS as part of the federal Energy Independence and Security Act of 2007. Under the RFS, blending ethanol into gasoline in steadily increasing proportions became mandatory, rendering the tax credit paid to refiners and other gasoline blenders redundant. Just as importantly, it expanded the scale of ethanol blending to such an extent that the total annual cost of the so-called blenders credit grew from roughly $1.8 billion in 2005 to a projected $6 billion this year--too big to ignore.
The deal agreed by Senators Feinstein (D-CA), Klobuchar (D-MN) and Thune (R-SD) last week would reportedly result in the early termination of both the ethanol tax credit, which was due to expire at the end of 2011 but could have been renewed, and the corresponding ethanol import tariff. It would devote $1.33 billion of the unspent funds to deficit reduction, while diverting another $668 million to extend tax credits for alternative fuel refueling (or recharging) infrastructure and cellulosic biofuel tax credits. This outcome appears to have pleased at least part of the ethanol industry. However, in order for it to become law, it must still be voted on by both houses of Congress, either by itself or as a provision within another bill, perhaps even the debt ceiling extension package that could emerge from the ongoing deliberations between the House, Senate and White House.
The ultimate effect of these changes on the ethanol industry remains somewhat uncertain, though it is hard to see them as a net positive, other than the longer-term benefit of supporting infrastructure investments that could be crucial in resolving a key bottleneck in ethanol distribution. Without much higher sales of gasoline blends containing more than 10% ethanol, the market is already nearly saturated with ethanol, and that's before factoring in the additional imports that the elimination of the tariff is likely to promote. And at least in the case of ethanol derived from sugar cane, those imports will enjoy an important advantage over ethanol derived from corn: most of them are likely to qualify for the stricter designation of "Advanced Biofuel" under the RFS, a category for which the annual quota is just starting to take off, and that cannot be satisfied by corn ethanol but also seems unlikely to be filled by domestic cellulosic ethanol any time soon.
Biofuels Digest suggested that long-dated ethanol futures have already nose-dived in anticipation of the end of the tax credit. It's true that ethanol for delivery in January 2012 is trading for around $0.35/gal. less than the August 2011 ethanol futures contract, reflecting a widening of ethanol's discount to the gasoline futures contract over that interval of around $0.11/gal. However, it also seems highly relevant that corn futures have recently retreated from their early-June peak of nearly $8/bushel to $6.80, with December corn--from which January ethanol might be produced--down at $6.20/bu. That leaves ethanol producers a small but still positive margin on that January futures price. So it is hardly certain that the end of the tax credit will, by itself, stress US corn ethanol producers. If anything, refiners and consumers--who have arguably received most of the benefit of the credit in recent years--stand to lose the most from its disappearance.
Import competition could have much more serious consequences, as the fuel ethanol industry truly begins to globalize. Brazil is the big player internationally, even if the recent rise in sugar prices and a smaller-than-expected cane crop have created the bizarre situation of Brazil actually importing corn ethanol from the US. The historically fragmented Brazilian sugar cane industry is currently both expanding and consolidating, led by companies like Raizen, the new joint venture between Shell and Cosan, which has indicated plans to double its ethanol capacity to 5 billion liters per year (1.3 billion gallons per year.) Nor is Brazil the only tropical country that can grow cane and produce sugar, ethanol and electricity from modern facilities. The Brazilian model could be replicated elsewhere in Latin America, the Caribbean, and West Africa. Not all of that extra ethanol will come here, but enough of it could, helped by the RFS, to put an effective cap on US ethanol prices. I'm not aware of a similar constraint on corn prices.
The US ethanol industry has matured in the last three decades. Today's ethanol plants are much more efficient than the ones supplying the small quantities used for gasohol in the early 1980s, and they now consume around 40% of the US corn crop. The industry has expanded on a scale that would have seemed nearly impossible thirty years ago, though in my view it has in the process fallen into the classic overcapacity trap of commodity manufacturers. Whether that situation is temporary or permanent depends on the success of blends containing more than 10% ethanol--blends that the market has so far treated with indifference. But either way, when the training wheels finally come off with the end of the blenders credit and import tariff, we shouldn't be surprised to see more of the small and higher-cost producers fall by the wayside. That will have local consequences, but the ethanol industry will survive, just as it survived the bankruptcies of some ethanol producers during the financial crisis. Ethanol is here to stay, and it is about to embark on a new career as a more normal commodity.
Showing posts with label blenders credit. Show all posts
Showing posts with label blenders credit. Show all posts
Tuesday, July 12, 2011
Monday, May 09, 2011
Twilight of the Ethanol Subsidy?
The current tax credit for blending grain ethanol into gasoline, the Volumetric Ethanol Excise Tax Credit (VEETC), has outlived its usefulness. That's not just because I consider it unwise to subsidize any industry to such a generous extent for more than thirty years, but also because the passage of the ambitious federal Renewable Fuels Standard in 2007 made it redundant. Refiners aren't just paid to blend ethanol into gasoline; they're required by law to do so. One of the trade associations for the ethanol industry reached a similar conclusion last year, though presumably for different reasons. Nevertheless, the politics of such a big change looked dire. Now it appears that the unthinkable might be happening with the introduction of two separate bills in the Senate, one of which would scale back the ethanol credit significantly, while the other would eliminate it outright.
The tougher of the two bills comes from a pair of Senators representing states that consume far more ethanol than they produce. In fact, I couldn't find a single ethanol plant in Oklahoma, which Senator Coburn (R) represents. Whether the Feinstein-Coburn bill stands a chance or not, I'm much more interested in the equally bi-partisan measure from two farm state senators, Kent Conrad (D-ND) and Charles Grassley (R-IA). As described in the press, it would reduce the VEETC from $0.45 per gallon this year to $0.20/gal. for 2012 and $0.15/gal. for 2013, after which it would fall to a level indexed to oil prices. At the current price of West Texas Intermediate, it would be zero.
Of course the context for the Conrad-Grassley bill is that without legislative action the current blenders credit is due to expire completely at the end of this year. However, we've been in this position before, more than once, and each time the tax credit was rolled over with a few minor tweaks, such as the cut from $0.51/gal. to $0.45/gal. in 2008. My default assumption has been for a similar rollover this year, but with support from the largest ethanol trade groups in the country, the provisions of the Conrad-Grassley Bill appear to have become the new default. The bill also extends some tax credits for cellulosic biofuel and alternative fuel refueling facilities, including E85, and reduces the ethanol import tariff modestly, starting in 2012.
Although outright termination of the corn ethanol tax credit would be justifiable, it would also be highly disruptive to an industry that we've encouraged for so long, and that has struggled with thin margins even with the tax credit in place. A phase-out seems reasonable and would at least save taxpayers up to $3.3 billion next year and more the following year, depending on how much ethanol is actually sold and how many retailers take advantage of the incentives for installing E85 facilities. There's an argument that this might result in higher prices at the pump, as refiners' blending costs rise, though any such impact is likely to be lost in the noise of normal fuel price volatility.
Winding down this subsidy in an orderly fashion is important, but it's even more important that we learn the lessons it teaches. The cultivation of corn and its conversion to ethyl alcohol are subject to natural limits of scale that are lower than those for wind and solar power or plug-in electric cars, all of which also benefit from generous subsidies. Our pockets simply aren't deep enough to repeat our experience with ethanol subsidies with these other energy alternatives. In an era of fiscal limits, alternative energy tax incentives that are orders of magnitude higher per BTU or kilowatt-hour than those enjoyed by conventional energy sources should only be offered for a limited time, and then phased out on a predictable schedule before they take on the mantle of permanent entitlements.
The tougher of the two bills comes from a pair of Senators representing states that consume far more ethanol than they produce. In fact, I couldn't find a single ethanol plant in Oklahoma, which Senator Coburn (R) represents. Whether the Feinstein-Coburn bill stands a chance or not, I'm much more interested in the equally bi-partisan measure from two farm state senators, Kent Conrad (D-ND) and Charles Grassley (R-IA). As described in the press, it would reduce the VEETC from $0.45 per gallon this year to $0.20/gal. for 2012 and $0.15/gal. for 2013, after which it would fall to a level indexed to oil prices. At the current price of West Texas Intermediate, it would be zero.
Of course the context for the Conrad-Grassley bill is that without legislative action the current blenders credit is due to expire completely at the end of this year. However, we've been in this position before, more than once, and each time the tax credit was rolled over with a few minor tweaks, such as the cut from $0.51/gal. to $0.45/gal. in 2008. My default assumption has been for a similar rollover this year, but with support from the largest ethanol trade groups in the country, the provisions of the Conrad-Grassley Bill appear to have become the new default. The bill also extends some tax credits for cellulosic biofuel and alternative fuel refueling facilities, including E85, and reduces the ethanol import tariff modestly, starting in 2012.
Although outright termination of the corn ethanol tax credit would be justifiable, it would also be highly disruptive to an industry that we've encouraged for so long, and that has struggled with thin margins even with the tax credit in place. A phase-out seems reasonable and would at least save taxpayers up to $3.3 billion next year and more the following year, depending on how much ethanol is actually sold and how many retailers take advantage of the incentives for installing E85 facilities. There's an argument that this might result in higher prices at the pump, as refiners' blending costs rise, though any such impact is likely to be lost in the noise of normal fuel price volatility.
Winding down this subsidy in an orderly fashion is important, but it's even more important that we learn the lessons it teaches. The cultivation of corn and its conversion to ethyl alcohol are subject to natural limits of scale that are lower than those for wind and solar power or plug-in electric cars, all of which also benefit from generous subsidies. Our pockets simply aren't deep enough to repeat our experience with ethanol subsidies with these other energy alternatives. In an era of fiscal limits, alternative energy tax incentives that are orders of magnitude higher per BTU or kilowatt-hour than those enjoyed by conventional energy sources should only be offered for a limited time, and then phased out on a predictable schedule before they take on the mantle of permanent entitlements.
Friday, December 17, 2010
Christmas for Renewables
Last night the US House of Representatives passed the compromise tax bill without any amendments and by a healthy margin, though narrower than the 81-19 vote in the Senate on Wednesday. The bill now goes to the President for his signature. The provisions added after the initial negotiations between the White House and Republican leadership delivered a substantial Christmas present to the nation's renewable energy industry, including several key items on the industry's wish list: extension of the ethanol blenders' tax credit at its current rate of $0.45 per gallon; extension of the Treasury Renewable Energy Grants, which provide cash in lieu of investment tax credits; and a retroactive extension of the $1.00 per gallon biodiesel tax credit, which had lapsed at the end of 2009. However, as with many Christmas presents, the bill that will come due next year is also substantial. And the one-year extensions granted to these incentives leaves their long-term fate in the hands of the new Congress, which is widely expected to be more focused on deficit reduction than on stimulus.
This result constitutes a remarkable trifecta. As recently as a week ago it seemed likely that the Treasury Grant program would expire on schedule, and that the ethanol credit, if not actually allowed to expire, would at least be reduced to reflect its redundancy with the Renewable Fuel Standard (RFS), which requires refiners and fuel blenders to add biofuel to gasoline. As for the biodiesel tax credit, it looked like a lost cause all year, having failed on multiple previous attempts to reinstate it. The US ethanol industry even prevailed in having the $0.54 per gallon duty on imported ethanol extended for another year, in order to shield taxpayers from paying incentives to foreign producers and the industry from cheaper competition--though I'm not sure how competitive Brazilian cane ethanol really is these days, with sugar trading at around $0.30/lb ex duty. (As I understand the tradeoff, a gallon of cane ethanol consumes roughly the same raw materials as 10 lb. of cane sugar.)
It's a tribute to the greatly expanded scale of renewable energy that the price tag for the one-year extension of these three incentives is as high as it will be. This year, even with US wind turbine installations running well behind their record pace in 2009, the Treasury has spent $3.9 billion on the grant program for projects installing geothermal, solar, wind and other renewable electricity equipment. With continued strong growth in both solar thermal and photovoltaic projects and even a modest uptick in wind installations, the tab for 2011 could easily break $4 B. (A separate manufacturers tax credit, which had a better claim on creating green jobs here in the US, was not extended.) Meanwhile, with conventional ethanol and biodiesel blended at the mandated rates for next year, they should account for around $5.9B and $0.8 B, respectively. That comes to $10.7 billion for all three programs.
Although the tax compromise has extended the energy policy status quo for another year, change is in the air. With continued, though narrower bi-partisan support, the ethanol industry's argument that its tax credit is still necessary after 32 years--even with a steadily increasing RFS mandate--is losing credibility. Part of the industry would prefer this money to be spent encouraging infrastructure for E85 and other higher-percentage blends that represent ethanol's future growth opportunity, if any. As for the Treasury Grants, a temporary stimulus measure intended to make up for the disappearance of the tax equity market during the financial crisis, the defensibility of treating the investment tax credit on which it is based differently from any other credit in the tax code is waning. This mechanism looks increasingly exposed as the broader category of "tax expenditures" becomes an obvious target for deficit cutters, and the justification for extending it beyond next year would probably vanish if the Congress enacted legislation along the lines of Senator Graham's Clean Energy Standard. The industry should make the most of the current Christmas package, because the odds are against a repetition of it turning up under next year's tree.
This result constitutes a remarkable trifecta. As recently as a week ago it seemed likely that the Treasury Grant program would expire on schedule, and that the ethanol credit, if not actually allowed to expire, would at least be reduced to reflect its redundancy with the Renewable Fuel Standard (RFS), which requires refiners and fuel blenders to add biofuel to gasoline. As for the biodiesel tax credit, it looked like a lost cause all year, having failed on multiple previous attempts to reinstate it. The US ethanol industry even prevailed in having the $0.54 per gallon duty on imported ethanol extended for another year, in order to shield taxpayers from paying incentives to foreign producers and the industry from cheaper competition--though I'm not sure how competitive Brazilian cane ethanol really is these days, with sugar trading at around $0.30/lb ex duty. (As I understand the tradeoff, a gallon of cane ethanol consumes roughly the same raw materials as 10 lb. of cane sugar.)
It's a tribute to the greatly expanded scale of renewable energy that the price tag for the one-year extension of these three incentives is as high as it will be. This year, even with US wind turbine installations running well behind their record pace in 2009, the Treasury has spent $3.9 billion on the grant program for projects installing geothermal, solar, wind and other renewable electricity equipment. With continued strong growth in both solar thermal and photovoltaic projects and even a modest uptick in wind installations, the tab for 2011 could easily break $4 B. (A separate manufacturers tax credit, which had a better claim on creating green jobs here in the US, was not extended.) Meanwhile, with conventional ethanol and biodiesel blended at the mandated rates for next year, they should account for around $5.9B and $0.8 B, respectively. That comes to $10.7 billion for all three programs.
Although the tax compromise has extended the energy policy status quo for another year, change is in the air. With continued, though narrower bi-partisan support, the ethanol industry's argument that its tax credit is still necessary after 32 years--even with a steadily increasing RFS mandate--is losing credibility. Part of the industry would prefer this money to be spent encouraging infrastructure for E85 and other higher-percentage blends that represent ethanol's future growth opportunity, if any. As for the Treasury Grants, a temporary stimulus measure intended to make up for the disappearance of the tax equity market during the financial crisis, the defensibility of treating the investment tax credit on which it is based differently from any other credit in the tax code is waning. This mechanism looks increasingly exposed as the broader category of "tax expenditures" becomes an obvious target for deficit cutters, and the justification for extending it beyond next year would probably vanish if the Congress enacted legislation along the lines of Senator Graham's Clean Energy Standard. The industry should make the most of the current Christmas package, because the odds are against a repetition of it turning up under next year's tree.
Friday, December 03, 2010
Will Oil Prices Rescue Ethanol?
Time is running out for the ethanol blenders credit and the matching ethanol import tariff, which at least one industry publication suggests are likely to survive, but at "sharply reduced rates." Although I'm among those who suspect that the blenders credit probably benefits consumers more than ethanol producers, as long as the national Renewable Fuel Standard is binding on blenders, it seems fortunate for the US ethanol industry that this situation is playing out when crude and gasoline prices have risen to levels we haven't seen since spring, and could go higher if current economic indicators hold up.
The US benchmark futures price for crude oil is suddenly flirting with $90/bbl again, and UK Brent crude, a better gauge of world oil prices whenever WTI inventories at Cushing, OK are this high, has already surpassed that mark. Even if oil's move is at least partly the result of recent currency fluctuations, it is supported by fundamentals in the form of gasoline and distillate inventories that for the first time in months are back within their normal seasonal ranges. Crack spreads, an indicator of refining margins, look strong, reflecting solid demand. All of that suggests that if crude prices move higher, increases will be passed on in product prices, rather than being absorbed partly by refiners. That doesn't sound like good news for motorists, but how could it help compensate the ethanol industry for the potential loss of some or all of the $0.45 /gal. blenders credit?
It helps in two ways. First, by pushing wholesale gasoline prices above those for prompt ethanol even without factoring in the credit, this gives refiners more incentive to add as much ethanol to gasoline as they can, to increase their profit margins. That should put positive pressure on ethanol prices, even as blenders approach the 10% "blend wall" that the recent EPA decision on E15 hasn't yet affected. That opens up headroom for ethanol producers who have recently seen their margins, or "crush spreads", squeezed by strong corn prices. And it's especially crucial for those producers who only recently emerged from Chapter 11 protection after a protracted margin squeeze in late 2008 though mid-2009. This is an industry that spent the last five years in a frenzy of capacity building, and that only escaped creating a severe and persistent glut of ethanol because some of the marginal operators couldn't afford to run their plants. If gasoline prices fell while corn prices remain high, losing the blenders credit could put a number of plants back into bankruptcy; rising gasoline prices constitute a lucky break.
It's anyone's guess whether the present configuration of markets will remain in place long enough to ease the ethanol industry through the transition it faces after December 31, if the Congress cuts the blenders credit and tariff or allows them to lapse. After all, Europe has just dodged another bullet with Ireland, and the Euro could come under renewed threat from Portugal, Spain or Italy at any time. If recent shopping results are any indication, the US economy is looking healthier, although joblessness remains high and unemployment benefits for millions are set to end before the holiday bills come due. If oil prices swooned in the next few weeks, consumers might be relieved, but ethanol producers would see it as another lump of coal in their stocking.
The US benchmark futures price for crude oil is suddenly flirting with $90/bbl again, and UK Brent crude, a better gauge of world oil prices whenever WTI inventories at Cushing, OK are this high, has already surpassed that mark. Even if oil's move is at least partly the result of recent currency fluctuations, it is supported by fundamentals in the form of gasoline and distillate inventories that for the first time in months are back within their normal seasonal ranges. Crack spreads, an indicator of refining margins, look strong, reflecting solid demand. All of that suggests that if crude prices move higher, increases will be passed on in product prices, rather than being absorbed partly by refiners. That doesn't sound like good news for motorists, but how could it help compensate the ethanol industry for the potential loss of some or all of the $0.45 /gal. blenders credit?
It helps in two ways. First, by pushing wholesale gasoline prices above those for prompt ethanol even without factoring in the credit, this gives refiners more incentive to add as much ethanol to gasoline as they can, to increase their profit margins. That should put positive pressure on ethanol prices, even as blenders approach the 10% "blend wall" that the recent EPA decision on E15 hasn't yet affected. That opens up headroom for ethanol producers who have recently seen their margins, or "crush spreads", squeezed by strong corn prices. And it's especially crucial for those producers who only recently emerged from Chapter 11 protection after a protracted margin squeeze in late 2008 though mid-2009. This is an industry that spent the last five years in a frenzy of capacity building, and that only escaped creating a severe and persistent glut of ethanol because some of the marginal operators couldn't afford to run their plants. If gasoline prices fell while corn prices remain high, losing the blenders credit could put a number of plants back into bankruptcy; rising gasoline prices constitute a lucky break.
It's anyone's guess whether the present configuration of markets will remain in place long enough to ease the ethanol industry through the transition it faces after December 31, if the Congress cuts the blenders credit and tariff or allows them to lapse. After all, Europe has just dodged another bullet with Ireland, and the Euro could come under renewed threat from Portugal, Spain or Italy at any time. If recent shopping results are any indication, the US economy is looking healthier, although joblessness remains high and unemployment benefits for millions are set to end before the holiday bills come due. If oil prices swooned in the next few weeks, consumers might be relieved, but ethanol producers would see it as another lump of coal in their stocking.
Thursday, July 29, 2010
The Incredible Shrinking Energy Bill
When legislation is introduced in the US Congress, most of the discussion typically concerns its specific provisions. Sometimes, as in the case of the "public option" absent from the final healthcare bill, notable omissions vie for attention. However, in the case of this year's greatly-diminished energy bill released this week by Senator Reid (D-NV), most of the controversy seems to be focused on its long list of missing elements, including but not limited to cap & trade, a national renewable energy standard for electricity, and extensions for various expiring renewable energy incentives. That's not to say that what's left doesn't deserve careful scrutiny, particularly provisions affecting offshore oil and gas drilling. But compared to the energy bill that might have been, this draft looks like a pitiful remnant, even at 409 pages.
Although I can appreciate the frustration of those who expected Congress finally to enact cap & trade this year, I find the convoluted tactical arguments and finger-pointing over its failure to reach consensus on this issue to be mostly "inside baseball" rationalization. The clues adequately explaining its omission from the current bill are on display in the bill's title, "The Clean Energy Jobs and Oil Company Accountability Act of 2010". In other words, what happened to cap & trade this year was the recession and the oil spill. The former made the country less receptive to what is at its core a substantial new tax, while the latter scuttled the best chance for a bi-partisan "grand compromise" based on swapping expanded access to US off-limits oil and gas resources for stronger emissions regulations. Even though the taxation underlying cap & trade is intended to recognize a serious unpriced externality of our energy economy, it still represents a significant redistribution of wealth from energy producers and consumers to the government and the purposes for which the government chooses to spend the proceeds: at best a zero-sum game with frictional losses, and at worst--insert Waxman-Markey--a monumentally-distorting boondoggle.
Then there's the missing national renewable electricity standard (RES), which in clear English is a mandate for utilities to obtain a defined and escalating percentage of the electricity they provide customers from selected renewable sources. The American Wind Energy Association (AWEA), the trade association for the US wind industry, sees this as an absolute necessity for their industry to continue growing and was vexed over its exclusion from the current bill--this in spite of the fact that the wind industry's main federal support, the Production Tax Credit, was previously extended through 2012, along with the valuable option to select an Investment Tax Credit instead. I see two practical explanations for this omission, though it's clear from the efforts of AWEA and other groups that it could still find its way back into the bill. First, the RES is really another tax. Instead of being levied on taxpayers by the government, it would be levied by utilities on ratepayers when the costs of the renewable energy projects or the tradeable Renewable Energy Credits they can buy in lieu of buying green power are passed on to their customers. On a more practical level, with 29 states plus the District of Columbia already having equivalent Renewable Portfolio Standards in place, most of the best US wind and solar resources are already covered by such targets. A national RES might not add a lot more of these energy sources, but it certainly would trigger a scramble for the states with limited renewable resources to line up supplies from elsewhere. That might be good for the renewable energy sector, but it's of questionable benefit to a national economy still struggling to emerge from the recession.
Also absent from this draft are the expiring renewable energy incentives highlighted in yesterday's New York Times editorial. These include the $0.45/gal. ethanol blenders' credit, about which I've blogged extensively, and the Treasury renewable energy grants offering up-front cash for the Investment Tax Credits that would otherwise require waiting for next year's tax return--assuming the recipient company had sufficient taxable income to benefit from the entire amount of the credit. These grants look problematic, as I noted last fall, when reports first surfaced that most of the money paid--approaching $2 billion--had gone to non-US firms. As I discussed at the time, this reflects the reality of a wind energy market in which US firms account for less than half of domestic sales, supported by a thoroughly-globalized supply chain, not unlike many other industries. The arguments pro and con too easily reduce to unappealing sound-bites.
That leaves us with what is currently in the bill, which I have so far only had time to skim. It seems to consist mainly of well-intended but overly-politicized efforts--one section is entitled the "Big Oil Bailout Prevention Unlimited Liability Act of 2010--to hold BP accountable for the Gulf Coast oil spill and to address the liability for future spills, while trying to reduce the chances of another one. That sounds like motherhood and apple pie at this point, but as always the devil is in the details; implementing some of these details would leave the US with a much smaller offshore oil capability. That might appeal to environmentalists but would be catastrophic for energy consumers, our trade deficit, and US energy security. And why would you charge the Secretary of Energy with issuing a monthly report, starting in September or October, on the economic and employment impact of a deepwater drilling moratorium that is only intended to last through November? Interestingly, the bill would also establish a Congressional version of the President's oil spill commission, this time with specific technical criteria for appointment to this body. Alternative, compromise versions of the bill's oil provisions are already emerging from within Senator Reid's own party, and with a lot of luck we could end up with measures that would actually make offshore drilling safer and more responsible without killing it--and the roughly 30% of domestic oil production it provides.
In addition to its oil spill provisions, the bill also offers some generous tax credits for converting heavy-duty trucking to natural gas, along the lines of the Pickens proposals I discussed last Friday, plus similar help for vehicle electrification and infrastructure, yet more energy efficiency measures (this time focused on homes), and funding for an old government program to buy up land and waterways for parks and nature preserves. All of this is notionally paid for ("PAYGO") by raising the Oil Spill Liability Trust Fund fee on all the oil produced and used in the US from $0.08 to $0.45 per barrel, which would directly increase the size of the fund to cover future disasters from $1 billion to $5 billion, while indirectly making all the bill's other provisions appear deficit-neutral. The proposed fee increase has the potential to raise an extra $2.5 billion per year.
It's not clear whether even this slimmed-down bill can garner enough votes to pass in the Senate, let alone do so before the summer adjournment. In any case I'd expect the version that comes up for a final vote--if it does at all--to look somewhat different than this draft. It would almost certainly grow much longer, a malady that has afflicted all major legislation in recent Congresses. Whether it will actually make a meaningfully-positive impact on the serious energy challenges the US faces remains to be seen.
Although I can appreciate the frustration of those who expected Congress finally to enact cap & trade this year, I find the convoluted tactical arguments and finger-pointing over its failure to reach consensus on this issue to be mostly "inside baseball" rationalization. The clues adequately explaining its omission from the current bill are on display in the bill's title, "The Clean Energy Jobs and Oil Company Accountability Act of 2010". In other words, what happened to cap & trade this year was the recession and the oil spill. The former made the country less receptive to what is at its core a substantial new tax, while the latter scuttled the best chance for a bi-partisan "grand compromise" based on swapping expanded access to US off-limits oil and gas resources for stronger emissions regulations. Even though the taxation underlying cap & trade is intended to recognize a serious unpriced externality of our energy economy, it still represents a significant redistribution of wealth from energy producers and consumers to the government and the purposes for which the government chooses to spend the proceeds: at best a zero-sum game with frictional losses, and at worst--insert Waxman-Markey--a monumentally-distorting boondoggle.
Then there's the missing national renewable electricity standard (RES), which in clear English is a mandate for utilities to obtain a defined and escalating percentage of the electricity they provide customers from selected renewable sources. The American Wind Energy Association (AWEA), the trade association for the US wind industry, sees this as an absolute necessity for their industry to continue growing and was vexed over its exclusion from the current bill--this in spite of the fact that the wind industry's main federal support, the Production Tax Credit, was previously extended through 2012, along with the valuable option to select an Investment Tax Credit instead. I see two practical explanations for this omission, though it's clear from the efforts of AWEA and other groups that it could still find its way back into the bill. First, the RES is really another tax. Instead of being levied on taxpayers by the government, it would be levied by utilities on ratepayers when the costs of the renewable energy projects or the tradeable Renewable Energy Credits they can buy in lieu of buying green power are passed on to their customers. On a more practical level, with 29 states plus the District of Columbia already having equivalent Renewable Portfolio Standards in place, most of the best US wind and solar resources are already covered by such targets. A national RES might not add a lot more of these energy sources, but it certainly would trigger a scramble for the states with limited renewable resources to line up supplies from elsewhere. That might be good for the renewable energy sector, but it's of questionable benefit to a national economy still struggling to emerge from the recession.
Also absent from this draft are the expiring renewable energy incentives highlighted in yesterday's New York Times editorial. These include the $0.45/gal. ethanol blenders' credit, about which I've blogged extensively, and the Treasury renewable energy grants offering up-front cash for the Investment Tax Credits that would otherwise require waiting for next year's tax return--assuming the recipient company had sufficient taxable income to benefit from the entire amount of the credit. These grants look problematic, as I noted last fall, when reports first surfaced that most of the money paid--approaching $2 billion--had gone to non-US firms. As I discussed at the time, this reflects the reality of a wind energy market in which US firms account for less than half of domestic sales, supported by a thoroughly-globalized supply chain, not unlike many other industries. The arguments pro and con too easily reduce to unappealing sound-bites.
That leaves us with what is currently in the bill, which I have so far only had time to skim. It seems to consist mainly of well-intended but overly-politicized efforts--one section is entitled the "Big Oil Bailout Prevention Unlimited Liability Act of 2010--to hold BP accountable for the Gulf Coast oil spill and to address the liability for future spills, while trying to reduce the chances of another one. That sounds like motherhood and apple pie at this point, but as always the devil is in the details; implementing some of these details would leave the US with a much smaller offshore oil capability. That might appeal to environmentalists but would be catastrophic for energy consumers, our trade deficit, and US energy security. And why would you charge the Secretary of Energy with issuing a monthly report, starting in September or October, on the economic and employment impact of a deepwater drilling moratorium that is only intended to last through November? Interestingly, the bill would also establish a Congressional version of the President's oil spill commission, this time with specific technical criteria for appointment to this body. Alternative, compromise versions of the bill's oil provisions are already emerging from within Senator Reid's own party, and with a lot of luck we could end up with measures that would actually make offshore drilling safer and more responsible without killing it--and the roughly 30% of domestic oil production it provides.
In addition to its oil spill provisions, the bill also offers some generous tax credits for converting heavy-duty trucking to natural gas, along the lines of the Pickens proposals I discussed last Friday, plus similar help for vehicle electrification and infrastructure, yet more energy efficiency measures (this time focused on homes), and funding for an old government program to buy up land and waterways for parks and nature preserves. All of this is notionally paid for ("PAYGO") by raising the Oil Spill Liability Trust Fund fee on all the oil produced and used in the US from $0.08 to $0.45 per barrel, which would directly increase the size of the fund to cover future disasters from $1 billion to $5 billion, while indirectly making all the bill's other provisions appear deficit-neutral. The proposed fee increase has the potential to raise an extra $2.5 billion per year.
It's not clear whether even this slimmed-down bill can garner enough votes to pass in the Senate, let alone do so before the summer adjournment. In any case I'd expect the version that comes up for a final vote--if it does at all--to look somewhat different than this draft. It would almost certainly grow much longer, a malady that has afflicted all major legislation in recent Congresses. Whether it will actually make a meaningfully-positive impact on the serious energy challenges the US faces remains to be seen.
Monday, July 19, 2010
Building a Market for Biofuels
For the first time in many years I find myself in general agreement with one of the major ethanol trade associations on a key matter of energy policy. Last week Growth Energy, which represents a significant portion of the US ethanol and biofuels industry, announced its support for a phase-out of the federal Volumetric Ethanol Excise Tax Credit, or "blender's credit", in preference to using these funds to provide incentives for constructing the infrastructure needed to offer ethanol at every gas station, and to promote vehicles that can safely burn higher-percentage ethanol blends. This looks like a prudent shift for several reasons, and I hope that the Congress is paying close attention.
No, I haven't suddenly abandoned my aversion to ethanol subsidies that have dragged on for more than three decades and are now long overdue for full retirement, at least for ethanol derived from corn and other food crops. The Congressional Budget Office just released a study on these subsidies showing that when applied to volumes of biofuel equivalent to a gallon of gasoline, the current $0.45 per gallon ethanol blenders' credit equates to $0.73/gal., and the full cost to taxpayers of displacing a gallon of petroleum gasoline with ethanol works out to $1.78/gal. That doesn't count any of the actual production costs of the fuel, either. US ethanol output may thus displace roughly 500,000 barrels per day of imported gasoline (or the imported oil from which to refine it) but it's hardly a bargain. However, I'm also aware that the US has made an enormous policy--and political--commitment to biofuels, including advanced biofuels from cellulosic biomass.
We've done this for reasons that transcend economics. But unless we invest smartly to create a bigger market for these biofuels, the Renewable Fuel Standard will shortly collide with the "blend wall", and US biofuels policy will be stymied. That will happen sooner than might otherwise have been expected, because instead of growing at a steady 1-2% per year as they had prior to the enactment of this policy, US gasoline sales have actually shrunk since then. Trying to cram additional amounts of ethanol into this market--and into cars that weren't designed to use more than 10% of it without damage to engines, fuel systems, and emissions equipment--is a dead end. In order to keep growing, ethanol--including cellulosic ethanol--requires an independent outlet. That's where E85, the 85% ethanol/15% gasoline mix that's as close to straight ethanol as can effectively be delivered to the gas station and used in flex-fuel cars, comes in. So far, though, E85 occupies a tiny niche market mainly in the corn states of the Midwest.
Growth Energy appears to have assessed the longer-term environment for their fuel and reached a similar conclusion: paying refiners to blend ethanol into the shrinking space left in each gallon of ordinary gasoline--which is what the current VEETC does--now makes a lot less sense than helping the nation's 100,000-plus service stations (most independently owned) to adapt their forecourts to deliver a wider mix of products. Promoting flexible fuel vehicles--including wider awareness of which cars are already capable of safely using higher ethanol blends--is also an important element of creating a market for these fuels, though to some degree this is already underway through the government's Corporate Average Fuel Economy regulations and voluntary manufacturer initiatives.
This won't be easy. Growth Energy expresses confidence that ethanol can compete against gasoline without a per-gallon subsidy, as long as it's widely available and most cars are equipped to burn it. However, the industry must somehow overcome the fact that each gallon of pure ethanol contains just 66% of the energy of a gallon of petroleum gasoline. Most drivers don't notice the impact of this when they use gasoline blended with 10% ethanol, but at 85% ethanol and just 15% gasoline, this effect becomes impossible to ignore. Beyond those customers willing to absorb that hit for reasons of perceived patriotism or environmentalism, E85 must ultimately be priced at a discount that reflects the reality that a tank of it won't take you nearly as far.
As of last Friday, ethanol for August delivery traded for $1.61/gal on the Chicago exchange. (That doesn't include freight to market, mainly by rail, which can easily add another dime.) That works out to $2.46 per gasoline-equivalent gallon. Meanwhile Unleaded Regular without ethanol was worth $2.05/gal on the New York exchange (pre-tax.) Nor is this difference anomalous; over the last year wholesale gasoline was consistently cheaper than its energy equivalent in wholesale ethanol, to the tune of roughly $0.90/gal. Unless the ethanol industry figures out how to produce its product at a lower cost, or gasoline prices go up without ethanol prices following, as they did in 2008, then tax credits for distribution and sales infrastructure may not foster as big a market for ethanol as Growth Energy expects, or as profitable a market as I'm sure they'd like. Yet as a matter of policy equity, and from the standpoint of what taxpayers are getting for their money, guaranteeing access for ethanol looks like a better approach than guaranteeing sales, as we do now. It also has the additional benefit of having a logical end-point, instead of the open-ended support we've effectively provided ethanol since 1978.
The current ethanol blenders' credit expires at the end of 2010. The announcement by Growth Energy is even more notable because the Renewable Fuels Association, which represents a larger slice of the industry, has come out in favor of an extension of existing policy through 2015, when the subsidy in question would likely approach $7 billion per year. If this divergence within the ethanol industry is reflected among its supporters in Congress, we could see a surprisingly lively--and fruitful--debate over how best to integrate support for ethanol into a more cohesive national energy framework. Compared to continuing the status quo, Growth Energy's idea of investing to create a mass biofuels market, rather than just paying for space in gasoline, has considerable merit. This approach could also be done for a lot less than the current subsidy, because it wouldn't be necessary to install E85 pumps in every service station in the country. Most of the benefit could be achieved by focusing incentives on strategically-located high-volume outlets, and the rest of the money could go back into the Treasury, where it belongs.
No, I haven't suddenly abandoned my aversion to ethanol subsidies that have dragged on for more than three decades and are now long overdue for full retirement, at least for ethanol derived from corn and other food crops. The Congressional Budget Office just released a study on these subsidies showing that when applied to volumes of biofuel equivalent to a gallon of gasoline, the current $0.45 per gallon ethanol blenders' credit equates to $0.73/gal., and the full cost to taxpayers of displacing a gallon of petroleum gasoline with ethanol works out to $1.78/gal. That doesn't count any of the actual production costs of the fuel, either. US ethanol output may thus displace roughly 500,000 barrels per day of imported gasoline (or the imported oil from which to refine it) but it's hardly a bargain. However, I'm also aware that the US has made an enormous policy--and political--commitment to biofuels, including advanced biofuels from cellulosic biomass.
We've done this for reasons that transcend economics. But unless we invest smartly to create a bigger market for these biofuels, the Renewable Fuel Standard will shortly collide with the "blend wall", and US biofuels policy will be stymied. That will happen sooner than might otherwise have been expected, because instead of growing at a steady 1-2% per year as they had prior to the enactment of this policy, US gasoline sales have actually shrunk since then. Trying to cram additional amounts of ethanol into this market--and into cars that weren't designed to use more than 10% of it without damage to engines, fuel systems, and emissions equipment--is a dead end. In order to keep growing, ethanol--including cellulosic ethanol--requires an independent outlet. That's where E85, the 85% ethanol/15% gasoline mix that's as close to straight ethanol as can effectively be delivered to the gas station and used in flex-fuel cars, comes in. So far, though, E85 occupies a tiny niche market mainly in the corn states of the Midwest.
Growth Energy appears to have assessed the longer-term environment for their fuel and reached a similar conclusion: paying refiners to blend ethanol into the shrinking space left in each gallon of ordinary gasoline--which is what the current VEETC does--now makes a lot less sense than helping the nation's 100,000-plus service stations (most independently owned) to adapt their forecourts to deliver a wider mix of products. Promoting flexible fuel vehicles--including wider awareness of which cars are already capable of safely using higher ethanol blends--is also an important element of creating a market for these fuels, though to some degree this is already underway through the government's Corporate Average Fuel Economy regulations and voluntary manufacturer initiatives.
This won't be easy. Growth Energy expresses confidence that ethanol can compete against gasoline without a per-gallon subsidy, as long as it's widely available and most cars are equipped to burn it. However, the industry must somehow overcome the fact that each gallon of pure ethanol contains just 66% of the energy of a gallon of petroleum gasoline. Most drivers don't notice the impact of this when they use gasoline blended with 10% ethanol, but at 85% ethanol and just 15% gasoline, this effect becomes impossible to ignore. Beyond those customers willing to absorb that hit for reasons of perceived patriotism or environmentalism, E85 must ultimately be priced at a discount that reflects the reality that a tank of it won't take you nearly as far.
As of last Friday, ethanol for August delivery traded for $1.61/gal on the Chicago exchange. (That doesn't include freight to market, mainly by rail, which can easily add another dime.) That works out to $2.46 per gasoline-equivalent gallon. Meanwhile Unleaded Regular without ethanol was worth $2.05/gal on the New York exchange (pre-tax.) Nor is this difference anomalous; over the last year wholesale gasoline was consistently cheaper than its energy equivalent in wholesale ethanol, to the tune of roughly $0.90/gal. Unless the ethanol industry figures out how to produce its product at a lower cost, or gasoline prices go up without ethanol prices following, as they did in 2008, then tax credits for distribution and sales infrastructure may not foster as big a market for ethanol as Growth Energy expects, or as profitable a market as I'm sure they'd like. Yet as a matter of policy equity, and from the standpoint of what taxpayers are getting for their money, guaranteeing access for ethanol looks like a better approach than guaranteeing sales, as we do now. It also has the additional benefit of having a logical end-point, instead of the open-ended support we've effectively provided ethanol since 1978.
The current ethanol blenders' credit expires at the end of 2010. The announcement by Growth Energy is even more notable because the Renewable Fuels Association, which represents a larger slice of the industry, has come out in favor of an extension of existing policy through 2015, when the subsidy in question would likely approach $7 billion per year. If this divergence within the ethanol industry is reflected among its supporters in Congress, we could see a surprisingly lively--and fruitful--debate over how best to integrate support for ethanol into a more cohesive national energy framework. Compared to continuing the status quo, Growth Energy's idea of investing to create a mass biofuels market, rather than just paying for space in gasoline, has considerable merit. This approach could also be done for a lot less than the current subsidy, because it wouldn't be necessary to install E85 pumps in every service station in the country. Most of the benefit could be achieved by focusing incentives on strategically-located high-volume outlets, and the rest of the money could go back into the Treasury, where it belongs.
Monday, May 17, 2010
Ethanol and the Gulf Spill
The implications for the oil industry from the ongoing Gulf of Mexico oil spill are already taking shape, with the administration calling for a Challenger-style investigation and rewriting the playbook for oil & gas leasing and the issuance of safety and environmental permits for offshore drilling. It's less clear how the spill might affect other aspects of energy, beyond boosting the public's interest in pursuing clean energy options. However, it would be ironic if a problem perceived to have arisen because of a "cozy relationship" between oil companies and regulators resulted in an even cozier relationship between the government and the ethanol industry that depends on it for both financial support and the rules that mandate the use of its product. Yet that's exactly what could happen as the administration decides whether to increase the allowable percentage of ethanol in gasoline.
Perhaps you've seen the new ads from Growth Energy, an ethanol trade association: "No beaches have been closed due to _____ spills", with the word "ethanol" fading slowly into view. Then there's "We won't have to wait millions of years to replenish our _____ reserves," and other statements emphasizing ethanol's employment and energy security benefits. It's a clever campaign, and well-timed. On one level, using more ethanol in gasoline seems an obvious response to concerns about our dependence on oil. For all its many shortcomings, ethanol remains the most successful oil substitute in the US market, thanks to the combination of a $0.45 per gallon blenders' tax credit and the steady ratcheting-up of the annual federal renewable fuels standard. Ethanol currently displaces the equivalent of approximately 500,000 barrels per day of gasoline that would otherwise be imported or refined here from imported crude oil. The problem is that the market penetration of ethanol is rapidly approaching the 10% blending limit that has been approved as safe for use in engines that haven't been modified to run on higher-percentage ethanol blends, such as E85. And because E85 has so far failed dismally to take off--accounting for just 0.01% of US gasoline sales in 2008, based on EPA's analysis--any additional ethanol would have to be squeezed into ordinary gasoline, at least in the near term.
Our proximity to this threshold, referred to as the "blend wall", is determined by two factors, in addition to the federally-mandated ethanol blending volume: total US gasoline sales and US ethanol output. Last year Americans bought just under 138 billion gallons of gasoline (including the ethanol blended into it), a reduction of about 3% from the 2007 peak. Without further growth in demand, 10% of that would be 13.8 billion gallons per year (gpy). According to the Renewable Fuels Association, another ethanol trade association, the capacity of existing US ethanol facilities plus those under construction already totals 14.7 billion gpy. In other words, once all the ethanol plants now being built are finished, the industry could supply more than 10% of US gasoline demand without breaking a sweat. But without either a higher blending limit in gasoline or a sudden, unexpected surge in E85 sales, any additional ethanol beyond that level would have no home in the US fuels market. Nor is it obvious that corn ethanol exports represent a viable long-term outlet. Left unresolved, this is a guaranteed train-wreck.
Under the circumstances, it's natural for the ethanol industry to ask its patron for help, in the form of a request for a waiver to blend more than 10% ethanol into each gallon of gas. Last winter, the Environmental Protection Agency told Growth Energy that it was studying their request and would respond by mid-2010. That deadline is nearly upon us, and with more oil spilling into the Gulf of Mexico every day, the pressure on EPA to agree must be mounting. This can't be an easy call to make, especially with the auto makers citing test results indicating that ethanol blends above 10% could harm some car engines. Saying no would call into question the nation's entire long-term renewable fuels strategy, at a time when green jobs and green energy are being widely promoted as the key to a new, more competitive economy. Yet granting that request, either as a favor to the ethanol industry or as a hasty response to the Gulf Coast oil spill would be a mistake that could have serious repercussions, both for consumers and for the administration making such a call. Stay tuned.
Update as of 6/18/10: EPA delays its decision on E15 until the fall.
Perhaps you've seen the new ads from Growth Energy, an ethanol trade association: "No beaches have been closed due to _____ spills", with the word "ethanol" fading slowly into view. Then there's "We won't have to wait millions of years to replenish our _____ reserves," and other statements emphasizing ethanol's employment and energy security benefits. It's a clever campaign, and well-timed. On one level, using more ethanol in gasoline seems an obvious response to concerns about our dependence on oil. For all its many shortcomings, ethanol remains the most successful oil substitute in the US market, thanks to the combination of a $0.45 per gallon blenders' tax credit and the steady ratcheting-up of the annual federal renewable fuels standard. Ethanol currently displaces the equivalent of approximately 500,000 barrels per day of gasoline that would otherwise be imported or refined here from imported crude oil. The problem is that the market penetration of ethanol is rapidly approaching the 10% blending limit that has been approved as safe for use in engines that haven't been modified to run on higher-percentage ethanol blends, such as E85. And because E85 has so far failed dismally to take off--accounting for just 0.01% of US gasoline sales in 2008, based on EPA's analysis--any additional ethanol would have to be squeezed into ordinary gasoline, at least in the near term.
Our proximity to this threshold, referred to as the "blend wall", is determined by two factors, in addition to the federally-mandated ethanol blending volume: total US gasoline sales and US ethanol output. Last year Americans bought just under 138 billion gallons of gasoline (including the ethanol blended into it), a reduction of about 3% from the 2007 peak. Without further growth in demand, 10% of that would be 13.8 billion gallons per year (gpy). According to the Renewable Fuels Association, another ethanol trade association, the capacity of existing US ethanol facilities plus those under construction already totals 14.7 billion gpy. In other words, once all the ethanol plants now being built are finished, the industry could supply more than 10% of US gasoline demand without breaking a sweat. But without either a higher blending limit in gasoline or a sudden, unexpected surge in E85 sales, any additional ethanol beyond that level would have no home in the US fuels market. Nor is it obvious that corn ethanol exports represent a viable long-term outlet. Left unresolved, this is a guaranteed train-wreck.
Under the circumstances, it's natural for the ethanol industry to ask its patron for help, in the form of a request for a waiver to blend more than 10% ethanol into each gallon of gas. Last winter, the Environmental Protection Agency told Growth Energy that it was studying their request and would respond by mid-2010. That deadline is nearly upon us, and with more oil spilling into the Gulf of Mexico every day, the pressure on EPA to agree must be mounting. This can't be an easy call to make, especially with the auto makers citing test results indicating that ethanol blends above 10% could harm some car engines. Saying no would call into question the nation's entire long-term renewable fuels strategy, at a time when green jobs and green energy are being widely promoted as the key to a new, more competitive economy. Yet granting that request, either as a favor to the ethanol industry or as a hasty response to the Gulf Coast oil spill would be a mistake that could have serious repercussions, both for consumers and for the administration making such a call. Stay tuned.
Update as of 6/18/10: EPA delays its decision on E15 until the fall.
Wednesday, October 07, 2009
Setting Ethanol Free
The Government Accountability Office (GAO) recently issued its report assessing the impact of the production and use of biofuels in the US. Among its recommendations was a call for the Congress to reassess whether corn ethanol still needs the support of a $0.45 per gallon blenders' credit, when its use by refiners and gasoline blenders is now mandated under the federal Renewable Fuel Standard (RFS) that was set by the Energy Independence and Security Act of 2007 (EISA). As you might imagine, this has set the cat among the pigeons and prompted a terse and dismissive response from the Renewable Fuels Association, the trade group representing the US ethanol industry. Along with several points that I interpret as making at least as good a case for dropping the subsidy as keeping it, their main defense boils down to a combination of historical precedent and envy of the industry that is its primary customer. Neither justification stands up to scrutiny.
Consider the historical argument first. There's no doubt that without the subsidies provided by the federal government and various states over the last thirty-plus years, the ethanol industry would not have grown to a sufficient scale to take on the new challenge set for it by Congress in the EISA. From the landmark establishment of a $0.40/gal. excise tax exemption for ethanol blended into gasoline under the Energy Tax Act of 1978, it took the industry 14 years to grow to the 1 billion-gallon-per-year (BGY) mark (equivalent to 43,000 barrels per day of gasoline) and another decade to reach 2 BGY. When EISA was passed at the end of 2007, the industry was already producing around 6 BGY and had built enough capacity to produce nearly 8 BGY, or around 5.5% of US gasoline demand that year, by volume. That was already more than the 7.5 BGY required under the previous RFS established by the Energy Policy Act of 2005. But as ambitious as the goals of the newly-enacted RFS seemed in 2007, the industry continued building capacity at a rapid pace, and by the start of this year had enough ethanol plants built or under construction to satisfy 97% of the 15 billion gallon target (and ceiling) that Congress set for corn ethanol.
Two things seem clear from this history: First, the combination of a generous blenders' credit, which until the start of this year paid $0.51/gal., and two successive federal biofuel standards led to over-expansion of the ethanol industry relative to demand, either mandated or economic. That harmed the industry and led to many ethanol plants being sold or mothballed in the last year, with a number of ethanol companies going bankrupt, including VeraSun, which had been an industry leader not long before its demise. Other important factors certainly contributed to these business failures, including the spike in corn and oil prices in 2007 and 2008 and the sudden collapse of the latter last fall; however, the over-extension of these companies as they went deeper and deeper into debt to build new capacity left them particularly vulnerable to volatile commodity markets and the emerging credit crisis.
In addition, the above figures make it very plain that the US corn ethanol industry doesn't need to grow further, because it is already within striking distance of the target set by the government, which also appears to represent the maximum prudent level of output for a fuel source that makes such heavy use of water and fossil energy sources in its production, and that ultimately competes with the consumption of corn as food or feed, here and abroad. In other words, the work of the subsidies and mandates for corn ethanol is complete, and the government has shifted its focus to cellulosic ethanol and other advanced biofuels, which enjoy their own distinct--and more generous--subsidies. It hopes these sources will expand from essentially zero to cover the remaining 21 BGY of the current RFS by 2022.
The argument that corn ethanol is somehow entitled to perpetual subsidies on the basis of an inaccurate comparison to the tax benefits currently enjoyed by the oil & gas industry--tax benefits that are currently under threat, themselves--is equally unpersuasive. In the posting in which I recently examined the Treasury Department's arguments for dismantling those oil & gas tax benefits, I compared the level of incentives for conventional fuels with those provided to ethanol. That $0.45/gal. ethanol blenders' credit swells to the equivalent of about $0.77/gal. after accounting for the lower energy content of ethanol. That compares to incentives of around $0.12/gal. for US oil production. And that doesn't even take into consideration the fact that producing a gallon of ethanol requires much more energy from other sources, such as natural gas, than producing a gallon of crude oil or gasoline. Thus ethanol receives at least six times the subsidy per delivered BTU that domestic oil does, even though their energy security benefits per gallon are identical.
The GAO report estimates the cost to the Treasury of the ethanol blenders' credit at $4 billion last year, growing to $6.75 billion by 2015, if not sooner. Although at a time of trillion-dollar deficits that may look no more significant than a rounding error in the government's books, continuing this outdated and unnecessary incentive sends a bad message to the developers of other, less mature alternative energy sources. It tells them that they don't need to worry so much about making their technologies competitive with conventional energy, because the government is likely to subsidize them until the end of time--or until the Treasury runs out of money, a date that will surely arrive faster, the more unnecessary subsidies it hands out. After having been extended by last year's Farm Bill, the present Volumetric Ethanol Excise Tax Credit and the tariff on imported ethanol that mirrors it are due to expire at the end of next year. After 30 years of assistance--spanning my entire career in energy--it's time to find out whether this industry can survive and compete on its own.
Consider the historical argument first. There's no doubt that without the subsidies provided by the federal government and various states over the last thirty-plus years, the ethanol industry would not have grown to a sufficient scale to take on the new challenge set for it by Congress in the EISA. From the landmark establishment of a $0.40/gal. excise tax exemption for ethanol blended into gasoline under the Energy Tax Act of 1978, it took the industry 14 years to grow to the 1 billion-gallon-per-year (BGY) mark (equivalent to 43,000 barrels per day of gasoline) and another decade to reach 2 BGY. When EISA was passed at the end of 2007, the industry was already producing around 6 BGY and had built enough capacity to produce nearly 8 BGY, or around 5.5% of US gasoline demand that year, by volume. That was already more than the 7.5 BGY required under the previous RFS established by the Energy Policy Act of 2005. But as ambitious as the goals of the newly-enacted RFS seemed in 2007, the industry continued building capacity at a rapid pace, and by the start of this year had enough ethanol plants built or under construction to satisfy 97% of the 15 billion gallon target (and ceiling) that Congress set for corn ethanol.
Two things seem clear from this history: First, the combination of a generous blenders' credit, which until the start of this year paid $0.51/gal., and two successive federal biofuel standards led to over-expansion of the ethanol industry relative to demand, either mandated or economic. That harmed the industry and led to many ethanol plants being sold or mothballed in the last year, with a number of ethanol companies going bankrupt, including VeraSun, which had been an industry leader not long before its demise. Other important factors certainly contributed to these business failures, including the spike in corn and oil prices in 2007 and 2008 and the sudden collapse of the latter last fall; however, the over-extension of these companies as they went deeper and deeper into debt to build new capacity left them particularly vulnerable to volatile commodity markets and the emerging credit crisis.
In addition, the above figures make it very plain that the US corn ethanol industry doesn't need to grow further, because it is already within striking distance of the target set by the government, which also appears to represent the maximum prudent level of output for a fuel source that makes such heavy use of water and fossil energy sources in its production, and that ultimately competes with the consumption of corn as food or feed, here and abroad. In other words, the work of the subsidies and mandates for corn ethanol is complete, and the government has shifted its focus to cellulosic ethanol and other advanced biofuels, which enjoy their own distinct--and more generous--subsidies. It hopes these sources will expand from essentially zero to cover the remaining 21 BGY of the current RFS by 2022.
The argument that corn ethanol is somehow entitled to perpetual subsidies on the basis of an inaccurate comparison to the tax benefits currently enjoyed by the oil & gas industry--tax benefits that are currently under threat, themselves--is equally unpersuasive. In the posting in which I recently examined the Treasury Department's arguments for dismantling those oil & gas tax benefits, I compared the level of incentives for conventional fuels with those provided to ethanol. That $0.45/gal. ethanol blenders' credit swells to the equivalent of about $0.77/gal. after accounting for the lower energy content of ethanol. That compares to incentives of around $0.12/gal. for US oil production. And that doesn't even take into consideration the fact that producing a gallon of ethanol requires much more energy from other sources, such as natural gas, than producing a gallon of crude oil or gasoline. Thus ethanol receives at least six times the subsidy per delivered BTU that domestic oil does, even though their energy security benefits per gallon are identical.
The GAO report estimates the cost to the Treasury of the ethanol blenders' credit at $4 billion last year, growing to $6.75 billion by 2015, if not sooner. Although at a time of trillion-dollar deficits that may look no more significant than a rounding error in the government's books, continuing this outdated and unnecessary incentive sends a bad message to the developers of other, less mature alternative energy sources. It tells them that they don't need to worry so much about making their technologies competitive with conventional energy, because the government is likely to subsidize them until the end of time--or until the Treasury runs out of money, a date that will surely arrive faster, the more unnecessary subsidies it hands out. After having been extended by last year's Farm Bill, the present Volumetric Ethanol Excise Tax Credit and the tariff on imported ethanol that mirrors it are due to expire at the end of next year. After 30 years of assistance--spanning my entire career in energy--it's time to find out whether this industry can survive and compete on its own.
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