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.
Showing posts sorted by relevance for query blenders credit. Sort by date Show all posts
Showing posts sorted by relevance for query blenders credit. Sort by date Show all posts
Friday, December 03, 2010
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.
Tuesday, July 12, 2011
Ethanol's Future Without Subsidies
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.
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.
Wednesday, July 02, 2008
The Ethanol Tariff and Subsidy Reform
Brazilian ethanol producers have long sought a level playing field on which to compete with their US counterparts, and this week they are launching a campaign to publicize their message that ethanol derived from sugar cane could be imported from Brazil at a lower cost than ethanol can be produced from corn in the US, if only the import tariff were reduced or eliminated. Legislation to reduce the tariff has been introduced in both the House and Senate. But while the modest step of cutting the tariff to match the domestic ethanol subsidy makes sense, eliminating it entirely would require substantial changes in the mechanism by which the federal government supports the use of domestic ethanol, to prevent taxpayer dollars directly subsidizing Brazilian cane growers and distillers. It is hard to imagine legislators wanting to open such a can of worms this year.
With the exception of imports under the Caribbean Basin Initiative, all ethanol imported into the US is subject to an import tariff and "secondary duty" worth about $0.60 per gallon. Although its original purpose may have been to protect domestic producers from foreign competition, it serves an important practical function, because of the way the US subsidizes domestic ethanol. Along with direct support to corn farmers and loan guarantees and other benefits for ethanol distillers, the government provides a credit of $0.51/gal. to companies that blend ethanol into gasoline, as a reduction to the fuel tax they would otherwise owe--though no longer at the expense of funding for road maintenance. The Farm Bill recently enacted over President Bush's veto reduced this "blenders' credit" to $0.45/gal, starting next year, but it will still amount to over $3 billion per year, based on 2007 volumes, which are slated to double by 2012.
Due to surging US ethanol production in 2007, imports from Brazil fell last year, compared to 2006. However, in the wake of the flooding that has devastated crops and paralyzed rail and barge transport in a large section of the Midwest, more imports might be necessary in order to meet the mandated volume of 9 billion gallons of ethanol for this year, under the Renewable Fuel Standard provisions of the Energy Independence and Security Act of 2007. If the tariff were repealed without changing the way the blenders' credit is paid, and if Brazilian imports merely matched their 2006 level, taxpayers could end up subsidizing Brazilian ethanol producers to the tune of $220 million this year.
I see two possible ways to avoid this outcome, while still taking advantage of lower-cost, higher-efficiency Brazilian ethanol: First, the law governing the ethanol credit could be modified to restrict its application to volumes produced in the US. Even if that passed muster under World Trade Organization rules, it would require the creation of a two-tier ethanol subsidy system and the means of monitoring it. In the process, it would increase the incentives for ethanol smuggling. That might sound like a relic of Prohibition, but given their established involvement in evading gasoline taxes, organized crime might find it a lucrative new line of business.
The other, more drastic alternative would be to shift the point of subsidy payment from the blender to the ethanol producer. This would impose its own regulatory and accounting burden and create other opportunities for abuse. However, it would also raise a more awkward question for ethanol producers. The original choice to subsidize blenders was hardly accidental; it was designed to encourage greater use of a domestic fuel during the previous energy crisis, and it has certainly achieved that goal. But with refiners and other blenders of gasoline now required by law to blend specified quantities of ethanol into gasoline, and with wholesale ethanol now generally selling for less at the distillery gate than wholesale gasoline, the justification for providing blenders with additional financial incentives to use this fuel has been greatly diminished.
Considering all these factors, ending the tariff and duty applied to imports of ethanol from Brazil and elsewhere would hardly be the simple matter suggested by the supporters of this idea. It would force a choice between extending ethanol subsidies to foreign producers--imagine that coming up in a presidential debate--and confronting the larger question of continuing ethanol subsidies at a time when our ethanol use is widely perceived to contribute to higher food prices. Unless the logistical problems caused by the Midwest flooding result in a severe enough shortage of domestic ethanol to drive up gasoline prices, I would be surprised if this idea got any traction this year.
With the exception of imports under the Caribbean Basin Initiative, all ethanol imported into the US is subject to an import tariff and "secondary duty" worth about $0.60 per gallon. Although its original purpose may have been to protect domestic producers from foreign competition, it serves an important practical function, because of the way the US subsidizes domestic ethanol. Along with direct support to corn farmers and loan guarantees and other benefits for ethanol distillers, the government provides a credit of $0.51/gal. to companies that blend ethanol into gasoline, as a reduction to the fuel tax they would otherwise owe--though no longer at the expense of funding for road maintenance. The Farm Bill recently enacted over President Bush's veto reduced this "blenders' credit" to $0.45/gal, starting next year, but it will still amount to over $3 billion per year, based on 2007 volumes, which are slated to double by 2012.
Due to surging US ethanol production in 2007, imports from Brazil fell last year, compared to 2006. However, in the wake of the flooding that has devastated crops and paralyzed rail and barge transport in a large section of the Midwest, more imports might be necessary in order to meet the mandated volume of 9 billion gallons of ethanol for this year, under the Renewable Fuel Standard provisions of the Energy Independence and Security Act of 2007. If the tariff were repealed without changing the way the blenders' credit is paid, and if Brazilian imports merely matched their 2006 level, taxpayers could end up subsidizing Brazilian ethanol producers to the tune of $220 million this year.
I see two possible ways to avoid this outcome, while still taking advantage of lower-cost, higher-efficiency Brazilian ethanol: First, the law governing the ethanol credit could be modified to restrict its application to volumes produced in the US. Even if that passed muster under World Trade Organization rules, it would require the creation of a two-tier ethanol subsidy system and the means of monitoring it. In the process, it would increase the incentives for ethanol smuggling. That might sound like a relic of Prohibition, but given their established involvement in evading gasoline taxes, organized crime might find it a lucrative new line of business.
The other, more drastic alternative would be to shift the point of subsidy payment from the blender to the ethanol producer. This would impose its own regulatory and accounting burden and create other opportunities for abuse. However, it would also raise a more awkward question for ethanol producers. The original choice to subsidize blenders was hardly accidental; it was designed to encourage greater use of a domestic fuel during the previous energy crisis, and it has certainly achieved that goal. But with refiners and other blenders of gasoline now required by law to blend specified quantities of ethanol into gasoline, and with wholesale ethanol now generally selling for less at the distillery gate than wholesale gasoline, the justification for providing blenders with additional financial incentives to use this fuel has been greatly diminished.
Considering all these factors, ending the tariff and duty applied to imports of ethanol from Brazil and elsewhere would hardly be the simple matter suggested by the supporters of this idea. It would force a choice between extending ethanol subsidies to foreign producers--imagine that coming up in a presidential debate--and confronting the larger question of continuing ethanol subsidies at a time when our ethanol use is widely perceived to contribute to higher food prices. Unless the logistical problems caused by the Midwest flooding result in a severe enough shortage of domestic ethanol to drive up gasoline prices, I would be surprised if this idea got any traction this year.
Friday, March 28, 2008
Ethanol Synergies and Subsidies
Many Americans have the mistaken idea that oil companies don't like ethanol. Perhaps this derives from the general lack of enthusiasm of oil companies for installing E-85 pumps in every gas station, or the sense that ethanol competes with oil and thus reduces oil company profitability. However, after a difficult transition away from MTBE, the industry's preferred fuel oxygenate, ethanol has generally turned out to be a good thing for oil companies--such a good thing, in fact, that we ought to rethink the rationale and mechanism for the 51 cent-per-gallon ethanol blenders credit.
A year ago, in an address to USDA Agricultural Outlook Forum the CEO of the American Petroleum Institute, Red Cavaney, said, "Clearly, there is a bright future for ethanol, as well as for biodiesel, although the latter is starting from a smaller base. We look forward to the promise of an ever-growing relationship between our two industries in the years ahead." To understand why the US oil industry is supportive of ethanol, you have to examine the US motor fuels supply and demand balance and the economics of ethanol blending.
Start with the fuel balance. US refineries produce on average 8.4 million barrels per day (MBD) of motor gasoline, or "mogas", while we consume 9.3 MBD. The difference is made up by imports of finished mogas and various unfinished petroleum-based blending components and ethanol. In fact, the quantity of imported finished mogas is roughly equal to current US ethanol production. That means that the volume displaced by a further doubling of ethanol output would come largely at the expense of foreign refineries, not US ones. As long as US oil companies made more on ethanol blending than their typically thin margins on imported mogas, they would be no worse off.
Historically, ethanol was more expensive than either gasoline or methyl-tert-butyl-ether (MTBE), another additive used to meet mandated fuel oxygenate standards. Today, MTBE is out of favor, and ethanol is cheaper than the RBOB--shorthand for "reformulated gasoline blendstock for oxygenate blending"--with which it is blended at distribution terminals to make finished gasoline for sale to consumers. If you compare the spot price of RBOB in the Gulf Coast this week, at $2.58/gallon, with the ethanol price on the Chicago Board of Trade, at $2.51/gal. plus approximately $0.12/gal. freight, and then subtract the blenders' credit, ethanol ends up 46 cents per gallon cheaper than the mogas with which it's blended. It would be the rare cargo of imported mogas, indeed, that yielded anything close to that kind of uplift. As a result, the industry has a healthy incentive to use this oil substitute that the government has deemed useful in reducing emissions and enhancing our energy security.
But here is where the interests of oil companies and ethanol producers diverge from those of consumers and taxpayers: A gallon of ethanol carries only about 70% as much energy as a gallon of gasoline. Fuel suppliers are indifferent to this fact, because, unlike your natural gas utility, they sell by volume, not energy content. But unless you are burning nearly pure ethanol in an engine optimized to make the most of its characteristics, that energy difference manifests in lower gas mileage. This effect is particularly pronounced for E-85, which contains only 75% as many BTUs as a gallon of ethanol-free mogas, and the EPA's fuel economy statistics on the performance of flexible-fuel vehicles bear that out. But even a 10% blend has about 3% less energy than normal gasoline, translating into about 0.7 mpg loss in a typical car. Some cars are more sensitive to this than others, but it works out to the equivalent of a hidden 10 cent-per-gallon tax on gasoline, at current prices.
What we have then, on balance, is a substantial federal subsidy that gives oil companies a significant incentive to produce a fuel that reduces consumer value and forces motorists to purchase more fuel to travel the same number of miles. Now, my industry colleagues would rightly point out that ethanol isn't quite the bonanza I've simplistically portrayed above. Because it can't be shipped in the petroleum products pipelines that are the heart of our national fuel distribution system, the logistics of ethanol are challenging, especially at remote locations far from Midwestern or coastal ethanol sources. It also costs a bit more to make RBOB, versus conventional gasoline, because of the need to compensate for ethanol's impact on gasoline vapor pressure, and thus evaporative emissions. Yet when I look at that RBOB/ethanol price relationship over the last year, I conclude that they are being well-rewarded for the extra effort involved.
I won't delude myself by thinking that we might abandon the federal ethanol subsidy any time soon, particularly in light of the dramatically-increased biofuels mandate enacted with the 2007 Energy Bill. The politics involved are insurmountable. But as the economy weakens and the federal budget deficit expands to fund economic stimulus and financial stabilization measures, it might not be beyond the pale to consider modifying the current fixed subsidy, by adding a floating cap that limited the ethanol blenders' credit to the net difference between prevailing gasoline prices and the delivered cost of ethanol, plus a fixed incentive. That would render ethanol cost-neutral for refiners and blenders, without undermining our national ethanol strategy. Even if this only shaved 10 cents per gallon off the subsidy, that could save taxpayers over a billion dollars per year, as ethanol volumes continue to rise for the next 15 years.
A year ago, in an address to USDA Agricultural Outlook Forum the CEO of the American Petroleum Institute, Red Cavaney, said, "Clearly, there is a bright future for ethanol, as well as for biodiesel, although the latter is starting from a smaller base. We look forward to the promise of an ever-growing relationship between our two industries in the years ahead." To understand why the US oil industry is supportive of ethanol, you have to examine the US motor fuels supply and demand balance and the economics of ethanol blending.
Start with the fuel balance. US refineries produce on average 8.4 million barrels per day (MBD) of motor gasoline, or "mogas", while we consume 9.3 MBD. The difference is made up by imports of finished mogas and various unfinished petroleum-based blending components and ethanol. In fact, the quantity of imported finished mogas is roughly equal to current US ethanol production. That means that the volume displaced by a further doubling of ethanol output would come largely at the expense of foreign refineries, not US ones. As long as US oil companies made more on ethanol blending than their typically thin margins on imported mogas, they would be no worse off.
Historically, ethanol was more expensive than either gasoline or methyl-tert-butyl-ether (MTBE), another additive used to meet mandated fuel oxygenate standards. Today, MTBE is out of favor, and ethanol is cheaper than the RBOB--shorthand for "reformulated gasoline blendstock for oxygenate blending"--with which it is blended at distribution terminals to make finished gasoline for sale to consumers. If you compare the spot price of RBOB in the Gulf Coast this week, at $2.58/gallon, with the ethanol price on the Chicago Board of Trade, at $2.51/gal. plus approximately $0.12/gal. freight, and then subtract the blenders' credit, ethanol ends up 46 cents per gallon cheaper than the mogas with which it's blended. It would be the rare cargo of imported mogas, indeed, that yielded anything close to that kind of uplift. As a result, the industry has a healthy incentive to use this oil substitute that the government has deemed useful in reducing emissions and enhancing our energy security.
But here is where the interests of oil companies and ethanol producers diverge from those of consumers and taxpayers: A gallon of ethanol carries only about 70% as much energy as a gallon of gasoline. Fuel suppliers are indifferent to this fact, because, unlike your natural gas utility, they sell by volume, not energy content. But unless you are burning nearly pure ethanol in an engine optimized to make the most of its characteristics, that energy difference manifests in lower gas mileage. This effect is particularly pronounced for E-85, which contains only 75% as many BTUs as a gallon of ethanol-free mogas, and the EPA's fuel economy statistics on the performance of flexible-fuel vehicles bear that out. But even a 10% blend has about 3% less energy than normal gasoline, translating into about 0.7 mpg loss in a typical car. Some cars are more sensitive to this than others, but it works out to the equivalent of a hidden 10 cent-per-gallon tax on gasoline, at current prices.
What we have then, on balance, is a substantial federal subsidy that gives oil companies a significant incentive to produce a fuel that reduces consumer value and forces motorists to purchase more fuel to travel the same number of miles. Now, my industry colleagues would rightly point out that ethanol isn't quite the bonanza I've simplistically portrayed above. Because it can't be shipped in the petroleum products pipelines that are the heart of our national fuel distribution system, the logistics of ethanol are challenging, especially at remote locations far from Midwestern or coastal ethanol sources. It also costs a bit more to make RBOB, versus conventional gasoline, because of the need to compensate for ethanol's impact on gasoline vapor pressure, and thus evaporative emissions. Yet when I look at that RBOB/ethanol price relationship over the last year, I conclude that they are being well-rewarded for the extra effort involved.
I won't delude myself by thinking that we might abandon the federal ethanol subsidy any time soon, particularly in light of the dramatically-increased biofuels mandate enacted with the 2007 Energy Bill. The politics involved are insurmountable. But as the economy weakens and the federal budget deficit expands to fund economic stimulus and financial stabilization measures, it might not be beyond the pale to consider modifying the current fixed subsidy, by adding a floating cap that limited the ethanol blenders' credit to the net difference between prevailing gasoline prices and the delivered cost of ethanol, plus a fixed incentive. That would render ethanol cost-neutral for refiners and blenders, without undermining our national ethanol strategy. Even if this only shaved 10 cents per gallon off the subsidy, that could save taxpayers over a billion dollars per year, as ethanol volumes continue to rise for the next 15 years.
Wednesday, August 01, 2012
Last Hurrah for the Wind Power Tax Credit?
Ahead of Thursday's meeting of the Senate Finance Committee, a bipartisan deal has apparently omitted the expiring production tax credit (PTC) for wind power from a package of "tax extenders"--various expiring federal tax provisions, including the annual "patch" for the Alternative Minimum Tax. This development might surprise some of the industry's supporters, but the politics of wind have changed since I last examined this issue in February. A measure that once enjoyed solid bi-partisan support is now caught between two presidential campaigns that hold diametrically opposed views on its fate.
A quick review of the PTC seems in order. This tax credit, which covers a variety of technologies but with wind as the main beneficiary, dates back to 1992--interrupted by several past expirations but then revived in essentially its present form. That's significant, because during the same 20 years in which the PTC has been escalating annually with inflation--from 1.5 ¢ per kilowatt-hour (kWh) to the present level of 2.2 ¢/kWh--the cost of wind turbines and their output has fallen significantly. In the same period, US installed wind capacity grew from 1,680 MW to nearly 49,000 MW as of the first quarter of 2012. So in effect, we're subsidizing today's relatively mature onshore wind technology by a larger proportion than we did when it was in its infancy. That makes no sense, especially in the current environment.
The US wind industry has received substantial government support in recent years. When the long-standing tax credit against corporate profits proved to be much less beneficial during the financial crisis, the administration gave wind developers a better option within the stimulus: a 30% investment tax credit that could be claimed as up-front cash grants, instead of having to wait until power was generated and sold over the normal 10 year period of the PTC. From 2009-11 the wind industry received a cumulative $7.7 B, in addition to ongoing tax credits on older projects, manufacturing tax credits for new wind turbine factories, and loan guarantees for selected wind farms. And even with new turbine installations in 2012 running well below their record rate of 10,000 MW in 2009, the wind projects that qualify for the PTC this year could receive a total of $4.5 B over the next decade.
Many people seem to want to equate the tax breaks that wind and other renewable energy technologies receive with the controversial tax benefits for the oil and gas industry, without realizing how unfavorable that comparison truly is for renewables. Subsidies for technologies such as wind are much higher per unit of energy produced, consistent with their intended purpose of bridging the competitive gap vs. conventional energy. Yet since the total output of new renewables is still relatively small, the disparity in total subsidies is much larger than it appears. One way to illustrate that is that if the oil and natural gas produced in the US received tax credits at the same rate per equivalent kWh as wind power, then the annual oil and gas tax preferences that the Congress and President Obama have been sparring over for the last three years wouldn't be $4.8 B per year, but around $100 B per year.
As the Reuters article makes clear, there will be other opportunities for the PTC to be reinserted in the extenders bill or other legislation. However, by persistently arguing for extending the existing credit without modification, the wind industry and its supporters may be misreading the public's appetite for such generous subsidies in a period of protracted economic weakness, notwithstanding the recent Iowa poll. Despite its rapid recent growth wind still contributes less than 4% of the nation's electricity and just 1% of our total energy consumption, and the green jobs angle is wearing thin. Last year's expiration of the ethanol blenders credit set a precedent for ending another large, generous subsidy before its beneficiaries agreed they were done with it. If congressional Republicans line up behind their party's standard bearer on this issue, the wind industry will have missed its opportunity for a graduated, multi-year phaseout of the PTC, instead of stepping off a cliff in 2013.
A quick review of the PTC seems in order. This tax credit, which covers a variety of technologies but with wind as the main beneficiary, dates back to 1992--interrupted by several past expirations but then revived in essentially its present form. That's significant, because during the same 20 years in which the PTC has been escalating annually with inflation--from 1.5 ¢ per kilowatt-hour (kWh) to the present level of 2.2 ¢/kWh--the cost of wind turbines and their output has fallen significantly. In the same period, US installed wind capacity grew from 1,680 MW to nearly 49,000 MW as of the first quarter of 2012. So in effect, we're subsidizing today's relatively mature onshore wind technology by a larger proportion than we did when it was in its infancy. That makes no sense, especially in the current environment.
The US wind industry has received substantial government support in recent years. When the long-standing tax credit against corporate profits proved to be much less beneficial during the financial crisis, the administration gave wind developers a better option within the stimulus: a 30% investment tax credit that could be claimed as up-front cash grants, instead of having to wait until power was generated and sold over the normal 10 year period of the PTC. From 2009-11 the wind industry received a cumulative $7.7 B, in addition to ongoing tax credits on older projects, manufacturing tax credits for new wind turbine factories, and loan guarantees for selected wind farms. And even with new turbine installations in 2012 running well below their record rate of 10,000 MW in 2009, the wind projects that qualify for the PTC this year could receive a total of $4.5 B over the next decade.
Many people seem to want to equate the tax breaks that wind and other renewable energy technologies receive with the controversial tax benefits for the oil and gas industry, without realizing how unfavorable that comparison truly is for renewables. Subsidies for technologies such as wind are much higher per unit of energy produced, consistent with their intended purpose of bridging the competitive gap vs. conventional energy. Yet since the total output of new renewables is still relatively small, the disparity in total subsidies is much larger than it appears. One way to illustrate that is that if the oil and natural gas produced in the US received tax credits at the same rate per equivalent kWh as wind power, then the annual oil and gas tax preferences that the Congress and President Obama have been sparring over for the last three years wouldn't be $4.8 B per year, but around $100 B per year.
As the Reuters article makes clear, there will be other opportunities for the PTC to be reinserted in the extenders bill or other legislation. However, by persistently arguing for extending the existing credit without modification, the wind industry and its supporters may be misreading the public's appetite for such generous subsidies in a period of protracted economic weakness, notwithstanding the recent Iowa poll. Despite its rapid recent growth wind still contributes less than 4% of the nation's electricity and just 1% of our total energy consumption, and the green jobs angle is wearing thin. Last year's expiration of the ethanol blenders credit set a precedent for ending another large, generous subsidy before its beneficiaries agreed they were done with it. If congressional Republicans line up behind their party's standard bearer on this issue, the wind industry will have missed its opportunity for a graduated, multi-year phaseout of the PTC, instead of stepping off a cliff in 2013.
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.
Tuesday, October 25, 2011
Key Renewable Energy Subsidies About to Expire
The US renewable energy industry faces a greatly altered incentive environment next year, as eligibility for two of its largest current subsidies comes to an end at the close of 2011. The corn ethanol sector will likely see the complete withdrawal of the blenders' credit that has fueled its growth for more than 30 years, while new projects generating electricity from renewable energy sources must shortly attract investment without the Treasury grants that provided up-front cash in place of federal investment tax credits against taxable income--a commodity sometimes in even shorter supply among recipients than the energy they seek to generate. With these expirations taking place against the backdrop of a US presidential election campaign and record levels of deficit and federal debt, the prospects for another round of one-year subsidy extensions look slim. Yet renewable energy development in the US won't grind to a halt without them, because these two programs represent merely the most generous layer of the complex web supporting renewables.
Consider the venerable ethanol tax credit, which was made mostly redundant by the passage of the Energy Independence and Security Act of 2007, with its Renewable Fuels Standard mandating the use of increasing quantities of ethanol in gasoline. In fact, ethanol producers were never more than indirect beneficiaries of the $0.45 per gallon credit, which was paid to refiners and other gasoline blenders in order to help create a market for ethanol. Mission accomplished. Moreover, with US gasoline sales having stalled at a level that can barely absorb all the ethanol that existing US ethanol plants can produce, unless gasoline blends containing more than 10% ethanol become popular, there is simply no need for corn ethanol output to expand further. In fact, the market will be more than sufficiently challenged providing outlets for the limited quantities of cellulosic and other advanced ethanol likely to be produced in the next few years. As I've noted previously, forward-looking members of the industry are now seeking help in expanding the market for high-ethanol blends, rather than perpetuating an outdated support for existing sales.
The situation for renewable electricity sources like wind, solar and geothermal energy is more complicated. The expiring Treasury grants were introduced as part of the 2009 stimulus to stand in for the "tax equity swap" market, a category of financial transactions that froze up during the financial crisis. These swaps provided a private-sector cash-flow bridge between project expenditures and tax credits that only paid off after start-up as income was earned or energy produced. That was particularly helpful for smaller, less profitable developers, but it also provided an additional check on marginal projects. Even after credit markets eased, most developers understandably preferred the cash grants, which reduced their financing costs and avoided the fees that bankers charged on tax equity deals. However, that preference doesn't justify continuing the cash grant program--particularly for the large, profitable corporations that increasing dominate this space. The industry should focus more effort on fostering the revival of a liquid and competitive tax equity market and less on lobbying for an extension of a temporary stimulus measure.
Either way, the tax credits behind these grants and swaps won't last forever. Under current law, the principal federal tax credit for wind will be in place only through 2012, for biomass and geothermal through 2013, and for solar through 2016. Instead of a scenario of perpetual last-minute extensions such as we've seen in the past, the industry and its investors should be thinking about a scenario in which all these tax credits end, either as part of comprehensive tax reform that eliminates most such "tax expenditures"--including the ones for the oil and gas industry that have become so contentious in the last few years--or a transition to providing renewables with similar sorts of incentives as oil and gas, which essentially amount to forms of accelerated depreciation and modest tax breaks for manufacturing in the US, rather than in other countries.
It's also important to realize that even without these tax credits and in the absence of comprehensive federal energy legislation that looks unlikely any time soon, the industry would still retain numerous state-level benefits, starting with the renewable portfolio standards (RPS) for electricity currently in place in 29 states and the District of Columbia, a tally that encompasses most of the states with the best wind and solar resources. These RPS's are similar to the Renewable Fuel Standard for biofuels in requiring utilities to include increasing proportions of renewable energy in their supply portfolios, whether owned or purchased. Such standards, including California's aggressive RPS targeting 33% renewable electricity by 2020, stand outside the polarizing political debate over taxation and government expenditures. They function as an implicit tax on ratepayers, rather than taxpayers, because they show up within customers' utility bills rather than on their 1040 forms. That distinction could be particularly important if the congressional supercommittee fails to reach a consensus, and the default spending cuts built into the Budget Control Act that resolved this summer's debt ceiling crisis kick in.
So while it might appear that the US renewable energy industry is about it be cut loose from the key incentives that enabled it to grow to its present dimensions, it will continue to benefit from supports not enjoyed by other industrial sectors. Even when the current tax credits expire, renewables will have a mandated market providing a floor beneath them. Ethanol output won't revert to 2005 levels, nor will renewables vanish from the landscape, even if their growth slows a bit while the rest of the economy struggles to emerge from the aftermath of the Great Recession and financial crisis, and to avoid a double-dip. Meanwhile, global overcapacity in wind turbine and solar module manufacturing will keep their prices trending lower--and installations stronger--pending industry consolidations that will position both for healthier, more sustainable growth in the long run. All of this falls well short of the level of help for the industry that most renewable energy supporters would like to see, but it's far more than the level playing field (ignoring externalities) that would see cheap and abundant natural gas sweep away all competition for new power generation.
Consider the venerable ethanol tax credit, which was made mostly redundant by the passage of the Energy Independence and Security Act of 2007, with its Renewable Fuels Standard mandating the use of increasing quantities of ethanol in gasoline. In fact, ethanol producers were never more than indirect beneficiaries of the $0.45 per gallon credit, which was paid to refiners and other gasoline blenders in order to help create a market for ethanol. Mission accomplished. Moreover, with US gasoline sales having stalled at a level that can barely absorb all the ethanol that existing US ethanol plants can produce, unless gasoline blends containing more than 10% ethanol become popular, there is simply no need for corn ethanol output to expand further. In fact, the market will be more than sufficiently challenged providing outlets for the limited quantities of cellulosic and other advanced ethanol likely to be produced in the next few years. As I've noted previously, forward-looking members of the industry are now seeking help in expanding the market for high-ethanol blends, rather than perpetuating an outdated support for existing sales.
The situation for renewable electricity sources like wind, solar and geothermal energy is more complicated. The expiring Treasury grants were introduced as part of the 2009 stimulus to stand in for the "tax equity swap" market, a category of financial transactions that froze up during the financial crisis. These swaps provided a private-sector cash-flow bridge between project expenditures and tax credits that only paid off after start-up as income was earned or energy produced. That was particularly helpful for smaller, less profitable developers, but it also provided an additional check on marginal projects. Even after credit markets eased, most developers understandably preferred the cash grants, which reduced their financing costs and avoided the fees that bankers charged on tax equity deals. However, that preference doesn't justify continuing the cash grant program--particularly for the large, profitable corporations that increasing dominate this space. The industry should focus more effort on fostering the revival of a liquid and competitive tax equity market and less on lobbying for an extension of a temporary stimulus measure.
Either way, the tax credits behind these grants and swaps won't last forever. Under current law, the principal federal tax credit for wind will be in place only through 2012, for biomass and geothermal through 2013, and for solar through 2016. Instead of a scenario of perpetual last-minute extensions such as we've seen in the past, the industry and its investors should be thinking about a scenario in which all these tax credits end, either as part of comprehensive tax reform that eliminates most such "tax expenditures"--including the ones for the oil and gas industry that have become so contentious in the last few years--or a transition to providing renewables with similar sorts of incentives as oil and gas, which essentially amount to forms of accelerated depreciation and modest tax breaks for manufacturing in the US, rather than in other countries.
It's also important to realize that even without these tax credits and in the absence of comprehensive federal energy legislation that looks unlikely any time soon, the industry would still retain numerous state-level benefits, starting with the renewable portfolio standards (RPS) for electricity currently in place in 29 states and the District of Columbia, a tally that encompasses most of the states with the best wind and solar resources. These RPS's are similar to the Renewable Fuel Standard for biofuels in requiring utilities to include increasing proportions of renewable energy in their supply portfolios, whether owned or purchased. Such standards, including California's aggressive RPS targeting 33% renewable electricity by 2020, stand outside the polarizing political debate over taxation and government expenditures. They function as an implicit tax on ratepayers, rather than taxpayers, because they show up within customers' utility bills rather than on their 1040 forms. That distinction could be particularly important if the congressional supercommittee fails to reach a consensus, and the default spending cuts built into the Budget Control Act that resolved this summer's debt ceiling crisis kick in.
So while it might appear that the US renewable energy industry is about it be cut loose from the key incentives that enabled it to grow to its present dimensions, it will continue to benefit from supports not enjoyed by other industrial sectors. Even when the current tax credits expire, renewables will have a mandated market providing a floor beneath them. Ethanol output won't revert to 2005 levels, nor will renewables vanish from the landscape, even if their growth slows a bit while the rest of the economy struggles to emerge from the aftermath of the Great Recession and financial crisis, and to avoid a double-dip. Meanwhile, global overcapacity in wind turbine and solar module manufacturing will keep their prices trending lower--and installations stronger--pending industry consolidations that will position both for healthier, more sustainable growth in the long run. All of this falls well short of the level of help for the industry that most renewable energy supporters would like to see, but it's far more than the level playing field (ignoring externalities) that would see cheap and abundant natural gas sweep away all competition for new power generation.
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.
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 09, 2011
The Battle to Extend Wind Incentives
With the end of the year approaching, the annual Congressional debate over extending a variety of expiring federal tax credits and other benefits is gearing up again. Few of these measures are as high-profile as the payroll tax cut, but each has a vocal constituency, including renewable energy. The American Wind Energy Association (AWEA) has launched a major effort seeking inclusion of the Production Tax Credit (PTC) for wind power in this year's "tax extenders" package. That might seem premature, since the PTC won't expire until the end of 2012, until you realize that eligibility for the stimulus-funded Treasury renewable energy grants for which many wind project developers have opted over the PTC ends in a few weeks with little chance of a further extension. However, before simply tacking another year (or four!) onto a tax credit that began nearly 20 years ago, Congress should answer two basic questions: Is this still the most effective way to promote renewables like wind, and does wind power now require subsidies at all?
I don't blame AWEA for tackling this issue early, since the US wind industry has experienced significant volatility when previous PTC expirations went down to the wire, and in several cases lapsed for up to a year. At the same time, taxpayers deserve a more compelling rationale for continuing to subsidize wind power than the one now being offered. The "green jobs" argument is wearing thin, post-Solyndra, and it has become increasingly evident that helping to create a market for renewable energy technologies is a necessary but not sufficient condition to establishing a sustainable, globally competitive renewable energy manufacturing industry. Although more of the wind power value chain is now produced in the US than previously, too much of each wind subsidy dollar still goes offshore for this to be deemed an efficient way to boost to US jobs and manufacturing without reform.
In order to address the first question I posed, concerning the continued suitability of the PTC, it's important to understand how it works and how it compares to other renewable energy incentives. The current PTC provides wind project owners (or the parties to whom the tax benefit has been sold via a "tax equity swap") with an income tax credit of 2.2 cents per kilowatt-hour (kWh) of electricity actually generated and sold from the completed facility. Based on recent estimates of the levelized cost of electricity from unsubsidized wind power, that's over 20% of a typical wind farm's production cost. It's also equivalent to more than half of this year's average wellhead price of natural gas--a far larger subsidy per BTU than the controversial tax benefits currently provided to oil & gas firms.
The best thing about the PTC is that it is entirely outcome-based. You only receive the benefit when your project is completed, brought online, and as power is sold to customers. Mess up any of those steps and you get zilch. Put your project in a location with poor wind resource or limited access to transmission, and you won't get nearly as much tax benefit. So from that standpoint--ignoring the green jobs angle that arose mainly from expediency when the financial crisis and recession hit--we are getting what we pay for: actual low-emission energy. The structure of the PTC has cash-flow implications that are viewed as a problem by many wind developers but might be regarded as a useful feature by taxpayers. Smaller developers, in particular, have greater difficulty financing projects when the incentive must be deferred until after start-up, or they may lack sufficient taxable income to take full advantage of the credit. They complain about the need to transact swaps with bankers and other investors to realize the subsidy sooner, at a cost. But perhaps it's not such a bad thing for companies that small to have to convince an experienced third party that their project is really viable.
There are many alternatives to the PTC, including the 30% Investment Tax Credit (ITC), the same one received by solar and other technologies. The stimulus bill extended the ITC as an option for wind and allowed the Treasury Department to pay it as a cash grant, rather than waiting for subsequent tax filings. This certainly put money in the hands of wind developers much quicker--$7.6 billion since 2009 including $3.3 billion so far this year--and it has the added benefit of automatically scaling down as the cost of the technology falls. The solar feed-in tariffs favored in Europe didn't have such a feature, with the result that countries have had to cut them numerous times, but only after the fat tariffs gave birth to a huge export-oriented solar manufacturing industry in Asia. Similar competition is now emerging in the wind industry.
The main problem with the ITC is that when viewed from an outcomes perspective, which really gets to the question of effectiveness, the outcome being promoted is construction, rather than energy production. You would get the same tax credit for a project with the best wind resource as for one with the worst. (This has also led to a lot of solar installations in places that would never otherwise have been considered.) So of the two main policy tools the federal government has used to subsidize renewable electricity, the PTC is probably more cost-effective in delivering the result we should really want, which is more renewable energy. As it is, even with rapid growth over the last decade, wind accounted for just 2.8% of our power generation this year through August.
That brings us to the bigger question of whether wind should be subsidized at all after the current PTC term expires. I get emails practically every day from folks who have serious concerns about the health and environmental impacts of power, as well as its cost- and emissions-reduction effectiveness. Even if we ascribed all of these concerns to NIMBYism, it doesn't change the fact that the wind PTC, complete with annual inflation adjustment, is providing the same level of incentive as it did when the technology was much less mature and cost many times what it does today; AWEA cites wind costs having fallen by 90% since 1980. Other factors have also changed in the last twenty years. A majority of US states--and most of those with attractive wind resources--now have in place Renewable Portfolio Standards requiring utilities to include increasing proportions of renewable power in their supply. These mandates create a similar redundancy as the one between the ethanol blenders credit, which is also due to expire 12/31/11, and the biofuel mandates of the federal Renewable Fuels Standard. In the absence of the PTC, the state RPS system should provide a safety net--and more--for the industry.
There are two other key factors missing from AWEA's arguments for extending the PTC. The first is the economy, which is the main reason that US electricity demand has not been growing at a rate that would support large generating capacity expansions of any kind. New wind installations have been anemic for the last two years, in spite of last year's extension of the Treasury grants. Moreover, wind must now compete with the explosion of domestic natural gas production from shale, which when used in combined cycle gas turbines produces cheaper electricity than wind, with low emissions of the air pollutants that are of the greatest concern to most Americans, while still beating coal-fired power hands down on greenhouse gases.
Where all this leaves us depends on your priorities. If your main focus is on reducing greenhouse gas emissions and you see renewable power as a key strategy, then in the absence of a price on carbon you might support extending the PTC for at least a little longer. If you are concerned about climate change but more worried in the short term about the deficit, then letting the PTC lapse next year and relying on state RPS quotas to put a floor under wind looks reasonable. If boosting US cleantech manufacturing is your aim, you should prefer a more direct incentive than the PTC. And if your main worry is oil imports, then the PTC is irrelevant, since the US gets less than 1% of its electricity from burning oil, and most of that in remote and back-up power roles that wind can't easily fill. On balance, if after considering all the alternatives the Congress decides to extend the Production Tax Credit, it should be for an explicitly final period, at no more than the 1.1 cent/kWh rate that technologies like marine, hydropower and waste-to-energy now receive, and without the annual inflation adjustment that undermines the incentive to continue reducing costs.
I don't blame AWEA for tackling this issue early, since the US wind industry has experienced significant volatility when previous PTC expirations went down to the wire, and in several cases lapsed for up to a year. At the same time, taxpayers deserve a more compelling rationale for continuing to subsidize wind power than the one now being offered. The "green jobs" argument is wearing thin, post-Solyndra, and it has become increasingly evident that helping to create a market for renewable energy technologies is a necessary but not sufficient condition to establishing a sustainable, globally competitive renewable energy manufacturing industry. Although more of the wind power value chain is now produced in the US than previously, too much of each wind subsidy dollar still goes offshore for this to be deemed an efficient way to boost to US jobs and manufacturing without reform.
In order to address the first question I posed, concerning the continued suitability of the PTC, it's important to understand how it works and how it compares to other renewable energy incentives. The current PTC provides wind project owners (or the parties to whom the tax benefit has been sold via a "tax equity swap") with an income tax credit of 2.2 cents per kilowatt-hour (kWh) of electricity actually generated and sold from the completed facility. Based on recent estimates of the levelized cost of electricity from unsubsidized wind power, that's over 20% of a typical wind farm's production cost. It's also equivalent to more than half of this year's average wellhead price of natural gas--a far larger subsidy per BTU than the controversial tax benefits currently provided to oil & gas firms.
The best thing about the PTC is that it is entirely outcome-based. You only receive the benefit when your project is completed, brought online, and as power is sold to customers. Mess up any of those steps and you get zilch. Put your project in a location with poor wind resource or limited access to transmission, and you won't get nearly as much tax benefit. So from that standpoint--ignoring the green jobs angle that arose mainly from expediency when the financial crisis and recession hit--we are getting what we pay for: actual low-emission energy. The structure of the PTC has cash-flow implications that are viewed as a problem by many wind developers but might be regarded as a useful feature by taxpayers. Smaller developers, in particular, have greater difficulty financing projects when the incentive must be deferred until after start-up, or they may lack sufficient taxable income to take full advantage of the credit. They complain about the need to transact swaps with bankers and other investors to realize the subsidy sooner, at a cost. But perhaps it's not such a bad thing for companies that small to have to convince an experienced third party that their project is really viable.
There are many alternatives to the PTC, including the 30% Investment Tax Credit (ITC), the same one received by solar and other technologies. The stimulus bill extended the ITC as an option for wind and allowed the Treasury Department to pay it as a cash grant, rather than waiting for subsequent tax filings. This certainly put money in the hands of wind developers much quicker--$7.6 billion since 2009 including $3.3 billion so far this year--and it has the added benefit of automatically scaling down as the cost of the technology falls. The solar feed-in tariffs favored in Europe didn't have such a feature, with the result that countries have had to cut them numerous times, but only after the fat tariffs gave birth to a huge export-oriented solar manufacturing industry in Asia. Similar competition is now emerging in the wind industry.
The main problem with the ITC is that when viewed from an outcomes perspective, which really gets to the question of effectiveness, the outcome being promoted is construction, rather than energy production. You would get the same tax credit for a project with the best wind resource as for one with the worst. (This has also led to a lot of solar installations in places that would never otherwise have been considered.) So of the two main policy tools the federal government has used to subsidize renewable electricity, the PTC is probably more cost-effective in delivering the result we should really want, which is more renewable energy. As it is, even with rapid growth over the last decade, wind accounted for just 2.8% of our power generation this year through August.
That brings us to the bigger question of whether wind should be subsidized at all after the current PTC term expires. I get emails practically every day from folks who have serious concerns about the health and environmental impacts of power, as well as its cost- and emissions-reduction effectiveness. Even if we ascribed all of these concerns to NIMBYism, it doesn't change the fact that the wind PTC, complete with annual inflation adjustment, is providing the same level of incentive as it did when the technology was much less mature and cost many times what it does today; AWEA cites wind costs having fallen by 90% since 1980. Other factors have also changed in the last twenty years. A majority of US states--and most of those with attractive wind resources--now have in place Renewable Portfolio Standards requiring utilities to include increasing proportions of renewable power in their supply. These mandates create a similar redundancy as the one between the ethanol blenders credit, which is also due to expire 12/31/11, and the biofuel mandates of the federal Renewable Fuels Standard. In the absence of the PTC, the state RPS system should provide a safety net--and more--for the industry.
There are two other key factors missing from AWEA's arguments for extending the PTC. The first is the economy, which is the main reason that US electricity demand has not been growing at a rate that would support large generating capacity expansions of any kind. New wind installations have been anemic for the last two years, in spite of last year's extension of the Treasury grants. Moreover, wind must now compete with the explosion of domestic natural gas production from shale, which when used in combined cycle gas turbines produces cheaper electricity than wind, with low emissions of the air pollutants that are of the greatest concern to most Americans, while still beating coal-fired power hands down on greenhouse gases.
Where all this leaves us depends on your priorities. If your main focus is on reducing greenhouse gas emissions and you see renewable power as a key strategy, then in the absence of a price on carbon you might support extending the PTC for at least a little longer. If you are concerned about climate change but more worried in the short term about the deficit, then letting the PTC lapse next year and relying on state RPS quotas to put a floor under wind looks reasonable. If boosting US cleantech manufacturing is your aim, you should prefer a more direct incentive than the PTC. And if your main worry is oil imports, then the PTC is irrelevant, since the US gets less than 1% of its electricity from burning oil, and most of that in remote and back-up power roles that wind can't easily fill. On balance, if after considering all the alternatives the Congress decides to extend the Production Tax Credit, it should be for an explicitly final period, at no more than the 1.1 cent/kWh rate that technologies like marine, hydropower and waste-to-energy now receive, and without the annual inflation adjustment that undermines the incentive to continue reducing costs.
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, November 15, 2010
Extend or Reform?
As the US Congress returns from its election recess to take up its "lame duck" session, one of many crucial pending items it will likely take up is the so-called "extenders" package: key tax provisions that are due to expire at the end of the year, unless extended by legislative action. From an energy perspective, this includes both the expiring ethanol blenders credit and the Treasury renewable energy grants issued in lieu of the investment tax credit (ITC) for renewables. Both incentives face a much more uncertain reception when the new Congress is sworn in next January, so the lame duck might just be their last gasp.
For the ethanol credit, that is as it should be; if 32 years of federal subsidies haven't made corn ethanol competitive with gasoline--particularly when its use is now mandatory--then nothing will. The situation for the renewable energy grants is more complicated. This is a relatively new benefit that, as I've noted in previous postings, was instituted as part of last year's American Recovery and Reinvestment Act--a.k.a. the stimulus--to substitute for a class of market transactions ("tax equity") that renewable energy developers could no longer access as a result of the financial crisis. Bridging that gap became all but essential for smaller companies without enough taxable earnings to take full advantage of the tax credit on their own, or lacking adequate working capital to afford to wait until their next tax filing to recoup the applicable ITC portion of the cost of a project.
If that situation still obtained, justifying the extension of the grants for another year or two would be easy. In the meantime, however, much has changed. Although not yet functioning at the same pace as before the financial crisis, the tax equity market is recovering. Banks and insurance companies have announced a growing number of tax equity deals in the last few months. This market might revive even faster if it weren't competing with essentially free money from the Treasury.
The other aspect of the situation that has changed is the growing dominance of large players in renewable energy project development, particularly for wind. Contrary to the perception that the Treasury grants mainly benefited small companies, more than half of the $5.4 billion in grants awarded to date went to just three companies, all of them large and profitable enough to have waited until tax time to collect their ITC benefits--though I don't doubt that getting cash up front improved the economics of their projects. For example, EDP Renovaveis, through its Horizon Wind Energy subsidiary, collected around $565 million in grants in the first half of 2010, after receiving "in excess of 685 million dollars" in 2009. Meanwhile, between its 3Q2010 earnings presentation and its 2009 full-year presentation Iberdrola Renovables claimed approximately $983 million in US renewable energy grants. NextEra Energy (the renamed parent company of Florida Power & Light) booked $556 million in grants in the first 9 months of 2010, on top of $100 million last year. All of this was entirely appropriate under the provisions of the stimulus, but it doesn't quite fit the picture of an emergency measure intended to help small, struggling firms.
Some have argued that in any case the grants are merely a matter of timing for the government: paying eligible developers cash now, or paying them the same amount later, via reduced taxes. That would only be true if every project that was eligible for a grant could (or should) proceed without one. Sparing wind farms, solar installations and other projects from the discipline of rigorous review by private investors risks allowing weaker projects to proceed, when they should either be rethought or cancelled. That was an unavoidable risk in early 2009, when the renewable energy industry was in peril of imploding, but overlooking it seems less justifiable today.
The Treasury renewable energy grants were instituted as an extreme step at an unprecedented time. It's hard to imagine that anyone intended them to become a permanent entitlement to replace the existing renewable energy tax credits, which were simultaneously extended through the end of 2012 for wind power and 2013 for most other technologies. However, if this program is to be extended for now, it ought to be reformed to exclude beneficiaries for which it constitutes merely a convenience, rather than a necessity. That would mean either capping the maximum payout for any recipient at something less than $100 million, or imposing a corporate income threshold. I'll be watching this issue with great interest between now and the end of the year.
For the ethanol credit, that is as it should be; if 32 years of federal subsidies haven't made corn ethanol competitive with gasoline--particularly when its use is now mandatory--then nothing will. The situation for the renewable energy grants is more complicated. This is a relatively new benefit that, as I've noted in previous postings, was instituted as part of last year's American Recovery and Reinvestment Act--a.k.a. the stimulus--to substitute for a class of market transactions ("tax equity") that renewable energy developers could no longer access as a result of the financial crisis. Bridging that gap became all but essential for smaller companies without enough taxable earnings to take full advantage of the tax credit on their own, or lacking adequate working capital to afford to wait until their next tax filing to recoup the applicable ITC portion of the cost of a project.
If that situation still obtained, justifying the extension of the grants for another year or two would be easy. In the meantime, however, much has changed. Although not yet functioning at the same pace as before the financial crisis, the tax equity market is recovering. Banks and insurance companies have announced a growing number of tax equity deals in the last few months. This market might revive even faster if it weren't competing with essentially free money from the Treasury.
The other aspect of the situation that has changed is the growing dominance of large players in renewable energy project development, particularly for wind. Contrary to the perception that the Treasury grants mainly benefited small companies, more than half of the $5.4 billion in grants awarded to date went to just three companies, all of them large and profitable enough to have waited until tax time to collect their ITC benefits--though I don't doubt that getting cash up front improved the economics of their projects. For example, EDP Renovaveis, through its Horizon Wind Energy subsidiary, collected around $565 million in grants in the first half of 2010, after receiving "in excess of 685 million dollars" in 2009. Meanwhile, between its 3Q2010 earnings presentation and its 2009 full-year presentation Iberdrola Renovables claimed approximately $983 million in US renewable energy grants. NextEra Energy (the renamed parent company of Florida Power & Light) booked $556 million in grants in the first 9 months of 2010, on top of $100 million last year. All of this was entirely appropriate under the provisions of the stimulus, but it doesn't quite fit the picture of an emergency measure intended to help small, struggling firms.
Some have argued that in any case the grants are merely a matter of timing for the government: paying eligible developers cash now, or paying them the same amount later, via reduced taxes. That would only be true if every project that was eligible for a grant could (or should) proceed without one. Sparing wind farms, solar installations and other projects from the discipline of rigorous review by private investors risks allowing weaker projects to proceed, when they should either be rethought or cancelled. That was an unavoidable risk in early 2009, when the renewable energy industry was in peril of imploding, but overlooking it seems less justifiable today.
The Treasury renewable energy grants were instituted as an extreme step at an unprecedented time. It's hard to imagine that anyone intended them to become a permanent entitlement to replace the existing renewable energy tax credits, which were simultaneously extended through the end of 2012 for wind power and 2013 for most other technologies. However, if this program is to be extended for now, it ought to be reformed to exclude beneficiaries for which it constitutes merely a convenience, rather than a necessity. That would mean either capping the maximum payout for any recipient at something less than $100 million, or imposing a corporate income threshold. I'll be watching this issue with great interest between now and the end of the year.
Wednesday, November 14, 2007
Smarter Ethanol
I've been writing about fuel ethanol since I started this blog in 2004, and I've been following it for just shy of 25 years. If there was ever a time for a critical reexamination of our national ethanol policy, it is now. Despite a broad array of federal and state agricultural and blending price supports, ethanol derived from grains is approaching a stall point, even as the Congress debates a nearly five-fold expansion of the federal Renewable Fuel Standard (RFS,) which mandates biofuel use in gasoline. At the same time, the means of producing ethanol from inedible plant material are on the verge of commercial-scale production. As questions about the sustainability of corn-based ethanol grow, it's becoming clear that we need a wiser ethanol strategy.
Ethanol production has grown enormously over the last five years. At the current production rate of around 6.6 billion gallons per year, cumulative production for 2007 should have eclipsed last year's 4.8 billion gallon record during the last two weeks. This impressive expansion has been driven by several key factors, including the phase-out of MTBE for oxygenate blending and the continued provision of the 51 cent-per-gallon blenders credit, along with an import barrier in the form of a 54 cent-per-gallon tariff.
While ethanol displaces some imported oil, most cars in the US cannot tolerate fuel blends containing more than 10% ethanol. Once it attains that share of total gasoline sales, ethanol will have reached a natural limit, at least until flexible fuel vehicles capable of burning 85% blends (E-85) become the norm, rather than a niche. That limit works out to around 14.5 billion gallons per year, after adjusting for ethanol's lower energy content, and it applies equally to ethanol derived from cellulose or corn. Note that this is much lower than the proposed 36 billion gallon RFS, which would require E-85 to capture about 13% of the gasoline market.
That means that new ethanol plants aren't being cancelled because the market is saturated, but because the economics of producing corn ethanol, even after the blenders' credit and tariff protection, are becoming marginal. High corn prices account for much of this, but high energy prices are contributing, as well, and this could get worse. The typical 6:1 ratio of oil price to gas price has increased to nearly 12:1 as crude marched past $90/bbl, and that can't last. If oil prices remain high, gas prices must eventually follow, as more gas is substituted for oil wherever possible. Because ethanol production is so energy-intensive, returning only 1.3 BTUs for every BTU invested, higher natural gas prices will make corn ethanol even more expensive to produce. Now factor in the long-term impact of the inevitable higher prices for water and the logistical challenges associated with getting larger volumes of ethanol to market. In this light, the proposed RFS, or at least the 15 billion gallons carved out for corn ethanol, looks unrealistic and unwise.
A quarter century of subsidies has not made ethanol from corn economically viable. Within a few years, corn ethanol will face new competition from ethanol derived from non-food plants and requiring significantly less energy, water, and other inputs in its production. These facts create a strong case for shifting the focus of the ethanol portion of US energy policy--and agricultural policy. Considering all the above factors, I believe a wiser ethanol policy would consist of the following:
Ethanol production has grown enormously over the last five years. At the current production rate of around 6.6 billion gallons per year, cumulative production for 2007 should have eclipsed last year's 4.8 billion gallon record during the last two weeks. This impressive expansion has been driven by several key factors, including the phase-out of MTBE for oxygenate blending and the continued provision of the 51 cent-per-gallon blenders credit, along with an import barrier in the form of a 54 cent-per-gallon tariff.
While ethanol displaces some imported oil, most cars in the US cannot tolerate fuel blends containing more than 10% ethanol. Once it attains that share of total gasoline sales, ethanol will have reached a natural limit, at least until flexible fuel vehicles capable of burning 85% blends (E-85) become the norm, rather than a niche. That limit works out to around 14.5 billion gallons per year, after adjusting for ethanol's lower energy content, and it applies equally to ethanol derived from cellulose or corn. Note that this is much lower than the proposed 36 billion gallon RFS, which would require E-85 to capture about 13% of the gasoline market.
That means that new ethanol plants aren't being cancelled because the market is saturated, but because the economics of producing corn ethanol, even after the blenders' credit and tariff protection, are becoming marginal. High corn prices account for much of this, but high energy prices are contributing, as well, and this could get worse. The typical 6:1 ratio of oil price to gas price has increased to nearly 12:1 as crude marched past $90/bbl, and that can't last. If oil prices remain high, gas prices must eventually follow, as more gas is substituted for oil wherever possible. Because ethanol production is so energy-intensive, returning only 1.3 BTUs for every BTU invested, higher natural gas prices will make corn ethanol even more expensive to produce. Now factor in the long-term impact of the inevitable higher prices for water and the logistical challenges associated with getting larger volumes of ethanol to market. In this light, the proposed RFS, or at least the 15 billion gallons carved out for corn ethanol, looks unrealistic and unwise.
A quarter century of subsidies has not made ethanol from corn economically viable. Within a few years, corn ethanol will face new competition from ethanol derived from non-food plants and requiring significantly less energy, water, and other inputs in its production. These facts create a strong case for shifting the focus of the ethanol portion of US energy policy--and agricultural policy. Considering all the above factors, I believe a wiser ethanol policy would consist of the following:
- Freezing the federal RFS at the current level of 7.5 billion gallons per year.
- Phasing out all subsidies for ethanol derived from food sources within five years.
- Phasing out the tariff on imported ethanol within two years.
- Shifting the point of subsidy from the blender to the ethanol plant, to ensure that future subsidies go to US producers, rather than offshore.
- Increasing the subsidy on cellulosic ethanol to $1.00/gallon until 2010, falling by 10 cents per gallon per year thereafter.
Such a program would focus federal incentives where they will do the most good, promoting the commercialization of cellulosic ethanol, which offers much larger energy and emissions-reduction benefits than corn ethanol and entails fewer concerns about sustainability. Since cellulosic ethanol is expected to be cheaper to produce, once it achieves economies of scale, it should not require permanent subsidies or tariff protection, as corn ethanol has. The result would be a very tough market for current ethanol producers, but it would ensure that the ethanol we use as an oil substitute is produced as efficiently as possible, without merely substituting LNG imports for oil imports. Whether or not something like this could ever be enacted by the US Congress, this is where the debate should focus, rather than on arguing about expanding an inefficient program by a factor of five.
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