Thursday, March 22, 2007

Questioning Ethanol

In the space of a few years, ethanol has become the de-facto fuel of the future, but without the kind of extensive public debate that should have accompanied such a choice. Although its political support as an agriculture and energy program has thus far seemed unassailable, an article in Business Week a few days ago described an alignment of interests coming together to oppose this headlong rush, and to attempt to put ethanol back on a free-market basis. This got me thinking about who else might be adversely affected, and thus have a stake in slowing ethanol's growth. Another industry immediately sprang to mind: soft drinks. They might not be a bad proxy for the rest of us, who stand to lose more than we gain from the steadily growing portion of the corn crop going into fuel production.

I don't know much about the soft drink business, beyond the fact that its number two ingredient by volume--after water--is high-fructose corn syrup, which is derived from the same part of the corn crop that is needed to produce ethanol. If I were running a soda bottler, I'd be very worried about what a further diversion of corn to ethanol could do to my costs. Even for companies that mainly own the brands and formulations, reduced demand for their products, due to a shift in their pricing relative to water, coffee, and other substitute drinks, would certainly create a drag on shareholder value. Nor would switching back to sugar necessarily solve the problem, given the increased use of Brazilian and Caribbean cane sugar to make ethanol, while Minnesota farmers look to turn sugar beets into yet more ethanol.

So if you're Coca Cola or Pepsi, what do you do? Well, you might join the growing coalition arguing for the repeal of corn ethanol's subsidy and tariff protection, thus exposing the corn ethanol industry to tougher competition. That might keep more corn available for sweetener production, in the long run. But with gasoline prices stuck in an uncomfortable range, while the US wages war in the Middle East oil patch, that could be risky. Concerns about ethanol sound different coming from a large corporation that stands to lose profits, as opposed to a rancher who can't afford to feed his cattle. Alternately, you could invest in a startup working on cellulosic ethanol, biodiesel, or some other alternative fuel that would compete with corn-based ethanol. You might even turn part of your own R&D team loose on the problem. The benefit of this strategy is that, even before these research avenues pay off directly, they help undermine the basis for maintaining such high subsidies for corn ethanol. Given this choice of options, I'd probably try all of them.

It's an uphill battle, but a worthwhile one, in my view. The energy and climate benefits of corn ethanol, though modestly positive, do not justify the emphasis or public funding it currently receives. We should be moving away from our disproportionate support of this single pathway, toward a more even-handed set of incentives. If we jettisoned the 51 cent/gallon ethanol blender credit, we could safely eliminate the 54 cent tariff on imported ethanol, fund a five- or ten-year federal excise tax holiday--worth 18.4 cents/gallon--for all non-petroleum fuels, and still return some money to the Treasury. If ethanol can win on those terms, then it deserves to be the fuel of the future.

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