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:
  1. Freezing the federal RFS at the current level of 7.5 billion gallons per year.

  2. Phasing out all subsidies for ethanol derived from food sources within five years.

  3. Phasing out the tariff on imported ethanol within two years.

  4. Shifting the point of subsidy from the blender to the ethanol plant, to ensure that future subsidies go to US producers, rather than offshore.

  5. 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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