An Ethanol Stimulus?

As the new Congress and incoming administration scramble to craft a stimulus package to lift the country out of the deepening recession, it's understandable that a variety of industries and their trade associations would be lobbying for their share of the expected federal assistance. Many struggling businesses no doubt feel at least as deserving of help as GM and Chrysler. With jobs at stake and pragmatism standing in for principle in this crisis, the Obama team and the Congressional leadership must make some tough calls in a very short span of time. One call that should not be difficult, however, is to rule out any further federal assistance for the struggling ethanol industry.

I'm late to the party commenting on a prospective ethanol bailout. Before New Year's, the Wall Street Journal and Business Week both reported that the Renewable Fuels Association and its members are seeking $1 billion in short-term loans and $50 billion "to develop ethanol technology and new biofuels," though I couldn't find anything on the RFA's website to confirm those figures. Backed by the lobbying muscle of Archer Daniels Midland, their chances of getting at least a portion of their request don't look half bad.

In order to see why a bailout ought to be unnecessary, let's remind ourselves of the federal assistance the industry already receives, summing the amounts for 2009 and 2010 to put them on a comparable basis to the stimulus:

• The largest item is the Volumetric Ethanol Excise Tax Credit, also known as the blender's credit. The 2008 Farm Bill reduced this benefit from $0.51/gal. of ethanol to $0.45/gal, unless the quantity sold falls below 7.5 billion gallons per year, in which case it reverts to $0.51.
• The Energy Independence and Security Act of 2007 (EISA) substantially increased the quantity of ethanol required to be blended into gasoline. Multiplying the minimum volumes for 2009 and 2010 by the blender's credit yields a combined $10.1 billion in assistance. While the ethanol producers don't receive this money directly, it supports the price of ethanol in the market and compounds the demand creation from EISA's Renewable Fuels Standard (RFS).
• Domestic ethanol producers are also protected from foreign competition by virtue of an ethanol tariff of 2.9% and import duty of $0.54/gal. The Farm Bill extended that benefit for another two years.
• As for assistance for advanced biofuels, EISA also authorized at least $595 million for R&D grants covering advanced biofuels, cellulosic biofuels, and biofuel-enabling infrastructure. Meanwhile, the Farm Bill provided a "producer's credit" of $1.01/gal. for advanced biofuel(i.e., not produced from corn starch.)

It's also relevant to consider why the ethanol industry is in trouble, just now. After being squeezed between spiking fuel and grain prices for the first two-thirds of the year, it faces a shrinking motor fuels market, in direct competition with a glut of wholesale gasoline that for weeks was selling for less than crude oil. But although these circumstances might appear at first glance to have been beyond the control of the industry, that's not entirely true. If ethanol producers had expanded at a slower pace over the last two years, instead of outracing the rising RFS mandate, there would be no ethanol surplus, their margins would be higher, and they would have less debt to service.

So that leaves us with an industry that will receive nearly $11 billion of federal assistance without a dime from the stimulus, and whose customers are required by law to buy most of their output. The excess capacity that is crushing its margins looks more like a manifestation of classic manufacturing boom-and-bust cyclicality than a result of the financial crisis, per se. If anything, the current slow-down might be an excellent time to prune the oldest, least efficient ethanol plants, to prepare the industry to compete with the next generation of biofuels from non-food sources, for which R&D is already well-funded by the government, venture capital, and the oil industry. That shakeout won't happen if producers are propped up with still more taxpayer money.