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.

Sales Mix and Fuel Economy

When Detroit's CEOs return to Washington, DC in early December for further Congressional hearings on a rescue package, the industry's prospects for meeting tougher fuel economy standards are likely exert significant influence on the granting of federal assistance. When I was writing last Monday's posting on "Detroit, Bailouts and Fuel Economy", the CAFE database of the National Highway Traffic Safety Administration, which administers the Corporate Average Fuel Economy standard, was undergoing maintenance. That meant I couldn't calculate the impact of this year's shift in the sales mix of the Big 3 on their fleet fuel economy. The numbers indicate that simply selling fewer SUVs and more of their existing car models, without any major changes in technology, is already yielding significant fuel savings. In addition, the figures for the leading Japanese brands indicate what might be possible for GM, Ford and Chrysler, simply by offering fewer V-8 and V-6 engines and selling more four-cylinder cars. That's a good thing, because the latest survey from R.L. Polk & Company suggests that hybrids will still make up less than 6% of US new car sales in 2012.

NHTSA tracks fuel economy for every automaker in three categories: domestic passenger cars, imported passenger cars, and light trucks. The latter includes most SUVs. These data, in combination with the year-to-date auto sales figures through October, facilitate some quick spreadsheet analysis revealing the key factors differentiating the fuel economy performance of the big US carmakers from their competitors, such as Toyota and Honda. For example, for the 2007 model year, the US companies averaged a combined 24.9 miles per gallon, while the US models of these two Japanese firms averaged 30.2 mpg. That gap is attributable to two components, neither of which comes as a surprise. The Japanese passenger cars averaged 5 mpg better than their US counterparts, helped considerably by their imported hybrid models. The passenger cars made in these firms' US factories averaged just under 3 mpg better than their US peers.

The other big influence comes from the relative sales mixes of these companies. Of the combined 2007 sales of GM, Ford and Chrysler, nearly 65% were "light trucks", comprised of SUVs and pick-up trucks. Such vehicles only made up 42% of the sales of Toyota and Honda. That's particularly significant for fuel economy, because the Big 3's light trucks turned in fuel economy ratings averaging 7 mpg lower than their passenger cars, while the light trucks of Toyota and Honda were 10 mpg worse than their cars.

With gas prices that surged past $4 per gallon this summer, 2008 has produced some modest but encouraging shifts in fuel economy. SUV sales are down much more than those of passenger cars, for both US and Japanese makes, while the cars and SUVs sold tended to be from the more economical models within their respective categories. This has improved the average fuel economy of the Big 3 by 0.4 mpg, year-to-date, with 75% of that improvement coming from the shift between passenger cars and light trucks, which fell to 63% of Detroit's mix. Toyota and Honda saw an even bigger fractional change in light trucks, with the drop to 38% of sales helping to boost their combined average by more than one full mile per gallon.

Why do these figures matter in the context of a bailout of Detroit? Last year the Congress passed, and President Bush signed, the Energy Independence and Security Act of 2007, which among its many provisions included an increase in the federally-mandated new-car fleet average to 35 mpg by 2020, including both passenger cars and light trucks. Given the emphasis during the recently-concluded election campaign on both energy independence and greenhouse gas emissions, Congress appears concerned that a bailout of Detroit should not be viewed as providing any leeway on fuel economy. So it's important to understand whether achieving 35 mpg would require a technological revolution that might be beyond the resources of the cash-strapped domestic industry. Encouragingly, the figures above suggest otherwise. If the Big 3 merely matched the 2008 passenger-car performance of the top Japanese brands (35.5 mpg) while reducing their light truck sales proportion to 25%--the level that prevailed in the US car fleet prior to 1990--they would be three-fourths of the way toward achieving their 2020 CAFE target.

As helpful as advanced-technology cars like the upcoming Chevrolet Volt would be for speeding up that transition, simply by shedding the least-efficient SUVs and offering peppy four-cylinder engines as the standard across most of their product lines, Detroit could deliver greatly-improved fuel economy, of the kind the Congress and new administration are seeking. Just as important, considering the priority that US consumers have placed on vehicle performance in the last decade, European-style turbo-diesels, better gasoline-engine technology, and hybridized drivetrains can deliver these gains at an mpg-vs-power trade-off that car buyers should find much more palatable than the one we were forced to accept in the early 1980s, the last time high oil prices focused US policy-makers on automotive fuel economy to this degree.

I don't want to make this change sound easier than it is likely to be. Reducing SUV sales by the necessary extent would require re-tooling on a massive scale, sending ripples through the North American auto supply chain that might be nearly as dramatic as the bankruptcy of one or more of the Big 3. Consumers are leading this shift today, and they must be willing--or encouraged by new policies--to stay the course. The fall of gasoline prices back below $2 per gallon, if it persists for more than the next few months, will work against that. If a rescue or restructuring is to succeed, it must result in a new mix of products that are globally competitive and not just more fuel-efficient, but also profitable to make and market. That argues against embedding expensive, unproven technology in millions of cars, until Detroit is strong enough to stand behind the warranties that will be crucial to selling them.

Tenth Time Lucky?

As the House of Representatives today takes up the financial rescue package passed Wednesday night by the US Senate, the renewable energy industry and its supporters now have two dogs in this fight. Restoration of the normal functioning of the country's credit markets--the main goal of this legislation--is as essential for the financing of renewable energy projects as it is for the rest of the economy. And if the House passes the same version of this package as the Senate, the renewable energy tax credits that are due to expire at the end of the year will finally be extended, by one year for wind and by eight for solar power.

It hasn't been easy to follow the legislative process involved in the creation of the "bailout" bills taken up by the House on Monday and the Senate on Wednesday. The bill passed by the Senate and referred back to the House, HR.1424, began life as the "Paul Wellstone Mental Health and Addiction Equity Act of 2007." The Senate then amended this dormant bill with the "Emergency Economic Stabilization" provisions--a modified version of the $700 billion rescue package plus a one-year boost in FDIC deposit insurance to $250,000--and the "tax extenders" package from S.3335, the "Jobs, Energy, Families and Disaster Relief Act of 2008" that I examined when the Senate considered it in August. That's where the wind and solar tax credits come in, along with the now-infamous "Modification of Rate of Excise Tax on Certain Wooden Arrows Designed for Use by Children" measure to which I called bemused attention.

So here's the dilemma faced by the House: having heard from many of their constituents that Monday's defeat of the earlier rescue package was ill-considered, they can either put the bill exactly as passed by the Senate to a straight up-or-down vote, or they can amend it further to address the concerns of fiscally-conservative Democrats--the so-called Blue Dogs--and others to strip out some of the pork added by the Senate. In the former case, the bill would then be sent to the President for his signature and become law. However, if the House amends it prior to passage, then as I understand it, it must go to a House-Senate conference to resolve differences and then be re-voted by both houses. That entails further delays and possibly more market instability.

For the tenth time in a bit over a year, the renewable energy industry sees the possibility but not the certainty that the tax credits it regards as essential for continued growth will be extended. We should know the outcome later today. But whether this provision survives into the final economic stabilization package or not, this is no way to encourage a sector that both sides of the political divide agree is a key component of our energy security and climate change strategies. What is urgently needed is a predictable framework of incentives for energy technologies that are still at an early stage of their development and deployment, combined with a judiciously-planned phase-out, to ensure that we aren't simply creating industries that are addicted to subsidies, in the manner of the US corn ethanol industry. The energy provisions of the current bailout bill fall far short of that standard.

Update: The House passed the bill, without amendment, by a vote of 263-171.