Ill-advised efforts to prevent setbacks in ethanol boom

by Morton I. Sosland Editor-in-Chief
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   It seems incredible in view of all the enthusiasm that is characterizing what might still be termed the birth process of the biofuel business that proposals are being seriously put forward that are meant to assure the industry does not suffer the consequences of any reversal of fortune. This is largely a process under way in the United States, which accounts for much of the investment being made in biofuels, but there’s no question that similar issues are being raised in Europe and Asia. The consequences for the global grain industry if even a few of these ideas became reality are so overwhelming that they merit serious study at this early stage.

   Like the dominant theme that sparked creation of the biofuel industry, supplanting imported oil with domestically-produced alternative fuels, the driving point of those seeking protection is that farmers and others willing to take a chance on this business deserve special protection. For the most part, these proposals reflect concerns about movements in crude oil prices, which are far beyond the influence of biofuel participants and investors, and how they have a positive as well as negative effect.   But the advocates of special protection measures also acknowledge that they worry about what happens to the present industry and its many plants built on a corn (maize) feedstock base in the event of success in producing ethanol from biomass.

   Volatile prices for denatured fuel ethanol, as reflected in trading on the Chicago Board   of Trade, help explains these worries. Ethanol fell from a high near U.S.$2.50 per gallon in June of last year to a low of $1.70 in September. After a brief recovery, that low was nearly repeated in January, followed by a rebound that is continuing, but not yet back to the prior high. These swings paralleled crude oil and refined gasoline, as well as shifts in the supply-demand situation within the ethanol market. Considering how prices for corn, the major feedstock in making ethanol, followed a steeply rising trajectory during this time, the nervousness of the ethanol industry over how it could be squeezed by such fluctuations is no surprise even though grain processors have dealt with these issues for centuries.

   Looking to government to resolve uncertainties about prices and markets is ill-advised. History has shown that markets are self-correcting much more efficiently than any governmental intervention. Suggesting the need for planning now for such intervention would add complexity to the steps already taken to help start the biofuel industry.   Besides many special incentives that have promoted massive investment in building ethanol capacity, federal tax credits stand out as a major continuing support. The 52¢-pergallon blender tax credit means federal tax credits totaling between $3.8 billion and $7.1 billion a year on the basis of a 7.5-billion and 14-billion-gallon production level for ethanol. That’s a huge subsidy for the biofuel industry   . Yet, it is magnified by the suggestion made that the government should be ready to increase the per-gallon credit rate or to keep raising the mandated minimum production level. “A decline in crude oil could be offset by government policy mandating ethanol production above market equilibrium levels” is correct only so far as it fails to take into account the potentially devastating effect of such a move on livestock and poultry feeding or exporting.

   Of similarly incendiary consequences is the idea that many of these matters may best be addressed by re-establishing a government-financed reserve program for feed grains that would be large enough to assure an adequate supply for feeding and ethanol in the event of a crop shortfall. Considering that use of corn in making ethanol has tripled in the past six years to 54 million tonnes in 2006-07, and that this is on top of nearly 250 million tonnes for “regular” domestic feeding, food use and exports, the size of the reserve needed to guard against disappointing crops is so large as to make such a   step unsupportable. Instead of initiatives that can hardly match the colossus created by the addition of ethanol demand, it would be far better to realize the heightened volatility markets will be experiencing and to devise means for dealing with this.