Our Latest Ethanol Non-issue

Dave Swenson

The EPA finally announced the amount of ethanol that will be blended with the nation’s fuel supply in 2015 and the amount to be blended in 2016 (see this summary in Bleeding Heartland). Depending on where your headline writers live, this was reported as a win for ethanol or a disappointment to the biofuels industry. Here in Iowa, the Des Moines Register told us that Iowa’s ethanol producers, notwithstanding a boost in ethanol mandate levels from earlier EPA proposals this year, found it necessary to “criticize new EPA fuel standard.”

A reasonable person might wonder, what’s up? What’s up, is the ethanol industry has an insatiable demand for public support of ethanol consumption, and it views any erosions in that support as an unforgiveable betrayal.

Some recent history. Around the middle of the last decade there was a widely-supported push to expand domestic energy production in the U.S. The easiest and fastest way to do that was with corn ethanol. The technology was well established, and the risks to investors were low. There was also strong affection towards producing more climate-friendly energy, so serious attention was paid to promote the rapid development of advanced biofuels. The nation first underwrote this rush to free ourselves from foreign oil dependence with the Energy Policy Act of 2005, which set a mandatory blending target of 7.5 billion gallons of biofuels by 2012. Nearly all of that mandate would come from corn-based ethanol because technologies had not developed commercially-feasible advanced fuels alternatives.

That sparked a corn ethanol expansion boom. And with energy price shocks due in large part to Middle East instability, oxygenate fuel-blending requirements in smog-prone areas, and 10 percent ethanol content blending mandates in a large fraction of the states, ethanol demand soared. As always happens with subsidy-driven industrial booms, we added ethanol production capacity far in excess of the original 2012 goal. The Energy Independence and Security Act of 2007 (EISA) was next passed, and it boosted the nation’s expected renewable fuels goal to 36 billion gallons by 2022, 15 billion of which at that time would come from corn ethanol. In two legislative years, the future targets for corn ethanol production doubled, and as a result ethanol investors added nearly that much capacity by 2010.

Two relevant things were assumed in EISA that pertain to the current to-do: first, U.S. gasoline consumption was expected to grow at a fixed rate through the projection period. And second, the nation would rapidly develop biofuels that were not based on food or feed crops to meet the aggressive targets. (It didn’t, and it is unlikely that it will to the degree expected in 2007. But that is a subject of another essay.)

Back to the first assumption. Due to the Great Recession, U.S. gasoline consumption declined, and that decline coupled with the EISA-driven annual ratcheting upwards of ethanol blends meant that the U.S. came up against a physical and commercial limit to the amount of ethanol the U.S. could feasibly use. This limit was called the blend wall, which meant that the average ethanol content in the country was at or very near 10 percent. As most automobiles in the U.S. were designed to run on no more than a 10 percent blend of ethanol (higher blends risked damaging older vehicles, power equipment, and sporting equipment), the EPA began to roll back near-year ethanol blend levels to match actual fuel demand under its Renewable Fuels Standards (RFS) authority to prevent breaching the blend wall.

But market reality and physical limits are irrelevant to the nation’s corn ethanol producers. It rankles many agricultural interests and many ag-state politicians that the EPA has prevented the nation’s fuel supply from absorbing more ethanol even though we are at the blend wall. In fact, they ardently support increasing the nation’s average blend level to 15 percent, though that is unsuitable for most automobiles and exceeds most new car warranties. Governor Branstad, as an ardent critic, has even gone so far as to assert that the EPA’s actions in setting the RFS at levels less than originally anticipated risk materially harming Iowa corn farmers and rural economies.

Why does all of this matter so much? The U.S. boosted the ethanol industry by first subsidizing each gallon of ethanol produced (hence the clamor to expand production initially), placing tariffs on the imports of ethanol from countries like Brazil, and by mandating higher levels of ethanol blending. Though the direct subsidies and the tariffs have been eliminated, the mandate is still in place, and because the demand is mandated by federal policy it does two things: it boosts the price paid for ethanol beyond what the market would normally bid for it given its energy value,* and in so doing, the combined demand and higher bid price for ethanol supports higher corn prices, which of course is a pocketbook issue for Midwestern farmers.

The U.S. overbuilt conventional biofuels capacity over the last decade, and as a result it also over produced corn. For a while life was good and corn prices soared, but now with corn supply excesses and concomitantly low prices, the no-longer magical formula of government support for both industries leaves ethanol producers and Midwestern grain farmers resentful.

The rhetoric about the RFS sounds as if it faces an up or down vote in toto or massive revisions. In truth, there have been of late merely EPA-driven adjustments on the margins -- adjustments that are practical, justified, and quite minor. The industry is not allowed to produce quite as much ethanol as was erroneously projected eight years ago, yet the new RFS levels allow it to produce more than it did last year. The industry is not satisfied. It wants the government to mandate higher production, as was targeted in the EISA in 2007, irrespective of physical or market considerations. As I said earlier, insatiable.

The RFS as recently adjusted is not an existential threat to ethanol production or to corn farmers. But one wouldn’t know that listening to ethanol trade groups or the very many politicians they underwrite.

*As I write this, the near month future price for gasoline is $1.26 a gallon, and the price for 100 percent ethanol is $1.50. As ethanol has just two-thirds the energy value of gasoline, its appropriate bid price is $.84 a gallon. Accordingly, the nation’s ethanol blenders (and motorists) are paying $.66 more per gallon for ethanol than an unmandated market price would support.

  • No mandate, no ethanol

    Would we even be able to buy any ethanol if we had no mandate? Don't the oil companies allow it on their pumps only because of the RFS? Is it practical to establish a competing set of service stations just so we could buy renewable fuels?

  • Great post, couple comments

    As always, a great factual post by Dave Swenson. Thank you!

    To answer the first comment, there would be some demand for ethanol without the RFS, as it is an oxygenate that is needed in gasoline to improve octane and reduce emissions. There are other oxygenates, but the other common oxygenate, MTBE, is toxic and has caused groundwater contamination.

    A couple of comments on the post. A big part of the gasoline demand reduction was due to the recession, but Obama administration’s push for higher fuel economy standards is also a significant contributor to the decrease in demand.

    Having witnessed some of the behind-the-scenes ethanol discussions and deliberations in Iowa, this Iowa reaction to the RFS changes is very much in line with Iowa ethanol interests’ “let’s ignore the inconvenient facts” tradition. To me, a good example was the ethanol interests’ approach to ethanol’s well-known impact on fuel economy (dictated by laws of physics due to lower energy content of ethanol when compared to gasoline). The Iowa ethanol folks for the longest time always downplayed this fuel economy penalty, stating wildly inaccurate or misleading statistics about it – especially when it came to the higher ethanol blends, like E85. (From what I’ve seen lately, the unanimous scientific consensus has finally forced the ethanol folks to face reality on this specific issue.)

    • Agree

      I agree totally with your comment. The industry has used a range of near-truths and not-truths to make their points (like a barrel of ethanol displaces a barrel of imported oil). They are now arguing over market share, that's all, and they want to exploit more of their capacity as mandated blend levels support higher prices.

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