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Strategizing for the Ethanol Industry

A reader recently sent me a link to the following story:

D.C. Discussions Advance Corn Issues

Extension of the Volumetric Ethanol Excise Tax Credit (VEETC) – This blender’s tax credit provides $.45 for each gallon of ethanol blended with gasoline and expires at the end of this year. The credit provides thousands of jobs, fuels economies and helps the U.S. to meet its mandated biofuels-production standard. The elimination of this credit will result in a 38-percent jobs and production loss. VEETC brings dollars back to the U.S. Treasury in the billions, eliminates more than $22 billion in oil imports and has led to a reduction of farm payments of more than $10 billion. Despite the success of the ethanol industry, some members of the Ohio delegation want its advancement to end – even delegates from areas where corn represents the largest economic portion of their district.

Granted, this is from the corn lobby, but that’s just unadulterated nonsense. It is scare-mongering, and given the advantages they already enjoy (and I am not opposed to some subsidies for the industry) it is sad to see corn farmers groveling for welfare like this. (The irony of this is that I grew up on a farm, in a farm community, and farmers love to gather at the local coffee shop to complain about “people on welfare” taking their tax dollars).

As I have been arguing, eliminating the ethanol credit (VEETC) wouldn’t absolve gasoline blenders from their obligations under the Renewable Fuel Standard (RFS). If the credit was eliminated today, gasoline blenders must still blend 12 billion gallons of ethanol in 2010, and 15 billion gallons by 2015. They just wouldn’t get paid to comply with the law.

Most of the attempted rebuttals to my recent essays on eliminating the VEETC completely missed the mark. People acted as if there was no RFS in place, and therefore they argued that eliminating the VEETC would completely destroy the ethanol industry. That was the gist of Growth Energy’s call to arms for their members; the VEETC was just too important to ethanol’s survival. That might have been a valid argument prior to implementation of the RFS, but it is not a valid argument today. If they really require both a mandate and a subsidy in order to compete, then we might as well stop this charade right now.

There was one response to my argument – made by several different people – that does have some merit. That response was that the VEETC helps incentivize blenders to blend more ethanol than what is required by law.

OK, setting aside for a moment the other arguments for and against the subsidies, it is true that the subsidy may result in the blender going above and beyond the law. But the response to that is simple: Only pay for what was blended above and beyond the law. Arguing for a subsidy that will cost almost $6 billion this year by some incremental blending above what the law requires is silly. In fact, that means you would be paying a very high subsidy for that incremental ethanol blending. How much? Try $4.18 per gallon of incremental ethanol blended.

Several related articles have recently been published along the same theme; that not only is a subsidy on top of a mandate redundant, but it subsidizes driving and wastes taxpayer dollars:

Mandates, Tax Credits, and Tariffs: Does the U.S. Biofuels Industry Need Them All?

It is puzzling why the biofuels industry continues to defend these subsidies when it has its mandates in place. Tax credits cost taxpayers more than $5 billion per year, and import tariffs convey the message that the ethanol industry is so uncompetitive that it needs protection against foreign competition. It would seem that there would be major political benefits from simply giving up all subsidies and import tariffs and for the industry to rely solely on the mandates . . .

Pay close attention to this bit: “Expanded mandates under the Renewable Fuel Standard provide ethanol and biodiesel producers a guaranteed future market at volumes that exceed what they have produced in the past.”

Think about what is going on here. Ethanol producers already enjoy mandates that guarantee a growing market. What other industry has that luxury? And on top of that, they want subsidies to complement the mandates? Outrageous.

I am in the middle of preparing my taxes, so tax dollars are much on my mind right now. And I strongly resent my tax dollars being wasted. The issue of taxpayer money has become a bit of a running joke with all of the multi-billion dollar bailouts and stimulus packages, but that money still comes from taxpayers, present and future. I will not sit idly by while we mortgage our children’s futures to pay a redundant subsidy.

That is a perfect lead-in to the theme of this article, which is what I think the ethanol industry’s strategy should be with the VEETC expiring this year. Now the ethanol/farm lobby might be able to push this redundant subsidy through regardless. I won’t be surprised if they do. But it is going to be a nasty fight, and it is going to shine a spotlight on this issue that they would rather have keep at a low profile. They are going to have to resort to scare tactics and exaggerations (as in the corn lobby’s missive above), and major questions will be asked as to why this industry still requires so much protectionism and taxpayer money to survive.

But imagine that instead of spreading a $6 billion subsidy across 12 billion gallons of ethanol (that oil companies are legally obligated to blend), that it was instead targeted at incremental E85 production. So instead of $6 billion, you could maybe spend $2 billion to get an incremental 2-4 billion gallons of E85 into the market. That would be smart politics by the ethanol industry, would save taxpayer dollars, and would still potentially grow their industry above and beyond their already guaranteed future market.

I haven’t been able to find E85 sales statistics for 2009, but there were lots of stories about how demand had dropped off during the year. The major problem here is in pricing; E85 is currently at about a 15 cent disadvantage (with the subsidy) relative to mid-grade gasoline (but only a nickel disadvantage relative to premium gasoline). If the VEETC was focused entirely on the E85 market, that disadvantage could be made to disappear at a fraction of the cost of the current program.

Further, I think E85 would be a much better outlet for the ethanol industry than trying to get nationwide E15 or E20 in the system. Instead of fighting the EPA, boat owners, the oil industry, the auto industry, etc. to force higher ethanol blends into the system (and I haven’t seen them step up and offer to assume the liability from potential damage caused by these higher ethanol blends), use it in cars that were designed for it.

There are numerous E85-ready cars on the road now. If the price is right, the demand will be there. The industry doesn’t even have to rely on the oil companies. There is nothing stopping farmer’s coops from getting together and opening up their own E-85 stations throughout the Midwest.

I am a fan of efficiency, and to me it doesn’t make much sense to produce ethanol in Iowa and ship it to Texas, while shipping finished gasoline products from Texas to Iowa. The Midwest consumes 40 billion gallons of gasoline per year. The ethanol industry should enjoy the largest cost advantage in the Midwest, close to the source of production. If we are going to incentivize ethanol, let’s first focus on getting E85 sales up in the Midwest, in the local markets where ethanol is produced.

I think some version of this argument – only use the VEETC to incentivize incremental ethanol production – would be a win-win for the ethanol industry. But continuing to argue that they need a subsidy for something oil companies are legally obligated to do anyway is not going to sit well with most people.

Note 1: (My recent Range Fuels’ essay has been republished in the current issue of Subsidy Watch).

Note 2: Major changes are coming to R-Squared. Details on Monday.

March 12, 2010 Posted by | Uncategorized | 218 Comments