Study shows ethanol subsidy obsolete

Cattle Market & Farm Reports, Editorials
Sep 24, 2007
by WLJ
—Transportation and oversupply concerns plague market.
Last week, Archer Daniels Midland Co. was passed as the largest producer of ethanol in the U.S. when Poet LLC started production at its new 65 million gallon plant in Portland, IN. The new plant, which will consume an estimated 22 million bushels of corn annually, will increase the company’s annual production to 1.1 billion gallons per year from 22 plants nationwide. The latest plant to come on line this year will boost ethanol availability in the U.S. to 7.2 billion gallons in 2007, a number which industry watchdogs point out exceeds demand of 6.7 billion gallons.

In fact, a report issued earlier this year by analysts at the investment firm Lehman Brothers estimated the surplus at about 1 million gallons per day starting in the second half of 2007. The firm’s report attributed part of that to the ethanol plant construction boom, but said transportation bottlenecks are a bigger problem.

The ethanol industry, which has faced increasing problems with distribution, now faces over- supply and dwindling margins which has led to a tightening of available capital for construction and expansion as well as a lower investment appeal for existing plants.

“Margins certainly have tightened over the last year and will continue to do so in the near future,” said Poet CEO Jeff Broin last week as the company started its newest plant into production.
In fact, financial industry analysts have painted a picture of the industry which is far more bleak.

“We expect the relentless supply of new ethanol production capacity will lead to a 70 percent decline in margins by 2009,” wrote Bank of America analyst Eric K. Brown in a May 2007 research report on the industry.

Ethanol and biodiesel production in the U.S. amounted to little more than a niche market for environmentally conscious consumers prior to the implementation of the government imposed mandate which required U.S. refiners to use 7 billion gallons of renewable fuels annually by 2012.

Since then, the industry has been plagued with distribution problems because ethanol cannot be shipped through existing pipelines which criss-cross the nation and are used for moving petroleum products. Instead, because of its corrosive nature, ethanol must be moved by truck or railcar from mostly rural central U.S. production areas to large, often coastal cities for refining or consumption. The transportation issue has led to bottlenecks and increasing costs for the industry. On top of these woes, many energy industry experts are now saying the ethanol business needs to stand on its own, without the lucrative government subsidies which have spurred its growth.

In fact, a meat industry-funded study released last week shows that ethanol production, particularly when funded by a government subsidy, may not be the panacea envisioned by some well meaning lawmakers. In fact, the economists who conducted the study found that ethanol is viable without government subsidy so long as the price of oil remains above $65 per barrel. Last week, crude oil set new record highs above $81 a barrel.
“Even without subsidies, ethanol production would be expanding at a significant rate due to high gasoline prices and the improvements in ethanol production technology in recent years,” the study’s authors said in their report.

The report, authored by Thomas E. Elam, president of, and commissioned by a coalition which included American Meat Institute, The National Turkey Federation and the National Chicken Council, argues that government ethanol subsidies should be tied directly to gasoline prices rather than the current flat rate paid to producers.

“In fact, if oil prices go high enough, the government should consider taxing ethanol used for fuel to alleviate the effects of ethanol demand on food prices,” Elam wrote. “At $80 per barrel, the U.S. food sector will find itself paying over $5 per bushel for corn. China, having seen what ethanol is doing to food costs, has banned further development of grain-based ethanol production.”

Elam contends that the federal 54 cent per gallon ethanol subsidy has the indirect effect of increasing the cost of ethanol and food production by increasing grain prices across the board.

“...the federal ethanol subsidy raises the breakeven corn price for ethanol plants by about $1.42 per bushel. If ethanol producers expand production until they bid corn prices up to their breakeven corn price point at today’s gasoline price level, it will take corn prices to near $4.75 per bushel, about double the average price of corn before the increase in gasoline prices,” Elam found. “At the current 12 billion bushels of annual corn production, that amounts to an increased corn cost for all U.S. users and our corn export customers of $17 billion per year. These costs are going up even as corn production increases. Included in those paying higher costs are ethanol producers themselves.”

He points out as a part of his research that the industry continues to push for 100 percent market penetration for 10 percent ethanol blend gasoline, known as E10. However, Elam notes that 100 percent penetration may not be feasible.

“At 100 percent penetration, the ethanol industry will require over 50 million acres of corn every year and total corn acres will need to be over 120 million. Until 2007, total corn acres rarely exceeded 80 million acres,” Elam pointed out. “Clearly, corn could further displace other crops, reducing their supply and raising their prices.”

More specifically, he said, 100 percent E10 penetration would require 200 million tons of corn annually, the equivalent of 10 percent share of global grain supply, creating a significant spike in global food costs.

However, according to Elam’s study, the actual cost of the ethanol production subsidy alone may be much higher than anyone anticipated.

“In total, the costs of ethanol paid by taxpayers, fuel purchasers and the food system is about $31 billion in 2007, or about $4.40 per gallon of ethanol produced. Corrected for energy content of ethanol relative to gasoline, this is equivalent to a wholesale gasoline price of $6.67 per gallon. Ethanol is not a cheap source of energy; it is about three times as expensive as gasoline,” Elam stated in his report. “Created at a time when the ethanol industry was not profitable, changing circumstances have rendered the current fixed-payment federal ethanol subsidy program obsolete.” — John Robinson, WLJ Editor