Is there an oops in U.S. ethanol policy?

Apr 9, 2010
by WLJ

Brazil will be one of the beneficiaries of the Environmental Protection Agency (EPA) finding that greenhouse gases will be reduced by ethanol, soy-diesel, and ethanol made from sugarcane. While the decision is good for U.S. corn and soybean producers, questions are being raised why U.S. biofuels want both a mandate for use as well as tax credits and import tariffs. U.S. biofuels policy is being taken to the woodshed.

Corn will be supplying the first 15 billion gallons of ethanol per year through the year 2015, with little displacement by either cellulosic ethanol or ethanol from foreign sources. Beyond that level, ethanol from biomass and related sources is responsible for meeting federal mandates. If Brazilian sugarcane can supply some of the cellulosic ethanol now, Iowa State University economist Bruce Babcock suggests that would mean increased demand for biofuels and that would increase the demand for corn and soybeans. In a recent newsletter, Babcock questions why the biofuels industry wants both the mandate to use ethanol as well as a tax credit that lessens its cost and an import tariff on foreign sources of ethanol. Calling them “difficult to defend policies,” Babcock says the biofuels industry is spending political capital to maintain the policies.

Babcock questions the policy of the biofuels industry based on economics. And he suggests:

1) Biofuel producers want to push demand beyond mandated levels when demand for their product is high, which occurs when oil prices are high. This explanation is consistent with the biofuels industry’s opposition to a variable tax credit that would provide higher subsidies when oil prices are low and low subsidies when oil prices are high.

2) Biofuels industry supports the tax credit to curry favor with gasoline and diesel producers, who prefer being paid to use biofuels rather than having to pay a tax to avoid using them. This explanation is a bit Machiavellian because the biofuels industry has historically cast big oil as a primary opponent of biofuels.

3) The biofuels industry does not believe that the mandates will be maintained in the future so tax credits are needed as an insurance policy. The likelihood that the mandates will be eliminated seems low.

Babcock says Brazilian ethanol made from sugarcane had competed with U.S. ethanol made from corn, but the tariff made the corn ethanol more profitable to fuel producers. He says the EPA ruling says corn and sugar ethanol are different products, and that will allow Brazilian ethanol to be imported to meet the needs of the advanced biofuels mandate, but corn cannot be used to make more than 15 billion gallons of ethanol. In a reversal of conventional wisdom, Babcock says in essence, Congress and the EPA have created a biofuels mandate that will benefit Brazil and force U.S. fuel producers to raise prices high enough to draw Brazilian ethanol into the U.S. market. And he adds that without corn to compete with Brazilian ethanol, there will be no benefit to maintain the import tariff. Some pundits would say that is an unintended consequence.

Biodiesel, on the other hand, can meet its own initial mandate as well as the mandate for advanced biofuels that is supposed to be allocated for cellulosic sources, according to Babcock. He says that is because of the higher energy content, and he expects it to reach a 3 billion-gallon market by 2019. But he says with the lack of cost competitiveness of soybean diesel, Brazilian ethanol will fill that demand as well.

Babcock says Brazilian ethanol will compete with corn for the U.S. ethanol market until 2013, then it will meet the mandate as an advanced biofuel, and not challenged by corn as a competitor.

He concludes by saying, “With the mandates in place, the tax credits will have no impact on industry profits or production levels unless oil prices climb high enough that the combination of market demand and the subsidies provided by the tax credit push ethanol production higher than mandated levels. In this case, it may be difficult to defend the tax credits because of their additional impact on corn prices and subsequent impact on the cost of producing meat and milk.”

The current ethanol policy may have created an unintended consequence and will allow ethanol from sugarcane to displace some corn as Brazilian sugarcane begins to fill the supply of cellulosic ethanol, even though corn based ethanol has not yet made its 15 billion bushel top. — Stu Ellis, University of Illinois