Ethanol Follies

Copyright © 2008, Greenwich Financial Management Inc., a registered investment advisor.

Alcohol is a great solvent, but it doesn’t mix well with politics. The story of the federal subsidy for ethanol provides a lesson about why politicians, even if well-intentioned, should not favor specific alternative fuels.

What are the subsidies? Under the Volumetric Ethanol Excise Tax Credit (2005), the United States pays refiners 51 cents for each gallon of pure ethanol blended into gasoline. As a sop to domestic producers, we levy a 54 cent gallon tariff per gallon on imported ethanol intended for fuel. The Department of Energy makes king size grants to builders of ethanol refineries. Without these and other distortions, the demand for ethanol as a fuel for motor vehicles would be limited to drag racing.

An article in the January 2007 issue of Scientific American, “Is Ethanol for the Long Haul?” by Matthew Wald, summarized research on the energy impact of ethanol production. Taking into account all fuel inputs—the gasoline needed to farm the corn, the trucks or trains needed to take corn to the refinery, the refinery process, and the delivery to gas stations—the net result is negative. Scientists are working on ways to use the cornstalk, and not just the kernels, in the hope to achieve a more efficient process.

The US Department of Energy has stated as a national goal to replace 30% of US petroleum consumption with ethanol by the year 2030. This is nonsense. About 14% of the US corn crop for 2005 already went to ethanol. Article on demand for ethanol. If all US corn and soybean production were devoted to make ethanol, and none for example to corn muffins,
this would meet only 12% of current demand for gasoline and 6% for diesel. See Article on Ethanol on biodiesel as alternative fuels

Using current technology, converting corn to ethanol uses 29% more in fuel inputs than is delivered by the finished product. Here are some alternatives: switchgrass, negative 50%; wood biomass, negative 57%; sunflowers, negative 118%; soybeans negative 27%. See “The Stupidest Federal Subsidy,” Slate, http://www.slate.com/id/2122961/.

Another problem is fresh water. Although production is becoming more efficient, ethanol refiners are enormous users of water. Putting refineries near the corn fields in the Great Plains puts further strains on dwindling aquifers. At the same time, corn fields are being planted in more arid areas, requiring irrigation. The nitrogen runoff from fertilizing additional corn fields further pollutes rivers leading to the Mississippi and then into the Gulf of Mexico. See "Ethanol and Water Don't Mix," in the March 1st-7th issue of The Economist.

Alcohol also has lower energy content per gallon than gasoline. Therefore, the mileage per gallon on gasoline/alcohol blends is lower. Alcohol evaporates easily, leading to the need for fuel supplements to retard this problem. The tendency of alcohol to absorb water (unlike fossil fuels) leads to other costs in refining and transportation. High alcohol concentrations can damage engines not set up for alcohol.

The subsidy for ethanol also encourages the trend toward corn mono-culture. If there is nothing but corn, there is a lack of plant diversity, pesticides need to be used more, and there is greater risk of a natural disaster akin to the potato blight in Ireland (which led to the Great Famine, 1844-1849).

Finally, the demand for corn diverts food from the chain that feeds human beings and livestock. This effect is helping to cause inflation in grain and meat prices, and it could worsen the problem of world hunger.

Ethanol demand has decreased unemployment and benefited many farmers. It has also been a boon for certain agricultural merchants, including Archer Daniels Midland (ADM). The subsidy, though, has cost US taxpayers dearly:

Ethanol might not conserve fossil fuels, but it makes great political hay. President Bush waves the flag for ethanol. Candidates Clinton and Obama both enthuse about energy from corn. Senator McCain, who bravely fought the ethanol lobby for years, flip-flopped during the Republican primaries and now is a strong ethanol supporter.
Article from Fortune

A way of discouraging fossil fuel use that is market neutral toward alternatives would be to increase the taxes on gasoline and diesel fuel. However, proposing this is viewed as political suicide. Instead, we jump on the ethanol subsidy hayride, feeling good about our civic virtues while worsening the true problem.

Andrew Szabo CFA is managing director of Greenwich Financial Management Inc., a registered investment advisor. Questions call 917-796-8500 or e-mail Szabo@GreenwichFinancial.com). To find full source citations, and daily market ideas, visit InvestmentValue Diary.

Print this post