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By Robert Rapier on Mar 17, 2009 with no responses

The WSJ Hates Ethanol

Actually, according to them everybody hates it:

Everyone Hates Ethanol

I can assure them that corn farmers, ethanol producers, and ethanol lobbyists don’t hate ethanol. :-) But they are correct that a coalition of strange bedfellows has united in opposition to our ethanol policy.

The article makes a lot of good points, but it is quite harsh:

These days, it’s routine for businesses to fail, get rescued by the government, and then continue to fail. But ethanol, which survives only because of its iron lung of subsidies and mandates, is a special case. Naturally, the industry is demanding even more government life support.

Corn ethanol producers — led by Wesley Clark, the retired general turned chairman of a new biofuels lobbying outfit called Growth Energy — want the Obama Administration to make their guaranteed market even larger. Recall that the 2007 energy bill requires refiners to mix 36 billion gallons into the gasoline supply by 2022. The quotas, which ratchet up each year, are arbitrary, but evidently no one in Congress wondered what might happen if the economy didn’t cooperate.

I laid out this scenario in A Vicious Circle. It goes like this.

1. First we create policies to subsidize, and when that doesn’t work well enough to mandate ethanol usage.

2. Overbuilding of capacity occurs, especially since the barriers to market entry are so low.

3. Margins fall, so producers find themselves in financial trouble.

4. Now we need more mandates, to keep the producers that were created in Step 1 from going bankrupt. Suddenly ethanol looks great, and given those low barriers to entry…

WSJ explains that a complicating factor is that fuel demand is down, so the amount of ethanol forecast to be produced is now more than the market is likely to absorb:

Americans are unlikely to use enough gas next year to absorb the 13 billion gallons of ethanol that Congress mandated, because current regulations limit the ethanol content in each gallon of gas at 10%. The industry is asking that this cap be lifted to 15% or even 20%. That way, more ethanol can be mixed with less gas, and producers won’t end up with a glut that the government does not require anyone to buy.

The amazing thing – and this is already starting to take place – is that oil refiners are potentially liable for any damages that result if higher blends damage engines:

The biggest losers in this scheme are U.S. oil refiners. Liability for any problems arising from ethanol blending rests with them, because Congress refused to grant legal immunity for selling a product that complies with the mandates that it ordered. The refiners are also set to pay stiff fines for not fulfilling Congress’s mandates for second-generation cellulosic ethanol. But the cellulosic ethanol makers themselves already concede that they won’t be able to churn out enough of the stuff — 100 million gallons next year, 250 million gallons in 2011 — to meet the targets that Congress wrote two years ago.

I have also said on numerous occasions that there is no way the cellulosic mandates will be met. Congress still hasn’t figured out that they can’t mandate technological breakthroughs. They keep assuming that if they pass laws, aspiring entrepreneurs will form companies and figure out the needed breakthroughs. If it was that simple, cancer and heart disease wouldn’t still be with us.

The article notes the irony that financially successful but politically unpopular business like oil companies are potentially liable for a product that has been politically forced upon them through companies that wouldn’t exist without generous subsidies and mandates. Their closing paragraph echos my previous essay on why this is a vicious circle that we are unlikely to break any time soon:

To recap: Congress and the ethanol lobby argue that if some outcome would be politically nice, it should be mandated (details to follow). Then a new round of market interventions is necessary to fix the economic harm resulting from the previous requirements, while creating more damage in the process. Ethanol is one of the most shameless energy rackets going, in a field with no shortage of competitors.

Once again, I note that it isn’t ethanol the fuel that I have a problem with. What I have always had a problem with is the system we have set up, which seems to have been done without giving enough consideration to potentially unintended consequences. If the government had spent more time listening to critics, instead of just dismissing them as shills trying to protect their interests, we may have been able to avoid some of this mess.

I have said before that I am a big fan of incentives, but not such a big fan of mandates. Incentives over time can – and should be rolled back as an industry starts to become established. If it can’t become established, going to a mandate means you are now trying to force something that is highly uneconomical. The problem with a mandate like this – which followed 30 years of subsidies that couldn’t get the industry to a self-sufficient state – is it forces you to purchase the fuel regardless of the cost. In the case of the subsidies, at least you have an idea about how much money is being funneled into the industry to keep it afloat. Mandates dictate that no matter how much it costs, we are going to blend 10.5 billion gallons of ethanol into the fuel supply in 2009.

The irony is that we could rely heavily on oil and coal for the ethanol production production, and yet the final product is ‘renewable’ and therefore heavily subsidized. That’s why I have frequently said that ethanol subsidies are indirect fossil fuel subsidies.

Note: I will be traveling for a couple of days, so probably no comments from me. I have set up another essay to automatically publish while I am away.