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By Geoffrey Styles on Jun 6, 2013 with 13 responses

Why the Timing is Ripe for Ethanol Policy Reform

rfs-collage

US Ethanol Policy Should Reflect Circumstances and Consequences

This April, two separate bills were introduced in the US House of Representatives to reform, or repeal, the federal Renewable Fuel Standard (RFS) that mandates how much ethanol and other biofuels must be blended into gasoline.

To understand why reform or repeal makes sense now, we should recall the factors that led Congress to enact this standard six years ago and consider how many of the basic assumptions underlying its design have changed since then. That requires a review of US fuel consumption and import trends, commodity prices, and the impact of the RFS on food prices. After summarizing the other points I want to focus on the last one, based on an interview I conducted with Dr. Yaneer Bar-Yam, an expert on complex systems who has developed a model that explains the behavior of food prices since the introduction of the first, less ambitious RFS in 2005.

Origins of the RFS

In the fall of 2007, when Congress was debating the Energy Independence and Security Act that included the current, enhanced RFS, the US energy situation looked dire. For four years oil prices had been rising more or less steadily from their historical level in the low-to-mid $20s per barrel (bbl) to around $90, on their way to an all-time nominal high of $145/bbl the following summer. US crude oil production was in its 22nd consecutive year of decline, while our crude oil imports had climbed to 10 million bbl/day, twice domestic production that year.

Even more relevant to the thinking behind the RFS, US gasoline consumption stood at a record 142 billion gallons per year and had been growing at an average of 1.6% per year for the previous 10 years–another 2 billion gallons added to demand each year. In its annual long-term forecast for 2007, the Energy Information Administration (EIA) of the US Department of Energy had projected that gasoline demand would grow to 152 billion gal/yr in 2013 and 168 billion gal/yr by 2020. Meanwhile, US net imports of finished gasoline and blending components had reached a million barrels per day in 2006, equivalent to 15 billion gal/yr–equal to the corn ethanol target set by the 2007 RFS for gasoline blending in 2015. And by the way, US corn prices for the 2006-7 market year averaged $3.04 per bushel (bu). In this environment, policy makers regarded ethanol as a crucial supplement to dwindling hydrocarbon supplies, from a feedstock that was cheap and readily expandable.

Trend Reversal

Without belaboring the events of the last five years, virtually every one of those trends has reversed course. That has occurred partly as a result of the recession and the lasting changes it produced in the US economy, and partly due to an energy revolution that was largely invisible in 2007 but had already begun.

US gasoline consumption peaked in 2007 and has since declined to 133 billion gal/yr last year. The EIA forecasts it to fall to 128 billion by 2020 and 113 billion by 2030. US crude oil output is the highest in 22 years and is set to exceed imports this year, while the US has become a net exporter of gasoline and other petroleum products. Since 2007 US ethanol production has grown from 6.5 billion gal/yr to 13.3 billion gal., and it seems more than coincidental that corn prices had doubled to an average of $6.22/bu by last year.

Food vs. Fuel

That brings us to the controversy that has been widely referred to as “food vs. fuel”. In the last several years I’ve read numerous papers attempting to determine by correlation or other empirical methods whether and to what extent the increase in US ethanol production from corn has affected food prices. To put this in context, since 2005 the quantity of corn used for US ethanol production has grown from 1.6 billion bu/yr to 5 billion bu/yr, or from 14% to 40% of the annual US corn crop.

Some studies, such as this 2009 analysis from the non-partisan Congressional Budget Office found a significant influence on food prices. Others, including an Iowa State study recently cited in a blog post from the Renewable Fuels Association, found a negligible influence. What differentiates the work of Dr. Bar-Yam is that he and his colleagues have developed a quantitative model based on two key factors — corn consumed for ethanol and commodity speculation — that closely fits the behavior of a global price index. Their model also accounts for the “distillers dried grain” byproduct from ethanol plants, which returns about 20% of the corn used in the form of protein-upgraded animal feed.

Before speaking with Dr. Bar-Yam last week, I was a bit skeptical of his results. Aside from skepticism being my default mode in such situations, I had spent a lot of time looking at claims of speculator influence on crude oil prices in the 2006-8 period and was never convinced that they were more than the “foam on the beer”, rather than a basic driver of prices. However, as I was reviewing his paper prior to our call, a light went on.

Rising Corn Demand Spurs Increased Speculator Activity

The curve his model predicted, which closely matched food price behavior, looked very much like the behavior of a process control loop responding to a ramped change in the set point–forget the jargon and think about how the temperature of your home responds to a steady increase in your thermostat setting: overshooting, then undershooting, before converging. We discussed this analogy and he confirmed that the effect could be characterized the same way whether it related to an electrical circuit or a market. In effect, the steadily increasing corn demand from the ratcheting up of the RFS started corn prices rising, and the presence of lots of speculators, including “index fund” investors, caused the price to successively overshoot and undershoot the equilibrium price track one would expect.

Dr. Bar-Yam explained that he had arrived at these two factors by eliminating factors that other groups had investigated, but that turned out to have no predictive value. These included shifting exchange rates, drought in Australia, a dietary shift in Asia from grains to meat, and linkages between oil and food prices. In his view the focus on ethanol and speculation is validated by the shift in dialog on this issue away from other, extraneous causes.

He also emphasized that his main concern is not the price of processed foods in developed countries such as the US, for which commodity grain costs are only one input, but rather the price paid for simple foods by poor people in the developing world. From that standpoint he doesn’t just want to see the RFS reformed. ”It is important not just to repeal, but to roll back the amount of ethanol used in the US.” He would prefer not 10% ethanol in gasoline, let alone 15%, but about 5%. “The narrative has to shift,” he said, “to recognize that people are going hungry.” Those are powerful words, and I’m still thinking about them.

Conclusion: Timing is Right for RFS Reassessment

At current production levels ethanol from corn contributes the energy equivalent of 6% of US gasoline consumption and about 2.5% of total US liquid fuel demand. That’s not trivial, and there’s a whole domestic industry of investors, employees and suppliers who made that happen at our collective request.

However, If Dr. Bar-Yam has accurately captured the relationship between ethanol and global food prices, then we urgently need to reassess what we’re doing with this fuel. We are also in a far better position now to consider scaling back our use of ethanol produced from grain than we were when the RFS was established. With increasing production of shale gas, tight oil and various renewables, the energy scarcity that has defined our policies for the last four decades is far less relevant to our policy choices going forward. I’ll tackle the practical aspects of RFS reform, in terms of the so-called “blend wall” and its impact on gasoline prices, in a future post.

  1. By James Van Damme on June 7, 2013 at 10:14 am

    Too many politicians and industrialists have an alcohol problem now. We need to get going on butanol from switchgrass, and stop burning corn.

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    • By Frank B. on June 7, 2013 at 10:46 am

      Uhhh. Butanol is an alcohol too, just like ethanol.

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      • By James Van Damme on June 7, 2013 at 1:26 pm

        Yeah, but not made from stuff we eat. And more like gasoline.

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        • By Moiety on June 11, 2013 at 7:49 am

          Actually that is not correct. The most advanced projects in my opinion are still at the stage of using food as feed stocks. Not only that but I suspect that companies like Cobalt are targeting the chemical market rather than the fuel market due to the much high price available for butanol.

          The issue with n-butanol is that current methods produce a very dilute fermentation mixture and this can only increase to a certain amount due to toxicity. Thus a lot of energy is required to get a pure product. Some shortcuts are maybe avaialble but these are not game changing in nature (see *).
          Some other companies like Gevo are getting around this by producing isobutanol (less toxic) but they are currently in a fight with Butamax. Robert Rapier worked as a butanol engineer in the past and has a post on the subject of butanol.

          *Control of the Heterogeneous Azeotropic n-Butanol/Water Distillation System, Luyben (2008)

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  2. By Tom G. on June 7, 2013 at 1:24 pm

    Well yes Frank you are correct – it is an alcohol however, it is not like ethanol. It has more carbon chains and therefor is a more compatible additive for gasoline and can be mixed at much higher concentrations. It also has about the same energy content as gasoline. It is also is less corrosive than ethanol.

    But after saying all of these things you are still correct – it is an alcohol. However, after considering everything; to me it is a better alcohol, LOL.

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  3. By LauraKearns on June 7, 2013 at 2:32 pm

    It’s a common myth that corn ethanol increases food prices. The reality is that the number one strongest influence over food prices is oil prices. That means that the price of corn is not determined by consumer supply and demand. Instead, prices are determined by traders in commodities markets. Commodity price trends in these markets are often in sync, even for very different categories of goods. Specifically, food commodity prices are linked to the price of energy commodities. We need to open up the fuel market and allow cheaper, cleaner replacement fuels to compete freely with oil.

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    • By Tom G. on June 7, 2013 at 5:49 pm

      Here are three different perspectives when it comes to corn based ethanol based on a Google search using the term “ethanol increases food prices”.

      This organization supports your position.

      http://www.fuelfreedom.org/myth-corn-ethanol-increases-food-prices/

      This organizations takes a quite different view of why the price of corn is important.

      http://blog.heritage.org/2013/02/07/ethanol-mandate-leads-to-social-unrest/

      And this organization takes yet another view.

      http://news.heartland.org/newspaper-article/2013/01/28/study-ethanol-mandates-causing-spiraling-us-food-prices

      As you can see it all depends on your perspective. If I were to survey the average American, I will bet most could care less if we used ethanol or butanol. They are more interested in the price they pay at the pump and getting to work on time. I hate to say this but most Americans don’t really give a rats behind about what goes into their tank as long as their car continues to run, LOL.

      Ethanol is currently easier to produce than butanol. When butanol can be produced for the same cost as Ethanol it will become the fuel of choice for lots of different reasons. However, the best part of this plan is that we don’t have to do anything to make this happen. It will just become the best product for the job at hand.

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    • By Geoffrey Styles on June 10, 2013 at 12:35 pm

      Laura,
      Thanks for your comment. However, that depends which food prices you’re looking at. If it’s grocery-level prices in developed countries like the US, you’ve got a good case for oil prices being important, too, though natural gas prices, which have come down significantly, could be at least as important, given their role in fertilizer production. But remember that Dr. Bar-Yam is focused on a UN global food price index that mainly tracks less-processed foods in the developing world, where supply chains are shorter and oil-based energy is much less of a factor.
      If your suggested solution includes ramping up grain-based ethanol even further, then it’s likelier to drive food prices up than down. Only if the replacement fuels are derived from non-food biomass (that doesn’t compete for cropland), natural gas or electricity would you likely see the effect you suggest.

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  4. By Russ Finley on June 7, 2013 at 11:51 pm

    It’s a strange world. Jeremy Martin, senior scientist with the Union of Concerned Scientists in an opinion piece he co-wrote with the president of DuPont Industrial Biosciences :

    Cellulosic biofuels have made the transition from the laboratory to commercial production and are a key element of the Union of Concerned Scientists’ plan to cut half of projected oil use over the next 20 years.

    Although they are very much against corn ethanol, they appear to think that it is a stepping stone to cellulosic, “…reducing our reliance on oil …will help make American energy cleaner and more secure while creating jobs in rural America …building a more secure energy future for the United States.”

    Once you take a scientist out of his or her lab, they are no wiser or more knowledgeable than anyone else. Ask a nuclear physicist to paint your portrait or rebuild your brakes and watch what happens.*

    * http://biodiversivist.blogspot.com/2010/03/ucs-union-of-concerned-scientists-is.html

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  5. By TimC on June 10, 2013 at 10:26 am

    In the mid term, we may see more corn ethanol dry mill plants retrofitted to produce E85 and other ethanol-gasoline blends. The ethanol-to-gasoline (ETG) conversion has been researched for decades, and is approaching commercial targets for selectivity and cost. This process uses similar zeolite catalysts, and has a nearly identical product distribution, as the methanol-to-gasoline (MTG) process developed by Mobil in the 70s. A dry mill could replace some of its molesieve dehydraters with ETG units, and become a gasoline plant, producing drop-in E10, E85, etc.

    In the long run, bio-ethanol will be squeezed out in favor of catalytic processes, such as Celanese TCX, that convert natural gas to ethanol. Bio-ethanol’s soft underbelly is it’s extremely high water usage, whether the feedstock is corn or cellulosic. Bio-ethanol requires 10X the water as catalytic ethanol. If the U.S. continues to use ethanol as an oxygenate, it will be made from natural gas, not corn.
    Any reform of the RFS or other regulations should take into account the rapidly-changing technology around fuel ethanol production.

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    • By Geoffrey Styles on June 10, 2013 at 12:44 pm

      I agree that technology advances, particularly for drop-in fuels, must be taken into account in any reset of the RFS. The big challenge for ETG is the high cost of energy for ethanol from grain. At today’s ethanol spot price on the CME of $2.39/gal., that equates to $3.65 per gasoline-equivalent gallon, before any processing. The comparison becomes even starker in BTU terms, at $31.45/million BTUs. Compare that to natural gas, which is at the front end of most MTG projects.

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  6. By Robert Rapier on June 11, 2013 at 7:43 pm

    “Without belaboring the events of the last five years, virtually every one of those trends has reversed course.”

    A little birdie in the ethanol lobby told me that ethanol is the reason all of those trends reversed course. :)

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    • By Geoffrey Styles on June 13, 2013 at 8:34 am

      Robert,

      It’s always risky to take credit for things beyond your control. ;)

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