Food vs. Fuel and the Midwest Drought

It was bound to happen.  As long as US corn output continued to climb year after year, the federal mandate to blend steadily increasing quantities of ethanol into gasoline could be accommodated without creating a shortage of this staple grain.  Unfortunately, crops are subject to all sorts of uncertainties, including the severe drought conditions that the middle of the country is experiencing this year.  Estimates for this year's corn crop have been revised downward, and corn prices have already broken through $8 per bushel, up from less than $6 a month ago, with consequences for the livestock, processed food and ethanol industries, as well as for export markets.  As soaring feed grain prices begin to translate into higher grocery prices for meat, poultry, dairy and other goods, will consumers demand relief from the EPA, which has the authority to curtail ethanol volumes?  The current betting appears to be that the administration will stand fast on the mandate, but anything can happen in an election year. 

Ethanol now accounts for at least 10% of US gasoline blending, by volume.  To meet that demand, ethanol producers will require around 5 billion bushels of corn.  In recent years, the ethanol industry's expanding corn demand was met by a combination of increasing yields and planting more acres in corn.  However, corn yields per acre are dropping sharply this year, potentially pushing output below last year's 12.4 billion bushels, if conditions don't improve soon.  That's in contrast to earlier expectations that this year's corn crop would exceed last year's by 20% .  This isn't the first time that the food vs. fuel trade-off inherent in crop-based biofuels has become an issue, but it might be the first time when both the demand for corn for ethanol is so high and the need for that ethanol in the gasoline blending pool is arguably so low.  In this context, food vs. fuel quickly boils down to a debate over the tangible benefits of corn-based ethanol as a fuel.  There's growing evidence that those benefits have been oversold, despite industry claims.

Start with the widely touted study from Iowa State University indicating that ethanol saved consumers $1.09 per gallon at the gas pump in 2011 and $0.89/gal. in 2010.  I read both the original study and its updated version when they came out.  It seemed obvious to me that the authors' grasp of gasoline markets and oil refining were inadequate, but I lacked the time necessary to dig through their math to uncover the source of their exaggerated results.  Fortunately, a pair of researchers from MIT and my alma mater, U.C. Davis, have now done that work and concluded that the Iowa State paper's findings--and the claims based on them--depended on a "spurious correlation": the relationships they saw were coincidental.

In contrast to the Iowa State studies, the MIT/Davis paper is very readable, and I recommend it to you.  In addition to debunking the statistics, the authors point out the key flaws in their counterparts' logic.  Foremost among these is that in order to have a large influence on gasoline prices, ethanol would have to have had a large impact on crude oil prices, which are the largest determinant of gas prices, by far.  From 2005-11 US ethanol production expanded by 10 billion gallons per year, the energy equivalent of 350,000 barrels per day of oil, or 0.4% of 2011 global oil supply. I've argued many times that the oil market responds disproportionately to modest changes in supply and demand, but the idea that a few hundred thousand barrels per day could translate into the equivalent of $45/bbl exceeds the wildest dreams of any trader I ever met.  The MIT paper concludes with the authors summarizing the likely impact of ethanol on gasoline prices as "near zero and statistically insignificant."

However, if ethanol hasn't done much to hold down gas prices, could a drop in US ethanol production resulting from paring back the ethanol mandate to reduce the pressure on corn prices cause a big spike in gasoline prices?  That's where the analysis in a paper presented to members of Congress yesterday comes in.  Dr. Elam's report suggests that rather than displacing imported crude oil, the main effect of increasing US ethanol use in fuels has been to divert domestic gasoline production into exports, while US crude imports have fallen based on a combination of lower demand (from the recession) and improved product yields per barrel of crude oil refined.  Even if you are inclined to be skeptical of these findings because the study was supported by poultry interests, data from the US Energy Information Agency and elsewhere show that US refineries are not fully utilizing their capacity, are exporting significant volumes of gasoline, and have a wider array of domestic and imported crude oils at their disposal than they did just a few years ago. In short, we're in a far better position to forgo a few billion gallons of ethanol this year than we would have been in 2008, the last time food vs. fuel concerns spiked along with gas prices. 

Corn growers have experienced droughts before, and in the past the price of corn sorted out who needed it most.  However, the market can't prioritize fairly among the competing calls on a drought-diminished corn crop when the single largest segment of demand is locked in place by a federal mandate. This represents a massive distortion that only the government can rectify. I'm sympathetic to the ethanol industry's dilemma.  After all, the federal government virtually begged them to overbuild capacity, but it couldn't guarantee they would earn a profit, even when it was providing a $0.45/gal. subsidy for their customers, who are required by law to use their main product.  However, the economic and environmental benefits of ethanol are too modest to shield this industry while forcing all other corn users to absorb the likely shortfall in corn supply.  The most sensible remedy would be to unshackle ethanol demand, at least temporarily, and waive at least a portion of the ethanol mandate for 2012-13.

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Key Renewable Energy Subsidies About to Expire

The US renewable energy industry faces a greatly altered incentive environment next year, as eligibility for two of its largest current subsidies comes to an end at the close of 2011. The corn ethanol sector will likely see the complete withdrawal of the blenders' credit that has fueled its growth for more than 30 years, while new projects generating electricity from renewable energy sources must shortly attract investment without the Treasury grants that provided up-front cash in place of federal investment tax credits against taxable income--a commodity sometimes in even shorter supply among recipients than the energy they seek to generate. With these expirations taking place against the backdrop of a US presidential election campaign and record levels of deficit and federal debt, the prospects for another round of one-year subsidy extensions look slim. Yet renewable energy development in the US won't grind to a halt without them, because these two programs represent merely the most generous layer of the complex web supporting renewables.

Consider the venerable ethanol tax credit, which was made mostly redundant by the passage of the Energy Independence and Security Act of 2007, with its Renewable Fuels Standard mandating the use of increasing quantities of ethanol in gasoline. In fact, ethanol producers were never more than indirect beneficiaries of the $0.45 per gallon credit, which was paid to refiners and other gasoline blenders in order to help create a market for ethanol. Mission accomplished. Moreover, with US gasoline sales having stalled at a level that can barely absorb all the ethanol that existing US ethanol plants can produce, unless gasoline blends containing more than 10% ethanol become popular, there is simply no need for corn ethanol output to expand further. In fact, the market will be more than sufficiently challenged providing outlets for the limited quantities of cellulosic and other advanced ethanol likely to be produced in the next few years. As I've noted previously, forward-looking members of the industry are now seeking help in expanding the market for high-ethanol blends, rather than perpetuating an outdated support for existing sales.

The situation for renewable electricity sources like wind, solar and geothermal energy is more complicated. The expiring Treasury grants were introduced as part of the 2009 stimulus to stand in for the "tax equity swap" market, a category of financial transactions that froze up during the financial crisis. These swaps provided a private-sector cash-flow bridge between project expenditures and tax credits that only paid off after start-up as income was earned or energy produced. That was particularly helpful for smaller, less profitable developers, but it also provided an additional check on marginal projects. Even after credit markets eased, most developers understandably preferred the cash grants, which reduced their financing costs and avoided the fees that bankers charged on tax equity deals. However, that preference doesn't justify continuing the cash grant program--particularly for the large, profitable corporations that increasing dominate this space. The industry should focus more effort on fostering the revival of a liquid and competitive tax equity market and less on lobbying for an extension of a temporary stimulus measure.

Either way, the tax credits behind these grants and swaps won't last forever. Under current law, the principal federal tax credit for wind will be in place only through 2012, for biomass and geothermal through 2013, and for solar through 2016. Instead of a scenario of perpetual last-minute extensions such as we've seen in the past, the industry and its investors should be thinking about a scenario in which all these tax credits end, either as part of comprehensive tax reform that eliminates most such "tax expenditures"--including the ones for the oil and gas industry that have become so contentious in the last few years--or a transition to providing renewables with similar sorts of incentives as oil and gas, which essentially amount to forms of accelerated depreciation and modest tax breaks for manufacturing in the US, rather than in other countries.

It's also important to realize that even without these tax credits and in the absence of comprehensive federal energy legislation that looks unlikely any time soon, the industry would still retain numerous state-level benefits, starting with the renewable portfolio standards (RPS) for electricity currently in place in 29 states and the District of Columbia, a tally that encompasses most of the states with the best wind and solar resources. These RPS's are similar to the Renewable Fuel Standard for biofuels in requiring utilities to include increasing proportions of renewable energy in their supply portfolios, whether owned or purchased. Such standards, including California's aggressive RPS targeting 33% renewable electricity by 2020, stand outside the polarizing political debate over taxation and government expenditures. They function as an implicit tax on ratepayers, rather than taxpayers, because they show up within customers' utility bills rather than on their 1040 forms. That distinction could be particularly important if the congressional supercommittee fails to reach a consensus, and the default spending cuts built into the Budget Control Act that resolved this summer's debt ceiling crisis kick in.

So while it might appear that the US renewable energy industry is about it be cut loose from the key incentives that enabled it to grow to its present dimensions, it will continue to benefit from supports not enjoyed by other industrial sectors. Even when the current tax credits expire, renewables will have a mandated market providing a floor beneath them. Ethanol output won't revert to 2005 levels, nor will renewables vanish from the landscape, even if their growth slows a bit while the rest of the economy struggles to emerge from the aftermath of the Great Recession and financial crisis, and to avoid a double-dip. Meanwhile, global overcapacity in wind turbine and solar module manufacturing will keep their prices trending lower--and installations stronger--pending industry consolidations that will position both for healthier, more sustainable growth in the long run. All of this falls well short of the level of help for the industry that most renewable energy supporters would like to see, but it's far more than the level playing field (ignoring externalities) that would see cheap and abundant natural gas sweep away all competition for new power generation.

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Industrial Scale Ethanol

After my recent posting on resurgent food vs. fuel competition from expanding corn ethanol production, one of my contacts called to ask if I was familiar with an industrial process developed by Celanese Corporation for producing ethanol from a variety of feedstocks, including natural gas, coal, and potentially cellulosic biomass. My initial reaction to him was based on my knowledge that such processes have been around for decades, and that until the policy-inspired growth of the corn ethanol industry, much of the ethanol for industrial use was produced in that fashion. However, I was unaware of plans to deploy this technology on a truly massive scale, in the form of a pair of 400,000 ton-per-year coal-to-ethanol plants in China. I consider this a really interesting development on several levels.

The attraction of producing ethanol for industrial or fuel use from indigenous non-food raw materials in China seems obvious. It enhances the country's food and energy security by avoiding imports of both. As I delved into the technology involved, I realized it starts with gasification, a process that my former employer, Texaco Inc., licensed to numerous facilities in China, going back to the 1980s. So China has deep experience with gasification as an effective and reliable way to turn feedstocks as diverse as waste oil, petroleum coke, low-value coal, and even natural gas into syngas, or synthesis gas, a mixture of carbon monoxide and hydrogen from which all sorts of useful organic chemicals can be produced. One of those is acetic acid (the acid in vinegar.) It turns out that Celanese's new ethanol process is an offshoot of the company's well-established "acetyl platform" for making acetic acid in plants like this one in Singapore.

It's noteworthy that the first ethanol plants Celanese is building are so large. 400,000 metric tons per year equates to 134 million gallons per year, larger than all but a couple of the corn-based ethanol plants in the US. I've also seen hints that these facilities could be expanded to 1 million tons/yr, which would put their output in the same league as the gasoline yield of the smallest oil refineries. That would be truly industrial scale fuel production that conventional or advanced biofuels can't yet match and may never do, because of their much more complex supply chain considerations. That also explains why Celanese could consider building a 40,000 ton ethanol plant in Texas based on natural gas. The supply chain isn't an issue when it's just an existing pipeline. In any case, large scale and low feedstock cost should result in ethanol output that's more than competitive with ethanol from biomass. US biofuel producers eyeing export markets ought to be concerned about the potential competition from Celanese, even if the federal Renewable Fuels Standard (RFS) guarantees them a market here.

My other instant reaction when I heard about this process focused on the potential environmental consequences of producing ethanol from coal. However, as I thought about it more carefully, it occurred to me that processing coal into ethanol using the extremely clean gasification process, which allows for sulfur and other contaminants to be easily and safely collected and disposed of, is probably a lot more benign than burning the same coal to produce electricity, particularly in power plants without state-of-the-art pollution equipment. Assessing the greenhouse gas impact of coal-to-ethanol requires a thorough lifecycle analysis that I have not yet found.

At the same time, it's clear that the environmental comparison to biofuels like corn-based ethanol isn't nearly as bad as suggested by an erroneous comment in a Business Week article on the subject last November, which stated that corn ethanol production "doesn't use a fossil fuel as a raw material." In fact, analysis by the Argonne National Laboratory of the US Department of Energy found that 78% of the energy in a typical gallon of corn ethanol comes from fossil fuels, including coal, diesel fuel, and natural gas. That's why the emissions from corn ethanol aren't much lower than from gasoline, after factoring in the natural-gas derived fertilizer used in growing the corn, the diesel fuel required for cultivation, harvesting and transportation, and the coal and natural gas used to generate electricity and process heat for the fermentation and distillations steps. Ethanol from coal might emit incrementally more greenhouse gases than food-crop based ethanol, but not orders of magnitude more. And I'd bet that a gas-to-ethanol plant would match or beat the emissions from a standard corn-based biorefinery, based on avoiding the need to separate the alcohol product from water. Distillation requires lots of energy.

It's getting harder to draw meaningful distinctions between conventional fuels and alternatives when we can make ethanol efficiently from fossil fuels and produce "drop-in" fuels--synthetic gasoline, diesel or jet fuel--from biomass like sugar cane or algae. I haven't seen how the detailed economics and energy balance of the Celanese ethanol process compare to traditional and advanced processes for producing ethanol from biomass, but I think we're going to be hearing a lot more about this option in the future. I was surprised to see that it even garnered a mention in the White House press release for the President's visit to China earlier this year.

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What's the Alternative to Oil Sands?

I can recall when technologies like oil sands and coal gasification were commonly referred to as alternative energy, with the same high-tech aura now attached to solar power and advanced biofuels. Much has changed since then, not least our perspective on climate change and the greenhouse gases that contribute to it. It's no longer possible to consider Canada's oil sands production and the means of transporting it without a serious examination of the environmental consequences, both at the source and along its journey to market. However, while I understand that perspective, the reaction to the proposed Keystone XL pipeline seems disconnected from the reality that crucial supplies of Middle Eastern oil suddenly look much riskier than they did. We should certainly weigh the costs and benefits of oil sands carefully, but the missing element from this conversation is the question of what the alternative would be if we ruled out more oil sands imports.

This train of thought began with a sobering analysis of the energy implications of the unrest in the Middle East by Amy Myers Jaffe of the Baker Institute at Rice University in Houston. The challenge she highlights is much subtler than the risk of exports from countries like Libya being disrupted for a few months or even a few years. Existing spare capacity in other producing countries can cope with some of that, although a portion of that capacity is in other countries that could be just another domino or two down the road, while the rest is in Saudi Arabia, which might not be immune, either. Yet if the worst case is the disruption of exports, we have a substantial Strategic Petroleum Reserve to fall back on. Prices might rise significantly, but the prospect of no fuel at your local gas station at any price remains remote for now.

However, as Ms. Jaffe demonstrates, much of the incremental oil production capacity on which forecasters have been relying to meet additional oil demand over the next two decades, and to backstop declining production in non-OPEC countries, must come from the same region that is now in turmoil. And as the charts in her presentation show, revolutions--democratic or otherwise--rarely result in higher oil output. If new governments or chastened existing governments don't invest in developing that extra capacity, then Peak Oil won't just be a theoretical construct in geology; it will be a very real outcome in geopolitics, and one that strategic inventories like the SPR would be unable to mitigate.

We have had a tendency to view Canada as the Saudi Arabia of the north. Considering that we now receive more oil from there than from all the countries of the Persian Gulf combined, and that our NAFTA partner's proved reserves of 178 billion barrels are second only to those of the Kingdom, that's not unreasonable. As recently as 2002, though, Canada's oil reserves were under 6 billion barrels, before the oil sands could be booked as reserves in large quantities. Without its oil sands, Canada would be just another mature oil province with declining conventional output. The question of how rapidly to develop those resources, and whether to export their output outside North America to any significant degree, is currently a hot topic in Canadian politics. The pipeline to transport this oil to Kitimat, British Columbia for export to Asia seems to be subject to a similar debate to the one we're having in this country concerning the Keystone XL line from Alberta to the Gulf Coast. But what if these projects didn't go forward? A world without oil sands might have a little less in the way of greenhouse gas emissions, but it would also have much higher oil prices, and those prices would be more volatile.

So what are the alternatives to these "dirty tar sands", as environmentalists now invariably refer to them? Well, if you're been reading my blog for a while, you know that wind and solar power don't enter into this discussion, because very little electricity is used for transportation and very little oil is used for generating electricity, outside of the developing world and now post-Tohoku Quake Japan. If we don't have access to oil sands imports, then the only other near-to-medium term options for reducing our oil imports from less stable suppliers involve more domestic oil production, more efficient vehicles, and more biofuels production.

Unfortunately the latest Department of Energy forecast incorporating all of those options still leaves us importing nearly 9 million barrels per day of oil in 2025. Without a significant portion of it coming from Canadian oil sands, we will still be forced to rely on imports from places like Venezuela and the Middle East, some of which aren't much more environmentally sound than the oil sands production. And that assumes that all the domestic production in these plans actually materializes. Turning up our noses at both offshore drilling and oil sands is pretty much mutually exclusive. (Or for that matter, shale gas and oil sands, even though these are different forms of energy.)

As for biofuels, we've already got just about as much corn ethanol as we can handle for many reasons, and the more advanced variety has not been especially cooperative in turning up on schedule. Replacing the oil sands capacity that the proposed Keystone XL pipeline could deliver would require more than 23 billion additional gallons per year of ethanol, or 180% of last year's US ethanol output. That figure exceeds the entire 2022 cellulosic and advanced biofuel target under the federal Renewable Fuels Standard. Biofuels are an important part of our energy mix, but the time when they could make oil sands crude unnecessary is still a long way off.

Americans are conflicted. We complain about $4 gasoline, and we're uneasy about another military intervention in the oil patch of the Middle East and North Africa, but then we throw obstacle after obstacle in the path of one of the few options that can provide us with a larger supply of reliable fuel from North America. No matter how sympathetic I am with communities that don't want the new pipeline to pass through or near them, or with concerns about the 17% increase in lifecycle greenhouse gas emissions that oil sands represent, compared to conventional oil, closing our border to additional imports of oil sands crude can only undermine US energy security, at the worst possible time.

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The Missing Food vs. Fuel Circuit Breaker

Corn futures have spiked to their highest price of the year, and, as the Wall St. Journal reported over the weekend, to their highest level since 2008, following news that US corn inventories had declined by 15%, compared to a year earlier. The Journal noted that prices were likely to continue rising until demand starts to moderate. Unfortunately, nearly all of that demand adjustment must come from consumers, exports, and livestock farmers. That's because corn used in ethanol production has grown to rival corn for livestock feed as the largest segment of domestic corn consumption, and it has been rendered essentially price-insensitive by government renewable fuel mandates.

It's a mark of the success of the nation's ethanol industry that it has grown large enough to be an important factor in two of the largest markets in the world: the US energy market and the US market for agricultural commodities. Yet despite supplying more than 13 billion gallons of fuel ethanol for blending into gasoline last year--the energy equivalent of 560,000 bbl/day of petroleum gasoline--ethanol hasn't eliminated oil or even gasoline imports, and its effect on pump prices is hard to detect, when gasoline prices are driven mainly by the price of crude oil, which is flirting with $120/bbl for UK Brent crude, the best current global oil-price indicator. However, ethanol's impact on corn prices, though subject to considerable controversy, is potentially much larger when the annual number of bushels converted into fuel must increase each year, even if the corn crop is lower than the previous year's.

That's driven by two factors. The less important of the two is that at the current price of oil, corn looks like a cheap source of oil-substitute. Even at $7.50/bushel, the corn inputs to ethanol work out to around $112/bbl., and after factoring in the $0.45/gal. tax credit that refiners and other fuel blenders receive for its use, that shrinks to $94/bbl. Compare that to wholesale gasoline at $132/bbl. In other words, even with competition for corn driving up ethanol prices, refiners have an incentive to use as much ethanol as they can, and they are, subject to the 10% blending limit for most of the fuel used by the public. Unfortunately for the ethanol industry, which has continued to expand capacity beyond the point at which they could satisfy 10% of US gasoline demand, that market is now effectively saturated, and price competition among ethanol suppliers has constrained their margins. Even ethanol producers such as Pacific Ethanol that emerged from bankruptcy after restructuring their sizable debts are making little or no profit from their ethanol operations.

The bigger factor driving ethanol demand--and thus corn demand-- is the Renewable Fuel Standard enacted as part of the Energy Independence and Security Act of 2007, a bill that was passed by a Democratic Congress and signed by a Republican President. If nothing else, this should serve as a reminder that however desirable bi-partisanship in energy policy is, its mere presence doesn't guarantee collective wisdom. What the RFS did was to layer on an escalating annual ethanol mandate on top of the existing system of tax credits for ethanol blenders and small ethanol producers. Unless ethanol producers could figure out how to get much more ethanol from the same amount of corn every year, which they have done to only a modest extent, this effectively created an escalating corn mandate for the fuel sector. So even if oil was still at $60 or $70/bbl ethanol demand, and by extension corn demand, would not decline with higher corn prices.

The current US ethanol policy has accumulated more distortions than you can shake a stick at, including the unnecessary layering of mandates and incentives, which also entrenches an unproductively high tariff on imported ethanol from places like Brazil that can produce ethanol with much lower inputs of energy than we can. But as competition for tight corn supplies intensifies due to a variety of factors, the absence of some sort of food-price-based circuit breaker in the relationship between corn and ethanol could turn out to be one of the most damaging distortions for US consumers and for people in other countries that depend on US corn exports. It's worth recalling that although ethanol had consumed just 14% of the previous year's corn crop when Congress passed the RFS, compared to the 40% expected this year, that expansion was an entirely predictable consequence of the legislation. For all the talk about the externalities of fossil fuel markets, this seems like an internality that merits a serious reexamination.

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Obama on Energy: Getting the Balance Right

Another energy crisis, another presidential speech? It must seem that way to many of us who came of age in the first set of energy crises in the 1970s, and the President acknowledged that history in his talk on energy at Georgetown University on Wednesday. Yet although it contained little in the way of new ideas or initiatives, along with a target that was remarkable mainly for the relative ease with which it might be met, it at least presented a perspective that balances the continuing importance of our current energy sources with the potential of our new ones. No more talk of "yesterday's energy."

I was under the weather this week, so this is at least a day later than it should be, but if nothing else was clear from Wednesday's speech it's that our energy challenges have persisted for so long, while our preferred solutions have shifted with the mood of the moment, that a day or a week changes nothing. However, a sense of urgency matters, as gasoline prices rise to levels we haven't seen since 2008. A president can't be seen to be behind the curve on this issue. Except for a few quibbles I'll come back to, Mr. Obama got matters mostly right, reminding his audience that we will remain dependent on oil for a long time, and that increasing domestic oil production and relying on stable neighbors are both crucial strategies for managing our vulnerability to imports from less dependable sources. That puts him squarely in the mainstream of serious American energy thinking for the last four decades.

The President's goal of reducing oil imports by one-third from their level of 11 million barrels per day in 2008 seemed appropriate for several reasons. First, because the basis of that goal is the right one: net imports of crude oil and petroleum products. It would do little for our energy security to reduce crude imports by constraining US refineries and then importing more refined products from abroad. Nor should one ignore the growing US exports of refined products arising from mismatches between US fuel regulations and refinery configurations and yields. More importantly, this is one of the first energy security goals I've seen that we stand a fair chance of achieving. The DOE's preliminary forecast for 2011-35 shows a 17% reduction in oil imports by 2025 in the reference, or base case. Last year's forecast for the high oil price case showed an even steeper reduction, meeting Mr. Obama's goal as early as 2021. Reaching the President's target shouldn't require Herculean efforts, provided we stay focused on the things with the greatest potential to deliver in that timeframe: increased domestic production, efficiency, and possibly next-generation biofuels. That leaves out electric vehicles, which are a longer-term proposition, along with wind, solar and other renewable electricity sources, which only stand to displace oil via EVs. (Remember, a million EVs replace less than 0.2% of our oil consumption.)

The President was right to highlight the potential contribution from biofuels while calling for reform in biofuel subsidies, a task that is long overdue. He cited two examples of how biofuels could help to reduce our oil imports. One related to the military's goal of obtaining half its domestic jet fuel needs from alternatives to petroleum, while the other promoted four "next-generation biorefineries", referring to facilities that produce fuel from non-food biomass. Unfortunately, he didn't mention cost as one of the key trade-offs involved. It's laudable for the military to seek to reduce its vulnerability to oil-supply disruptions, and it can provide a crucial early-adopter base for new technologies. However, to the extent that bio-based jet fuel is more expensive than conventional fuel, then either Air Force operating budgets must include cuts in other areas, such as missions and training, or we will be buying fewer new-gen aircraft to pay for it. And while subsidies can help next-gen biofuels reach commercial scale--I don't consider 20 million gallons per year (1,300 bbl/day) as meeting that definition--they can't guarantee they will be commercial. That will require mastery of one or more of the numerous technology paths now being pursued, more than a few of which have already disappointed. Technological mastery doesn't appear on command.

That's an important consideration, because as desirable as it is to produce large quantities of biofuel without setting up ruinous competition between food and fuel, it seems equally important not to build another industry that will be unprofitable without sustained large government subsidies for decades to come. Helping new technologies through the development stage and across the "commercialization chasm" makes sense, but the level of support now offered for cellulosic biofuel, at $1.01/gal., looks unaffordable once output finally start to take off. As it is, corn-based ethanol will collect roughly $6.3 billion this year from a subsidy less than half that generous, for its displacement of just under 7% of our gasoline consumption on an energy-equivalent basis.

That brings us to the only item in Wednesday's talk that we haven't been hearing about for years: the application of the nation's newly-tapped shale gas bonanza to address the problem of our oil imports. Aside from the jokey references to the expertise of his Secretary of Energy, whose Nobel Prize in Physics was for "development of methods to cool and trap atoms with laser light"--not so relevant to natural gas extraction--this was the speech's money line. Shale gas is the only new technology we have that can deliver huge amounts of energy to compete directly with oil in transportation using off-the-shelf-technology: no breakthroughs required. This would have sounded even more impressive and serious if the punch line had focused on knocking down the barriers to making that happen, including infrastructure requirements and vehicle conversion costs, rather than calling for a bill regulating the production of shale gas.

And unfortunately, that was symptomatic of the things that kept the President's talk from being a landmark in our decades-long battle with energy security. It's one thing to state the problem clearly and lay out the options; it's another to bring it all together in a realistic plan for action. The administration's new "Blueprint for a Secure Energy Future" merely incorporates natural gas into a grab bag of many of the same initiatives it has been pushing since Inauguration Day 2009. Nor does it help when the President repeats his old talking point about the US consuming 25% of the world's oil (it was actually 22% last year) but having only 2% of its oil reserves. Someone needs to pull him aside and explain that current US proved reserves are no more of a limitation on future US oil production than wind power's contribution of just 2% of US power generation last year caps its future potential at that level. Reserves support today's production; resources determine tomorrow's, and the US has many billions of barrels of untapped resources, many of which remain off limits under the administration's policies.

So call it two-thirds of a great speech on energy. Unfortunately, what we desperately need is that missing third that concentrates it into something that the American people--and American industry--can rally behind.

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Food vs. Fuel, Redux

Today's Washington Post includes a noteworthy opinion piece from Tim Searchinger of Princeton University concerning the impact of expanding biofuel production on global food prices and availability. Food vs. fuel competition made headlines in 2007 and 2008 but then subsided during the recession and financial crisis. This year, with global crop yields down and food demand up, and with food-derived biofuel production at record levels, the issue has returned. The relationship between biofuel output and food prices is certainly complex, but it is significant, particularly for those who spend much of their incomes on unprocessed grains and vegetable oils. And both population and biofuels demand will continue to increase from today's levels.

You might recall Mr. Searchinger's name in conjunction with a high-profile scientific paper in 2008 casting doubt on the value of crop-based biofuels in reducing greenhouse gas emissions. "Global land use impact" entered the lexicon of environmental consequences as a result of his and his collaborators' work, and it had a significant influence on the EPA's updated Renewable Fuel Standard (RFS) regulation, even if the agency's final version of the rule softened its application in constraining the least efficient corn ethanol facilities. So you might say that Mr. Searchinger is no great friend of first-generation biofuels in general. However, the issue that he's writing about today, while no less controversial in energy and policy circles, is much more straightforward to understand than the carbon debt of newly cultivated cropland.

As he notes in his op-ed, numerous studies have demonstrated a link between biofuel production and food prices in 2007-8, even in the US, where the basic inputs subject to this kind of price competition constitute a small portion of the retail prices of the processed foods we eat. It affects US food price inflation, but mainly indirectly through routes such as raising the price of livestock feed. Among others, the Congressional Budget Office looked at this issue in 2009. Most of the studies I saw also showed a significant effect on food prices from rising energy prices, another phenomenon that has reappeared in the last year. However one interprets all this, it is inescapable that a bushel of corn turned into ethanol is not available for export to countries that are experiencing a combination of rising demand and disappointing harvests.

As long as US harvests were increasing at a rate that kept pace with the growth of ethanol output, thanks to increased cultivation and better yields, that wasn't a zero sum game. Until recently, the corn that went into making ethanol was corn that might not otherwise have been grown. But in a year like this one, when annual ethanol consumption is set to rise by another billion gallons while the corn harvest is 5% smaller than the previous year's, something has to give. In fact, the US Department of Agriculture expects that ethanol plants will take 40% of this season's crop, compared to just 23% in the 2007-8 "market year." That exerts a lot more pressure on corn prices, which are pushing $7 per bushel for the first time since 2008.

If anything, the conclusion of Mr. Searchinger's op-ed downplayed the risks ahead. With output from the nascent cellulosic ethanol industry still minuscule, the EPA will be under tremendous pressure to allow corn ethanol to continue to expand beyond its current 15 billion gallon per year limit under the RFS. That's one reason the industry was pushing so hard to increase the maximum allowable percentage of ethanol in gasoline from 10% to 15%; it needs that headroom to continue expanding output beyond last year's 13 billion gallons. At 20 billion gallons per year--a quantity that I heard one USDA expert suggest several years ago was achievable--ethanol would require the equivalent of 55% of 2009-10's record US corn crop. It's hard to envision that happening without concerns about food vs. fuel rising to a much higher pitch.

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Renewable Energy and Egyptian Unrest

It's hard to watch the current turmoil in Egypt and not wonder what it means for us, particularly with regard to energy. Although Egypt's oil production roughly balances its consumption, the Suez Canal and the Sumed pipeline, with its Mediterranean terminus west of Alexandria, represent important transit routes for Eastern Hemisphere oil going to Europe--though not as important as in the past. And while some politicians have already cited this situation as a "wake-up call" and indication of our energy insecurity, the risk of a serious supply disruption appears low, unless the protests spread to the major oil producing countries of the Middle East. Yet even short of that extreme, renewable energy stands to benefit from the uncertainty these events create, as reflected in higher crude oil prices.

I don't claim any unique perspective on the events in Egypt or their likely outcome, although some of the scenarios I can envision are extremely worrying. I've read heaps of articles and op-eds on the subject and listened to a media conference call from the Council on Foreign Relations, but if there's a consensus view I haven't found it yet. What I do see, however, is that since the protests started on January 25, and without any actual disruption in oil deliveries, the price of UK Brent crude--currently a better indicator of global oil prices than West Texas Intermediate--has climbed by around $5 per barrel and now trades solidly above $100. And while that might reflect other factors in addition to an Egypt risk premium, currency exchange rates don't seem to be one of them.

If the present instability persists or spreads, oil prices are likely to go even higher. Renewables such as ethanol and other biofuels could benefit from that in a way that they haven't from the general increase in oil prices since the middle of last year. That trend was mainly attributable to resurgent global economic growth, particularly from developing Asia. China's GDP grew by more than 10% last year. Along the way, the prices of renewable energy products that compete directly with oil went up, but so did the cost of inputs such as grains and oilseeds, as part of a general surge in global commodity prices. As a result the "crush spread", the margin for turning corn into ethanol, has contracted since mid-2010 and currently stands at essentially zero on the basis of prompt ethanol and corn futures. Biodiesel margins should have experienced something similar, if soybean oil prices are any indication. These products stand to gain if oil prices are driven up by factors that don't also push up the prices of the commodities from which they're made.

Of course that's not the only possible outcome. This week's Economist even notes the potential for a scenario yielding the opposite result. They see other Middle Eastern countries stockpiling grain to avert protests of the kind that have spread from Tunisia to Algeria, Egypt, Jordan and Yemen, and driving up its cost in the process. However, that element of the scenario is more credible than the accompanying suggestion that the region's oil producers might boost production to pay for that extra grain, thereby sinking oil prices. At current levels, the region's oil exporters are already earning on the order of $1.5 billion a day, and even a small producer like Oman should be taking in around $20 billion a year. Even at $9 per bushel the entire 2009/10 wheat imports of Lebanon, Iraq, Iran, Israel, Jordan, Kuwait, Saudi Arabia, the UAE and Yemen barely top $6 billion.

It's worth recalling that if the recent rise in oil prices is reminiscent of 2007 and 2008, OPEC has far more spare capacity in reserve this time. It has done a remarkable job of avoiding the temptation to pump more to gain market share. Even with some cheating around the quotas, they've kept the market tight. If OPEC changes that policy, it seems likelier they'd do so to avoid stalling the global recovery than to cover some additional grain imports for which they already have ample cash on hand. Stay tuned.

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The Regulatory-Ethanol Complex

The US Environmental Protection Agency has a problem, and that problem is ethanol. Last Friday the EPA expanded its previous waiver on ethanol in gasoline to allow blends of up to 15% to be used in cars built in model year 2001 and later, compared to the earlier threshold of model year 2007. Because it did this just three months after granting the initial waiver, it's not clear how much additional testing was actually done, despite the agency's obligatory reference to "sound science". This step is a further indication that EPA is presiding over a failed biofuel mandate created by Congress in the expectation that a massive cellulosic biofuel industry would spring forth at their command, in parallel with a massive upsurge in sales of the 85% ethanol/15% gasoline blend, E85. None of that has happened, and for now the corn ethanol industry is the only horse that EPA has left to ride in this race. Until these waivers were issued, that horse was rapidly running out of track on which to run.

It's not that EPA loves corn ethanol. In fact, the first draft of its RFS2 renewable fuel standard incorporated an emissions-measurement basis that was distinctly unfavorable to older conventional ethanol facilities. That was subsequently toned down, after reinterpreting the science relating to "indirect land use impacts". Unfortunately for EPA, however, corn ethanol is the only avenue for continuing to comply with the annually escalating biofuel mandate set in the Energy Independence and Security Act of 2007, unless they want to flood the US with Brazilian cane ethanol. Oilseed-based biodiesel remains a niche product, and the US biodiesel industry is half-dead after the EU imposed anti-dumping tariffs as punishment for biodiesel exports to Europe that were subsidized by a $1.00 per gallon US biodiesel tax credit--a credit that lapsed at the end of 2009 but was reinstated retroactively as part of the Lame Duck Congress's tax deal.

The central problem relates to the so-called blend wall, the annual quantity of ethanol that can be accommodated in gasoline under the previous 10% blending limit. With US gasoline sales having dropped in 2008, rather than continuing on their path of 1-2% annual increases, and still not recovered to their former level, the entire US gasoline pool can only absorb 13.9 billion gallons per year of ethanol. As a practical matter, the blend wall is probably a billion gallons lower than that, given the challenges of getting ethanol to the remotest corners of the country. By coincidence, the RFS target for 2011 after backing out the renewable diesel requirement is roughly 13 billion gallons. The production capacity of the US corn ethanol industry already stands at 14 billion gallons per year, with more ethanol plants under construction or expansion.

Accommodating all that extra ethanol would have been easy if E85 had taken off as planned. However, if Minnesota's E85 statistics are any indication, E85 sales appear to have declined since 2008. In the absence of E85 demand, the EPA's waivers have the effect of moving the blend wall and giving the ethanol industry more headroom to grow. In theory, this would also have been needed to make room for cellulosic ethanol, but so little of that is being produced that EPA has had to scale back its quota for that category two years in a row, with a further adjustment in 2012 a virtual certainty.

Expanding the waiver to cover earlier car model years was crucial to making it useful. The first round didn't encompass enough cars--and thus enough annual fuel volume-to make it likely that refiners, distributors and retailers would incur the cost and risks of introducing it into the market. Going back to 2001 adds roughly another 90 million cars and light trucks and includes some of the highest car-sales years in US history. As a result, the broader waiver now probably covers about half of the 240 million light-duty vehicles on the road in the US.

The consequence for consumers will be higher taxes, in several forms. First, there's the tax associated with paying for fuel that has less value, due to ethanol's lower energy content, yet carries the same pump price. At current gasoline prices a gallon of E15 is worth about 5.5 ¢ less than the E10 blend most of us are buying today. Then there's the indirect tax associated with the higher maintenance and repair expenses that some motorists are likely to experience. Despite the EPA's reassurances about having tested E15, the focus of their testing was explicitly on emissions, not on performance and longevity. And finally there's the tax or debt we'll incur for the ethanol blenders credit that will be paid out on the incremental ethanol volumes facilitated by the waiver. That could eventually amount to an extra $3.2 billion per year, unless the current Congress finally ends this redundant subsidy that has been in place for more than thirty years.

Although it is probably best viewed as a marriage of convenience, for now the EPA and the corn ethanol industry are joined at the hip, forming a sort of regulatory-industrial complex. For political reasons EPA can't afford to abandon its partner, because the administration is fully committed to the RFS2 biofuel targets as part of its broader approach to energy security and emissions--even though corn ethanol does little or nothing to reduce the latter. Until and unless E85 takes off, the only real alternative to the E15 waivers would be to admit that the 2007 biofuel standards were unrealistically ambitious and must be suspended pending the arrival of so-called drop-in fuels--synthetic hydrocarbons derived from biomass sources such as algae, cellulose or sugar cane. Drop-ins could provide the same renewables energy benefits as ethanol, but without the latter's blending, fuel economy and logistical disadvantages. In the meantime, I will not knowingly fuel either of my family's 2004 model cars with E15, as long as I have a choice.

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Corn Nation

Driving across Ohio, Indiana, Illinois and Wisconsin, it's impossible not to be struck by the dominance of corn cultivation in this part of the Midwest. Those "amber waves of grain" in the song look more like amber waves of corn tassels, here. My family makes this drive every few years, and my unscientific impression is that we see more and larger corn fields every time. Given my focus on energy, I couldn't resist spending a few minutes using the hotel Wi-Fi to check on my hunch that most of this has been driven by the explosion of ethanol production in the last decade--up an average of 22% per year since 2000.

Based on data from the USDA, corn production has grown substantially in the last decade, though by a much smaller annual percentage than ethanol output, and with the peaks and valleys you'd expect for a crop affected by the variability of the weather. The total acres planted in corn have risen, though at an even slower rate, so that steady yield improvements have contributed as much as acreage to the growing corn supply. It might seem like an exaggeration to suggest that ethanol is the main factor behind all this growth, yet when you examine the trends in corn disposition, it would be hard to avoid that conclusion, as the chart below shows.




Since 2000, ethanol has gone from consuming about 10% of the annual corn crop to taking just over a third of a much larger crop. Over that same interval, the other main corn demand sectors have remained relatively constant. The modest drop in corn used for livestock feed probably correlates with the increased output of distillers dried grains byproduct from ethanol plants. For all the controversy about high-fructose corn syrup in our food and beverages, the quantity of corn involved in sweeteners hasn't changed much since the mid-'90s, and the US exports roughly as much corn annually today as it did before the current ethanol boom began. So it really does seem to come down to ethanol, and that has important implications for farmers and ethanol producers, because the practical limits of the expansion of corn ethanol are now in sight.

Corn ethanol output has doubled three times in the last decade, but it is most unlikely to double again. Even if the industry can convince the EPA to forestall the looming "blend wall" by raising the proportion of ethanol allowed in gasoline, ethanol's favored status under the federal Renewable Fuels Standard ends at 15 billion gallons per year of output, beyond which it will find it very hard to compete with biofuels from other mandated sources, including sugar cane and--whenever it becomes commercial--cellulosic ethanol. The impending debate over the extension of the current ethanol incentives signals big changes in the trends that have provided such a boost for US agriculture.

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Energy Lessons from Brazil

I was surprised by a headline I saw this morning: "Brazilians Call for Cut to 20% Ethanol Import Tax." At first I thought this referred to the US duty and tariff on ethanol imports, the repeal of which Brazil's President Lula has suggested to his US counterpart on more than one occasion. Instead, it seems that Brazil has had an ethanol import tariff of its own all along--who knew?--and today's call from Brazilian sugar trade association Unica stems from the recent weather-related shortfall in cane production that reduced ethanol inventories in Brazil and led to the government's temporary cut in the required ethanol content of gasoline from 25% to 20%. This situation illustrates a couple of energy lessons that don't quite square with the usual, overly-simplistic interpretation of Brazil's success at displacing oil with biofuel.

Brazil deserves recognition for its consistent approach to supporting the expansion of ethanol production from its normally-abundant sugar cane crop. The country has benefited from its government's deliberate efforts to promote the use of domestically-produced ethanol in a car fleet that increasingly consists of "flexible fuel vehicles" capable of running on widely-varying proportions of ethanol and gasoline. With an ethanol surplus and climate and geography well-suited to producing more--and much more efficiently than from corn and the other principal ethanol crops in northern latitudes--it's no surprise that Brazilians now consume more ethanol than petroleum gasoline. Yet as we see in today's news, Brazil's extraordinary reliance on biofuel creates a different kind of energy-security vulnerability, one related to crop yields rather than geopolitics. While Brazil's dual-fuel capability gives it ample flexibility to prevent a 5% drop in ethanol production for a few months from causing a crisis, just imagine the economic consequences of a comparable drop in oil production from the Middle East. Anyone advocating a complete switch to biofuels ought to ponder the potential unintended consequences carefully.

Another lesson hiding behind these ethanol statistics is that contrary to popular opinion, Brazil hasn't become energy independent because of its ethanol policies, though these have certainly helped. Rather, it is chiefly the surging output of Brazil's oil fields, which nearly doubled to 2.6 million barrels per day in the last 10 years and is not done growing, that has made Brazil self-sufficient in fuels. To put that in perspective, Brazil's oil platforms produce the energy-equivalent of 72 billion gallons of ethanol per year, or ten times its cane ethanol output. Although this was only possible because of the discovery of world-class resources off the country's coast, their development depended on consistent policies providing attractive access for the international firms that partnered with the state oil company, Petrobras, in exploring them. I wish more people in Washington, DC paid attention to the crucial contribution of offshore drilling to Brazil's appealing energy story.

As for the import tariff, I confess amusement at the inconsistency inherent in Brazilian politicians and business leaders criticizing a US tariff that exists mainly to prevent a US ethanol blending subsidy from leaking abroad, when they have their own tariff protection in place. I'd be happy to see both of these tariffs reduced or dropped entirely, but only if we finally ended our three decades of generous taxpayer support for ethanol blending. It's bad enough to subsidize domestic ethanol production from corn, but subsidizing Brazilian sugar companies to produce ethanol in their country would be a travesty, yet that's exactly what we'd do if we eliminated the tariffs without eliminating the Volumetric Excise Tax Credit, too.

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The Climate-Industrial Complex

An emailed link I received the other day led to a fascinating article featuring a truly eyebrow-raising statistic. According to the Center for Public Integrity the number of companies and groups now lobbying the US Congress on the subject of climate change has passed the 1,000 mark with room to spare, standing at 1,150 as of the second quarter of 2009. Now, in one sense that figure shouldn't surprise anyone; the pending legislation on greenhouse gas emissions would affect nearly everyone in America, directly or indirectly, and it would be remarkable if numerous firms and organizations didn't want to help shape the rules that will govern our future emissions. But let's not kid ourselves. There's more than altruism behind such activity, and the last few Congresses have encouraged it with an approach that turns important legislation such as this into a potential bonanza for favored sectors and groups. In addition to its primary economy-revamping aspects, the climate bill puts hundreds of billions of dollars in tax credits, subsidies, and direct research, development and deployment investment up for grabs, while levying massive sums to pay for it all. Deft lobbying could yield huge rewards or savings.

Browsing through the search function on the Center for Public Integrity climate change site turned up a fascinating array of companies and groups lobbying the Congress on this issue. Traditional energy firms are well represented, including both resource/refining companies and a large number of electricity suppliers and their trade associations. In a sign of the growing strength of the renewable energy sector the list includes not just the expected alphabet soup of "trades" such as AWEA, ACORE, RFA, and SEIA, but also individual biofuel, wind, solar, fuel cell, and synthetic fuels companies. If this fight drags out, or the SEC follows through on threats to force companies to disclose their potential climate change liabilities, the list of participants seems likely to grow even longer.

Nor is it just industrial concerns seeking to protect their interests or capture a piece of the new pie; organizations ranging from AARP to the Water Research Foundation and including, of all things, the National Turfgrass Federation want to be heard on this issue. Then we have agricultural interests, who as the article describes achieved a very valuable save for the ethanol industry in the House at the climax of the Waxman-Markey negotiations. If you're interested in seeing who else is represented and how much they've put into this fight, I encourage you to browse this useful database and its pre-set reports.

I don't blame companies for chasing the plums that Congress is offering. There's too much at stake for many to eschew that pursuit on principle. I do wonder, however, whether this could possibly be the best way to embark on what looks like the most important change in our economy in the last several decades. The outcome now rests with the US Senate. If it is willing to challenge the House over a distorted system for allocating free emission allowances, and the agricultural lobby on requiring corn ethanol to demonstrate that it actually improves global greenhouse gas emissions, compared to petroleum-derived fuels, while rationalizing a plethora of marginally-related provisions, then we might get a climate bill that puts a price on emissions without contorting the economy more than the minimum amount necessary to achieve that end. Otherwise, we will end up with legislation that will tell us more about which sectors and groups wielded the most influence in Washington, DC this year than about how best to cut emissions.

Note: Energy Outlook will be on vacation for the next week or so. New postings should resume on 7/21/09.

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Food vs. Fuel and Ethanol Bankruptcies

A couple of weeks ago an editorial in the Wall St. Journal called attention to a study by the Congressional Budget Office entitled, "The Impact of Ethanol Use on Food Prices and Greenhouse Gas Emissions." I finally found time to read the report and was surprised that, in addition to its main topic, it provides a useful analysis of the economics of ethanol manufacturing. Application of the CBO's rule of thumb correlating ethanol profitability to gasoline and corn prices goes a long way toward explaining the dismal current state of the industry, which has experienced a long string of bankruptcies in the last year--enough to warrant an entire conference devoted to that topic. The underlying dynamic in the ethanol sector turns out to be quite similar to one that has taught the oil refining industry some painful lessons in the last couple of decades. Potential investors in ethanol plants, conventional or even cellulosic, would do well to consider this relationship.

The CBO study's headline findings merit more attention than they have received in the media, considering the intensity of the food vs. fuel controversy this time last year. We truly have the attention spans of ferrets, these days. The CBO examined the effect of rapidly rising ethanol production on the supply and demand for corn in all its uses, along with the relationship between corn prices and broader food prices, and the impact of energy prices on both. They concluded that between April 2007 and April 2008, ethanol accounted for 10-15% of the increase in food prices in that period. Even considering only the resulting increase in the cost of federal food assistance programs, that added an extra $600-900 million to the roughly $4.6 billion in direct ethanol blending subsidies paid out by the federal government last year. The Journal estimated the additional cost to consumers at between $5.5 and $8.8 billion. If you add those figures together and divide by the 9 billion gallons of ethanol produced in US distilleries in 2008, the hidden cost of every gallon of ethanol that comes out of a gasoline dispenser averages around $1.40.

Even more remarkably, despite this sizable "externality" and the truly extraordinary five-year growth run of the industry, ethanol processing appears to be a miserable, wealth-destroying business for its owners. The CBO report explains this in a text box starting on page 4, which concludes that unless the retail price of gasoline exceeds 90% of the price of corn before factoring in ethanol subsidies, or 70% after subsidies, an ethanol plant cannot cover its fixed and variable costs and turn a profit. The box includes a chart showing the precipitous decline of that ratio since 2005, from a high above 1.0 to below 0.6. When I calculated the current ratio based on this week's average retail gasoline price and yesterday's Chicago Board of Trade prompt corn contract, I came up with a figure of 0.65. That's still below breakeven, despite the recent spike in gasoline prices.

While I've never looked at it quite this way before, the CBO's rule of thumb makes perfect sense as an example of how capacity investments tend to destroy the margins that justified those investments. It's much the same as when an oil refiner sees high prices for gasoline and low prices for residual fuel and decides to invest in a new coking unit to convert the latter into the former. When the unit starts up, it increases the supply of gasoline and raises the demand for feedstock, squeezing its own operating margin from both ends--along with the margins of everyone else in the industry. In the case of the dozen or so ethanol companies that have gone into Chapter 11 or de-facto Chapter 7 lately, we must conclude that a lot of their expected profits never materialized, either, for a similar reason. All those new ethanol plants increased the supply of "gasoline" while simultaneously increasing the demand for their feedstock, corn.

US corn ethanol output is still expected to expand by another 50% or so before it bumps into the artificial ceiling the Congress and the EPA set for it in the revised Renewable Fuel Standard. Yet this is an industry that has raised food prices, destroyed billions of dollars in shareholder value, and according to the CBO reduced US greenhouse gas emissions by only about 0.2%, even if we ignore offsetting global land-use changes. The best thing that can be said for it is that it displaces around 420,000 barrels per day of mostly imported petroleum-based gasoline. That's hardly trivial, but I leave it to you to assess whether it has been worth the cost.

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The Drilling vs. Alternatives Contradiction

F. Scott Fitzgerald once said, "The test of a first-rate intelligence is the ability to hold two opposed ideas in the mind at the same time, and still retain the ability to function." By that measure, the present debate over energy policy in the Congress looks truly impressive, incorporating a number of such "opposed ideas." A prime example is the arguments against expanded domestic oil and gas drilling, many of which look equally applicable to increasing our production of ethanol from grain. In particular, if expanded drilling can be dismissed as not worth the effort or associated trade-offs, based on a curiously-low DOE projection of future production from US oil resources currently off-limits to drilling, then the US grain ethanol program should be subject to the same criterion. However, in the absence of any single, all-encompassing solution to our energy problems, can we afford to reject any of these options, or worse yet, to pit them against each other as though they were somehow mutually exclusive? We need fewer such contradictions, if we are to make real progress in reducing our geostrategic and financial exposure to oil imports.

Start with the energy contribution of that off-limits oil. I find it extraordinary that the DOE's estimate of 200,000 barrels per day from this resource has been so widely accepted without question--mainly by those, the extent of whose expertise concerning oil generally begins and ends with the business end of a gasoline dispenser. But set aside for a moment the apparent disconnect with the government's own estimate of 18 billion barrels of oil resource in the off-limits portions of the US offshore, a quantity a dozen times larger than the DOE's forecasted cumulative yield from these resources over 20 years. Let's stipulate that paltry-sounding 200,000 bbl/day and convert it into BTUs. It works out to roughly 0.4 quadrillion BTUs/year (quads), or 0.4% of our annual energy consumption, coincidentally about the same quantity of energy we currently get from wind power, based on the natural gas it displaces. Now translate that energy content into its equivalent in ethanol, and you get a figure of 5.2 billion gallons per year, equal to the entire increase in ethanol output mandated between 2007 and 2010--a mandate that was just upheld by the EPA against an appeal from the Governor of Texas. But if it is not worth increasing domestic oil production by the equivalent of 5 billion gallons per year of ethanol, creating US employment and providing the federal government with significant royalty and tax revenues, while displacing $8 billion per year in energy imports at current prices, then what possible rationale can there be for mandating and subsidizing an increase in our ethanol output by a like amount and risking its uncertain impact on the price of grains and other foods?

But wait, you say, ethanol is renewable and good for the environment, while oil is a depleting resource and bad for the environment. The grain of truth in this argument is more than offset by the significant environmental costs associated with corn ethanol production, including high water consumption, fertilizer runoff that contributes to a growing Dead Zone in the Gulf Coast, and greenhouse gas emissions that may actually exceed those of oil, when the global impact on land use for agriculture is considered. Nor is the depletion argument very compelling. After all, it's not as though the opponents of drilling intend to save our untapped offshore oil for future generations, who they probably hope will be even more averse to drilling, and who may lack a domestic oil industry capable of undertaking such a project, in any case.

Long-time readers of this blog know that I am not exactly enamored with our current policy towards biofuels produced from foodstuffs, and particularly with the manner in which subsidies for them are handed out. Ethanol is no panacea, and it consumes vast quantities of natural gas, pushing up the latter's imports and price in the process, but at least it displaces much more oil than it consumes and makes a useful contribution to reducing our oil imports. The severity of this energy crisis requires that we pursue every such source we can, including new supplies of conventional and alternative energy, along with the savings from improved efficiency. If it is necessary to hold our noses to the extent of accepting that we need conventional ethanol in our energy mix, at least for now, and that we must have tens of thousands of wind turbines--which some consider a blot on the landscape--then the same logic ought to apply to exploiting the domestic oil resources to which we have restricted access for reasons that have been superseded by events. Loving renewables and hating domestic oil is a contradiction that only benefits OPEC and America's economic competitors.

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