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Robert Rapier

Robert Rapier

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Is The U.S. Ethanol Industry Under Siege?

Following the 2016 presidential election, I explained Why The Ethanol Industry Should Fear President Trump. Since that time, the ethanol industry has indeed been on the defensive. In fact, I recently characterized the industry as being under siege.

At issue is a requirement that ethanol is blended into the gasoline supply. The requirement has been in place since the Energy Policy Act of 2005 created the Renewable Fuel Standard (RFS).

Opposing Camps

Ethanol producers and corn farmers love the RFS because it gives them a mandated market for their product. Refiners hate the RFS because they are being forced to sell a competing product and because compliance with the policy costs them billions of dollars each year. (For more details of how the RFS is managed, and why refiners hate it so much in U.S. Ethanol Policy Set For Big Change).

EPA Administrator Scott Pruitt had opposed the program as Oklahoma’s Attorney General, so it was no surprise when he began to take steps to weaken the program. On the other side of the issue is Iowa Senator Chuck Grassley, who is perhaps the staunchest ethanol defender in Congress.

Last week Senator Grassley penned an editorial arguing the merits of the program. It’s similar to the competing press releases I get each week arguing the pros and cons of the RFS. They often contain misleading arguments, as Senator Grassley’s editorial does. I want to break down some of those arguments from his column.

An Honest Discussion?

Senator Grassley, who has consistently refused to entertain any changes to the RFS writes:

“An honest discussion about this program is long overdue. In order to do that, it’s necessary to understand where the RFS began, how it evolved and the role it plays in ensuring American prosperity and security.”

He then reviewed some of the history of the program, noting refiners use certain octane enhancers to meet octane requirements. Methyl tert-butyl ether (MTBE) was once commonly used to raise octane levels, especially after Congress passed the Clean Air Act Amendments of 1990. This act required the use of oxygenated gasoline in areas with high levels of air pollution, and MTBE helped meet the oxygenate requirement.

Then, Senator Grassley told a half-truth:

“However, when MTBE was exposed as a public health risk, its use sharply declined, leaving refiners searching for an alternative. That alternative was ethanol. In 2005, Congress passed the Energy Policy Act, which removed the oxygenate requirement for reformulated gasoline. It also instituted the RFS. Refiners eliminated MTBE from blending operations and switched entirely to ethanol.” Related: The Myth Of An Imminent Energy Transition

The reason that’s a half-truth is that refiners can meet all gasoline requirements without ethanol. I know this because in the past I blended gasoline in a refinery that produced high octane gasoline without using MTBE or ethanol. There are ways to achieve this, although in some cases ethanol could be the preferred option for boosting octane.

Ethanol Is Certainly Still Subsidized

That’s not a huge misstatement, but it begins a series of misleading comments:

“Some continue to believe there is a federal subsidy for ethanol, but that hasn’t been the case. The tax credit expired in 2011. Notably, the oil industry has yet to give up any of its specific tax incentives.”

This is misleading for what it omits. While the federal ethanol subsidy was allowed to expire (after a huge fight to preserve it from the ethanol industry), there is still a subsidy in place via the renewable identification numbers (“RINs”) that are assigned to biofuels as they pass through the supply chain.

Compliance with the RFS by “obligated parties” like refiners must be met by purchasing the fuel with the associated RIN or by purchasing the RINs (which can be separated from the associated biofuel). This means that the RFS artificially created a value for RINs that offsets some of the production cost for the biofuel producer.

Redirected Farm Income

Refiners spend billions of dollars to comply with the RFS. These compliance costs help subsidize the ethanol industry at the expense of refiners, and they help to artificially increase the price of fuel at the pump. Make no mistake — this is a direct transfer of wealth from refiners and gasoline consumers to the ethanol industry.

Ironically, last week I received a press release that cited a senior official with a biofuel industry group: “Farm-state lawmakers are furious that Administrator Pruitt has unilaterally undercut demand for biofuels with his secretive waivers, redirecting farm income to a few oil companies during the worst agricultural crisis since the 1980s.”

The irony is that these lawmakers are upset that farm-state income that was redirected to farm states in the first place is at risk of being redirected back to where it originated.

But then Senator Grassley veered onto thin ice with his claims about ethanol reducing dependence on foreign oil:

“The addition of ethanol into the U.S. fuel supply and advances in shale production, which I also support, allowed for increased domestic energy production. In turn, imports of foreign oil have dropped significantly – a staggering 40 percent since the RFS was implemented.

In fact, the U.S. Energy Information Administration noted in an independent analysis that in 2017, net U.S. imports of “petroleum from foreign countries were equal to about 19 percent of U.S. petroleum consumption,” which was the lowest percentage since 1967.”

Senator Grassley purposely blurs the lines here by implying that ethanol played a major role in that 40% drop in foreign oil. But let’s look at the facts.

According to the Renewable Fuels Association, ethanol production in 2005 was 3.9 billion gallons. By 2017, that level had reached 15.8 billion gallons. So over that timeframe, ethanol production increased by 11.9 billion gallons. That is a daily production rate increase of 776,256 barrels of ethanol.

However, one barrel of ethanol does not displace one barrel of oil. Ethanol has an energy content of 76,100 British thermal units (BTU) per gallon. Oil, which is used to produce gasoline, diesel, jet fuel, etc., has an energy content on average of about 138,000 BTU/gallon. However, the equivalent of about 10% of that barrel is consumed in converting the oil into finished products, so we can assume a net finished product energy content of around 124,000 BTU/gallon for oil.

Therefore, a barrel of finished ethanol will displace around (76,100/124,000) = 61% of a barrel of oil (ignoring the oil inputs required to produce that barrel of ethanol). That reduces the equivalent daily production rate increase from 776,256 barrels of ethanol to 473,516 barrels of oil equivalent. In other words, that’s how much oil that ethanol could have displaced over that time frame (again, ignoring oil inputs into the farming of corn and production and distribution of ethanol).

Over the same timeframe, U.S. oil production increased from 5.2 million BPD to 9.4 million BPD — nearly ten times the increase in ethanol production. Natural gas liquids (NGLs) production, some of which end up being processed into gasoline, increased by more than 600,000 BPD over the same timeframe. Related: Kenya Says It’s Ready For 70,000 Barrels Of Pilot Oil Exports

So, while it can be argued that ethanol made some contribution to the decrease in foreign oil dependence, the truth is that the overwhelming majority of the reason for the decrease was the increase in U.S. crude oil and natural gas production.

Further, unlike the gains in ethanol, the gains in U.S. crude oil and NGL production were not enabled by laws requiring the consumption of these products. Nor do consumers pay direct subsidies to these products akin to the RIN system in place for the ethanol industry. Oil companies do receive various tax breaks against taxes they owe, but then so do ethanol companies. That’s a topic for a different column.

A Free Market?

Senator Grassley winds down his editorial with:

“As a free-market conservative, I believe that competition spurs innovation, encourages dialogue and ultimately delivers the best quality products to consumers. That’s one of the many reasons I believe so strongly in ethanol as part of an all-of-the-above energy strategy.”

I agree with that, but that’s not the case with our ethanol policy. This isn’t a free market. Mandating a product and then forcing consumers to subsidize it is the opposite of a free market.

There is a natural market for ethanol for refiners to meet their octane requirements, but it is likely far lower than current ethanol consumption levels. That’s a problem for farm-state “free-market conservatives” like Senator Grassley who only believe in the free market to the extent that it doesn’t decrease demand for ethanol.

By Robert Rapier

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  • E.R. Schwegman on May 21 2018 said:
    The "free market" is not all knowing and all loving. I'm not saying this is what Grassley is aiming at by any means, but to say the free market is always correct, even if it kills us in the process, is a great argument for policy that intervenes with that free market.
  • CapitalistRoader on May 22 2018 said:
    E.R., you are correct of course but isn't your argument 'reductio ad absurdum'? That is, one could easily correctly write:

    'The "government" is not all knowing and all loving. To say the government is always correct, even if it kills us in the process, is a great argument for laws that intervene with government.'

    And considering that governments killed orders of magnitude more people than free markets last century, isn't that an argument for less government and more free markets?
  • Bill on May 22 2018 said:
    "In fact, I recently characterized the industry as being under siege."

    "Ethanol producers and corn farmers love the RFS because it gives them a mandated market for their product."

    The author seems incapable of distinguishing between two basic concepts - one, removing mandates and subsidies propping up an unnecessarily large (and possibly destructive, as it raises food prices for the poor) amount of production of a particular product (freeing the market), vs the other, an actual assault against a specific industry (i.e. regulations taxing or otherwise suppressing it or preventing them from being profitable). It is sad that modern "jornalists" are allowed absent the basic facility of reason.

    The removal of mandates is not an "assault on an industry," it is a "tax cut for the poor." There will still be plenty of ethanol if we remove the requirement to add it to gasoline. And, as fuel sources both will be obsolete within 20 years due to advancing technology anyway - so such restrictions only raise prices and hurt the poor.

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