ethanol subsidies

The headline in a recent issue of Ethanol Producer Magazine says it all:  "Colo. ethanol plant scores sugar feedstock for 6 cents per pound," as though the purchaser, Front Range Energy LLC, had just won the lottery.  While sugar is a regular feedstock at Brazilian ethanol plants, the US isn't exactly known as the world's most efficient location for sugar production.  The interlocking government interventions that made this simple headline possible are part of a fine ballet of ag support and protection policies -- though hardly a tribute to the market-based system that supposedly governs the US economy.  Here are the main components:

1)  Restrict sugar imports to prevent low-priced foreign sugar from competing with domestic sugar farmers 

This is a baseline of US ag policy:  we have apparently restricted sugar imports in one way or another since 1789.  Foreign refined sugar prices have been half or less of those in the US for the recent period, with the quotas costing US consumers more than $3 billon per year in extra charges.

2)  Guarantee domestic sugar prices at high levels; put taxpayers on the hook to pay off producers if prices fall

This is nicely accomplished through the Commodity Credit Corporation (CCC), a federal body that is part of the US Department of Agriculture.  As its name implies, CCC extends credit to farmers, generally using their crop as collateral.  Unfortunately for the taxpayer, the same factors that often cause defaults to the CCC (primarily falling crop prices) also mean that the value of the taxpayer collateral is equally depressed and the taxpayer ends up eating the loss.

3)  Mandate that the feds take over the sugar, and then force them to sell into the biofuels market 

The ironically titled "Feedstock Flexibility Program" or FFP (7 USC 8110) restricts rather than enhances flexibility for the government creditor to recover as much of its capital as possible in the event of a default.  Defaults (or expected defaults) on sugar-backed loans from CCC trigger a mandated purchase of the surplus sugar stock by the federal corporation -- which is then required to sell the crop into biofuel markets. 

The ag economists among you are probably wondering whether selling food-grade material into fuel markets rather than as regular sugar would result in a much lower valuation of the collateral.  Well yes, yes it would.  But the whole point is to reduce the supply of sugar not only from abroad (accomplished by the import restrictions), but domestically as well.  It's not about selling the collateral for as much as you can get.  By diverting the sugar into markets that don't directly compete with food-grade sugar, prices in the food-grade segment can be further propped up.  In addition to helping US producers of sugar from cane and sugar beets, high prices help to keep corn syrup competitive as well.  Ag policies that help corn tend to have bipartisan, long-lasting political support.

The statute (section b(1)(A)) seems to require that the sales to biofuel producers not lose money for the government [emphasis added]:

For each of the 2008 through 2013 crops, the Secretary shall purchase eligible commodities from eligible entities and sell such commodities to bioenergy producers for the purpose of producing bioenergy in a manner that ensures that section 7272 of this title is operated at no cost to the Federal Government by avoiding forfeitures to the Commodity Credit Corporation.

But based on the Front Range Energy LLC purchase, it appears as though "avoiding forfeitures" takes priority over "no cost."  Thus, if the program buys sugar just before the producer fails to pay its government loan, but at the forfeiture price, this is viewed as "no cost to the Federal Government," and meeting the law's goal of avoiding forfeiture.  But from an economic perspective, the maneuver is mostly semantic.  Since the inventory is already marked down, there are no savings relative to the default scenario.  Further, the requirement to sell into biofuel markets rather than into the most opportune outlet at the time (or holding until prices recover) could well trigger higher costs to taxpayers than in the baseline. In fact, this is what even CCC expects:

FFP is expected to cost CCC an estimated $54.5 million more than using the least-cost surplus management option. (FR 45445, 7/29/13).

As noted in CCC's most recent amended rules for this program, controlling supply is a main driver:

FFP addresses sugar surpluses sooner than the current Sugar Program by permanently removing such sugar from the market for human consumption.

The July 2013 amended regulations move non-FFP sugar stockpiles as well into biofuel markets by disposing of "sugar held in CCC inventory in ways that do not increase the domestic supply of sugar for human consumption..." (FR 45442, V. 78, No. 145, 7/29/13).  Over time, this shift would be likely to increase the portion of sugar subsidies that end up supporting biofuels.

4) Run an auction with the one market you are allowed to sell to, but provide little publicity and an extremely short lead time 

Want to be sure whatever you are selling generates a low price?  Don't advertise very much, and give bidders only a week between the first announcement (of the very first sugar sale under this program) and the bid closure.  So, although USDA wanted 25.2 cents/pound for the 14.2 million pounds of table sugar it put up for sale, it received only 6 cents/pound from the winning bidder. 

The result?  CCC guaranteed the crop for $3.58 million; paid $3.58 million for it before a formal loan default; then sold it at auction for $854,100.  Total loss to taxpayers:  $2.7 million.

No worries if you are an ethanol producer and happened to be on vacation during the entire one week first bid window.  There is another 184 million pounds of sugar on auction, which based on current prices will trigger more than $33 million in additional taxpayer losses.

5)  Force consumers to buy your subsidized sugar ethanol at above-market prices for fuel

Given the many interventions thus far, it would not be realistic to think that government involvement stops once the feedstock hits the ethanol plant.  That is not the American way when it comes to farming. 

In fact, there is one additional big sweetener to this whole scheme worth noting.  Government rules, in the form of the Renewable Fuel Standard (RFS) purchase mandates, require consumers to buy ethanol in their fuel even at above-market prices.  The extra cost of these rules to the fuel chain can be approximated through the market price of RFS compliance credits, called Renewable Identification Numbers, or RINs.  There are different types of RINs to deal with a variety of special definitions under the RFS, and it turns out that sugar used in ethanol production is generally of much higher value in meeting the RFS than is ethanol from corn (corn remains by far the largests US feedstock for domestic ethanol production).

The FFP final rule (FR 7/29/13, p. 45442) notes that..."EPA has confirmed that ethanol produced from U.S. sugarcane would qualify for an advanced fuel RIN."  However, aside from any grandfathered supply, ethanol produced from sugar beets would only qualify for conventional RIN credit.

The incremental value of advanced (D5) RINs relative to conventional (D4) RINs from corn has been very large for most of the RFS compliance period (see this chart). 

To make Front Range Energy's "score" possible, we had to pay higher prices for sugar and for motor fuel in our role as consumers; and to guarantee and then write-off a big chunk of the value of our sugar crop collateral in our role as taxpayers.  And that's even before considering the environmental impacts of domestic sugar production, such as new Roundup ready sugar beets and long-term water pollution from cane production in Florida.

My first stint in the world of subsidies was looking as federal disincentives to recycling in an analysis for the US Environmental Protection Agency.  Most often these took the form of subsidies to primary materials.  The linkages between extraction, energy-intensive processing, and competition with recycling and reuse markets were fascinating, but ones that EPA seems to have steered clear of for far too long. 

I recently participated in a Webinar looking at this issue again (slides are here), and it is useful to note that subsidies to landfilling and conversion of recyclable or compostable materials into base energy are growing and increasingly important impediments to higher materials reuse and recycling.  This is not a useful financial or fiscal outcome. 

On the horizon is now a subsidy-fueled push to convert municipal solid waste into ethanol.  Because the resultant fuel will qualify as cellulosic ethanol (though I'm not quite clear on how the large portion of organic food waste -- often including starches and sugars would be treated in the mix), the subsidies are rich indeed.  More than $1/gallon in production tax credits; plus what is likely to be substantial incremental subsidy values through the cellulosic RINs under the Renewable Fuel Standard and the related reverse auctions that may be run in the near-term to boost cellulosic supply. 

While this seems an insane policy to me (there is no way these plants will cull all of the recycable materials out of the waste stream first, any more than WTE plants have done), if you are part of the ethanol industry, it is all good news.  Here is Ethanol Producer Magazine:

The real excitement now is coming from the cellulosic ethanol sector. We expect to slowly and steadily be adding more plants under construction to our map. There appears to be a nice synergy emerging with MSW-to-ethanol projects and urban areas facing landfill issues. Financing is still very much an issue, but slowly, projects are finding a way to put together the package. It’s very satisfying to be able to report on those.

Note that the "package" reporter Susanne Retka Schill is talking about is an agglomeration of as many federal, state, and local subsidies the developers can possibly tap into to make the thing a go.  No matter that the environmental and global warming benefits from recycling, rather than conversion into a liquid fuel, would be much higher.

Subsidy arbitrage in international trade is not a new issue.  It is popping up again in the biofuels sector, this time regarding the collection of ethanol blending credits on fuel that is then shipped out of the United States.  Not surprisingly, producers in the receiving markets are not happy about it.  Robert Rapier has writting a good overview of the issue and the industry's denials ("Clarifying misconceptions about taxpayer-subsidized ethanol exports in the United States") for the most recent Global Subsidies Initiative newsletter.

I should have linked to this last month, but better late than never.  Robert Rapier has done a nice review of the Renewable Fuel Association's rather exuberant claims on the impacts of killing VEETC. Given that the mandate still requires the use of almost all of the ethanol produced domestically, the mechanism of support may shift (from tax credits to transfers from consumers, as illustrated by rising prices on compliance credits under the renewable fuel standard) but the demand will remain.

Part I covers the problems with their jobs impact numbers and the work of John Urbanchuk, RFA's frequent researcher on these questions.  Rapier points out that in stark contrast to the more than 100,000 jobs Urbanchuk says will disappear with the demise of VEETC, another analysis, done for food manufacturers, estimated keeping VEETC in 2011 would save a whopping 296 jobs and at a cost of roughly $20 million each.   Part II covers the inaccurate comparisons RFA has made on subsidy support to oil versus ethanol.  Having done detailed work on subsidies to both of these fuels, I concur with Rapier that RFA simplifies and skews the comparison. 

Faced with expiration of the ethanol blender's credit in only a few months, the ethanol lobby has been working the halls Congress to fashion together a fallback mix of subsidies -- even though mandates to use ethanol in vehicles remains in force.  Taxpayers for Common Sense summarizes the state of play, including assorted loan guarantees, support for new pumps and pipelines, and extension of the blender's credit, albeit at a slightly lower rate.

According to Bloomberg, the Obama administration will momentarily announce that current blend limits of 10 percent on ethanol in gasoline will be increased to 15 percent (E-15).  Research has been ongoing on the impact of higher blends on the functioning of vehicles not built to handle higher blends.  Older cars and other types of gasoline-powered vehicles such as boats are believed most as risk.  Access the Bloomberg story here.

The fact that auto companies are still opposing this change is a worrying sign, and supports the idea that the timing of this announcement is political, to strengthen Democratic support in the farm belt.  Pro-ethanol DomesticFuel.com discounts opposition to allowing E-15 blends in all cars as another round of the "usual suspects" opposing any and all pro-ethanol actions.  Yet, there is no obvious reason auto companies should care about what fuels are used in their cars unless they really believe it could cause vehicle problems, driving up warranty repairs and consumer complaints; and driving down brand image. The opponents have submitted their own technical data contrasting ethanol-industry sponsored research that found no problems with E-15 in any cars.  Interestingly, DomesticFuel.com included the Natural Resources Defense Council on its "usual suspects" list, despite many, many years of work by the environmental group to promote expanded biofuels in the US.

When I wrote about the push for higher blends last year, I suggested that many of us are very suspicious that the pro-ethanol lobby is sacrificing the service life of our automobilies (the second largest capital purchase for most people, exceeded only by their home) in the pursuit of higher profits for them.  The industry could address this concern simply and quickly:  by  cutting a deal with manufacturers to buy reinsurance on the existing warranties that would cover any ethanol-related damage that did crop up.  If the risk of vehicle damage is as low as the ethanol industry says, purchasing insurance coverage to protect the manufacturers should be easy and inexpensive.  If the ethanol boosters are unwilling to put their own cash on the line on the issue of vehicle damage, or if the reinsurance policies are very expensive, it ought to be a very big red flag, agruing against rapid allowance of higher blends.

Update:  The final decision allowed higher blends only in model year 2007 and higher, a much better outcome than boosting blend rates for all vehicles, without certainty the higher blends wouldn't damage the vehicles.  A nice summary by Geoffrey Sytles on how this ruling will or will not alter the competitive strategy of the fuel marketing sector can be found here.  As the RFS, expansion of the EPA ruling to more model years, or financial inducements lead to more service stations selling E15, it will be interesting to see how stations prevent owners of more sensitive vehicles from inadvertantly filling up with higher-than-recommended blends.

Thanks to Ron Steenblik for making me aware of a top 10 enemies list, recently developed by Tom Waterman at The Ethanol Monitor.  Alas, neither Ron nor I made it.  We'll just have to try harder I suppose.  Robert Bryce, who has also been critical of the industry for some years, and has written a good summary of the whole affair, did squeek by with an honorable mention.

In addition to Bryce's take, I see a number of interesting aspects about who is on this list:

• Only two of the parties listed ("Big Oil" and the Grocery Manufacturers Association) have any direct financial interest in the way the ethanol debate comes down.  That is quite significant in terms of how much I weight what they say.  It is also quite different from the main ethanol boosters, who generally have quite large financial interests in keeping the subsidy spigot flowing.  It also suggests that maybe, just maybe, there may be some real and important aspects of biofuels production that need to be front and center in policy making.

• Given ethanol's effort to position itself as a green alternative to oil, seeing the California Air Resources Board as enemy number 2 seems rather odd.  Yes, there is clearly a rationale to it (indirect land use again), but the choice underscores a big erosion in the original claims being made for the fuels.

• If the impact of biofuel subsidies on food prices were really as insignificant at the ethanol lobby likes to claim, it would be surprising for the Grocery Manufacturers Association to waste its time on this issue.    Clearly, GMA is spending enough on the issue to be viewed as a top 10 threat to the industry, so I guess they think there must be a great deal more to the food versus fuel issue than does the ethanol industry.   Now if GMA could only come out against crop subsidies in general, we'd be on our way...
  
• Including both Tim Searchinger and David Pimentel on this list indicates that their papers on the environmental impacts of biofuels are being heard and influencing policy.  I've had the privilige to work with both of them, and am grateful for their willingness to expend so much of their time and intellectual capital on this issue -- and perhaps even more grateful that they've continued to do so while enduring continual attacks by ethanol subsidy backers.  They have raised very important issues with respect to protecting the environment as biofuels continue to scale upwards.