RFS

Some interesting research coming out of MIT and UCAL Davis challenges claims by the biofuels industry that Renewable Fuel purchase mandates have resulted in enormous savings to fuel consumers.   Claimed savings have been massive, indeed.  Last month, energy economist Phil Verlager published an analysis concluding that

Crude oil today might easily sell at prices as high as or higher than in 2008. Preliminary econometric tests suggest the price at the end of August would have been $150 per barrel.

The implication for world consumers is clear. As noted in the August 2013 Petroleum Economics Monthly , the US renewable fuels program has cut annual consumer expenditures in 2013 between $700 billion and $2.6 trillion. This translates to consumers paying between $0.50 and $1.50 per gallon less for gasoline.

That's right:  as much as $2.6 trillion in savings every year.  In contrast, the few billion in subsidies sure look small.  These figures are included in an updated ad campaign (below) by the Renewable Fuels Association, a biofuels trade promotion group.

And Verlager is not alone in claiming very large economic impacts.  Using 2011 data, economists Dermot Hayes and Xiadong Hu of Iowa State University estimated average savings of $1.09 per gallon -- with savings in the mid-West region reaching as high as $1.69/gallon.  Their estimated savings over a longer period (2000-2011) were significantly lower, though, at about $0.29/gallon.

Economists Christopher Knittel (MIT) and Aaron Smith (UCAL Davis) reworked the estimation approach used by Hayes and Wu and found it had a number of problems.  They argued that a key metric (the crack ratio, or the price of gasoline divided by the price of oil) was over-generalized.  They also argued that the earlier paper suggested a causal relationship with ethanol and crack ratio movements, rather than mere correlation.  The Knittel and Smith analysis found a much smaller impact of ethanol blending mandates on prices to consumers.  Knittel noted in an interview with the MIT news office that

In the very short run, if ethanol vanished tomorrow, we would be scrambling to find fuel to cover that for a week, or less than a month.  But certainly within a month, increases in imports would relax or reduce that price impact.

The full paper can be accessed here.  There's a fair bit of interchange as well between Knittel and Smith, and Hayes, and this provides an interesting window into the methods of both parties:  Hayes 1.  Knittel and Smith 1.  Hayes 2. 

RFA Ad campaign touting large savings from ethanol

I expect that Knittel and Smith are much closer to the true impacts than either Hayes and Wu or Verlager.  The ethanol market share is simply too low to be causing shifts of such a large percentage of the market price.  Further, continuing shifts in fuel market structure are likely to weaken the marginal impact of ethanol on fuel prices relative to other factors.  These shifts include continued efficiency gains in the fleet, growing use of hybrids, ethanol fuel production above the blend wall, growing exports of refined fuels from the US, and increasing sources of oil. 

An important related point to this general discussion of price impacts is that one shouldn't claim savings in gas prices from blending mandates while ignoring the negative impacts that these mandates have on consumers in other ways.  For example, the ethanol subsidies (now dominated by the RFS) drive up the cost of animal feed and human food (the degree of which is another fiercely contested data point).  This is properly seen as an offset to whatever gains may exist at the pump.  There is also the direct cost of the subsidies themselves -- not only through biofuel support programs, but also from long-lived subsidy programs for irrigation and corn production are are increasingly being captured by the biofuels market segment as more and more crop ends up and fuel.   And globally, there are negative impacts on land use as artificially high prices for biofuel production displace other claims on the land ranging from different food crops to ecological uses.

It's an interesting time to watch biofuels markets.  A couple of years ago, with commodity prices spiraling, there was great concern that fuel markets were outbidding food and feed markets for edible biomass.  Now, reporter Judy Keen notes that the United States is facing drought in nearly 80 percent of the country's corn-growing area; and more of the country's landmass is facing drought than any time since 1956.

Back in 2006, biofuel proponents were touting the introduction of ethanol as a boon for domestic energy security.  National security was one of the central planks proponents used to advocate for continuing large and growing subsidies to the fuels.  The industry continues to highlight the energy security angle.  Here is the Renewable Fuels Association on energy security:

As a domestic, renewable source of energy, ethanol can reduce our dependence on foreign oil and increase the United States' ability to control its own security and economic future by increasing the availability of domestic fuel supplies. By displacing hundreds of millions of barrels of imported oil, the increasing reliance on domestically-produced ethanol is making available billions of dollars for investment in domestic renewable energy technologies.

Energy Security has More than one Parameter

There's a grain (sorry) of truth in this argument.  Being able to put ethanol into vehicles instead of gasoline provides a bit of competitive leverage against oligopolistic petroleum suppliers.  The leverage, however, is fairly limited.  The US Congressional Research Service recently concluded that

Despite the fact that ethanol displaces gasoline, the benefits to energy security from ethanol remain relatively small. While roughly 40% of the U.S. corn crop was used for ethanol in 2011, the resultant ethanol only accounts for about 7% of gasoline consumption on an energy-equivalent basis. Expanding corn-based ethanol production to levels needed to significantly promote U.S. energy security is likely to be infeasible.

Fuel substitution is only part of an energy security picture though, and it is important to look at the security issue  holistically.  Supply security also matters.  And, just as world events disrupt oil supplies causing price shocks and dislocations, so too can the supply of biofuels be disrupted.  Here's what I wrote on the issue six years ago (p. 58):

Biofuels do offer a diversification benefit, inasmuch as they may be less vulnerable to the same kinds of disruptions that threaten supplies of petroleum from politically unstable regions of the world. However, the cost per unit of displacement [i.e., subsidies per gallon of oil displaced] is very high, and there are likely many more efficient means to achieve the same end.  Moreover, the feedstocks from which biofuels are currently derived are also vulnerable to their own set of unmanageable and unpredictable risks, such as adverse weather and crop diseases.

It turns out that those "unmangeable and unpredictable risks" are not something that should be ignored.  The chart below is from a 2007 article by Bruce Babcock at Iowa State University, a frequent researcher on corn and biofuels issues.  He notes that corn harvests have regularly deviated from expected yields, and often by a large margin.  Shortfalls are particularly relevant with respect to biofuels markets that mandate particular consumption levels.  Responding to claims that crop innovation had made corn at a lower risk from drought than in the past, Babcock was skeptical:

It is an open question whether future supply shocks will follow the historical patterns. Many feel that current corn hybrids are better able to withstand hot and dry weather of the type seen in 1983 and 1988. This has yet to be demonstrated, though, as we have not had a severe drought since 1988. Dry weather in Illinois in 2005 and in the western Corn Belt in 2002 caused significant local yield losses, which suggests that corn crops remain vulnerable to drought.

Supply Shortfalls in the Face of Mandated Consumption

As crop production is threatened, food prices and crop futures rise. The higher prices send signals to all consumers that they might want to shift to other feedstocks or to figure out how to use the now more-expensive inputs more carefully.  This rationing process works best when all consumers of the affected commodity feel pressure to substitute or conserve.  Biofuel mandates mess up this process because they require diversion of a large portion of the corn crop into vehicle fuels -- even at very high prices.  In effect, the mandates hard-wire the markets so that transport uses for corn will outbid feed and fuel uses.

In an interesting review of corn market dynamics under the present drought, Darrel Good and Scott Irwin at the University of Illinois point out that compliance with the blending mandates does have some flexibility.  The rules allow some banking of prior year credits.  This carryover has been estimated at "at least 2 billion gallons" -- important, but still a small slice of the more than 13 billion gallons required for blending during the next mandate year.  Thus, when they estimated how markets would respond to rising corn prices, they assumed that carryover stocks of Renewable Indentication Numbers (commonly referred to as "RINs," and which are the market mechanism for tracking compliance with the RFS biofuel blending mandates) would be used first to reduce the need for buying actual (and expensive) corn.  This makes logical sense, but only solves part of the problem.  Good and Irwin further note that

without policy changes ethanol use after the stock of RINS is used up would become perfectly price inelastic.

Becoming "perfectly price inelastic" is economist terminology that means fuel markets will continue to buy the same amount of ethanol no matter how much the price of the fuel rises.  This is a big deal, because it means the residual demand for ethanol for fuel will outbid all other uses for corn during the period of scarcity:  food, animal feed, exports, everything.  And this will happen only because of the Renewable Fuel Standard subsidy, not because of the inherent economics of the product.

Good and Irwin point out that the ability to borrow credits from future years (up to 20% of the requirement) could theoretically be used to further reduce the need to buy actual corn for fuel markets.  However, they didn't see this strategy being widely deployed.  Borrowing for 2012/13 would mean the need to blend even more than the mandate for 2013/14 -- yet markets are already saturated with ethanol making incremental blending quite difficult. 

The drought brings into greater focus problems that have existed in biofuel markets for some time.  First, that biofuel feedstocks, like oil, are subject to supply disruptions and this volatility reduces the security element of the fuel.  Second, that the mandates result not only in market challenges but a moral one as well when the least important end-use from a societal stand point (fuel for cars) ends up diverting increasingly scarce supplies of corn or other biofuel crops from feeding people.

Ships Passing in the Night

Lest the mandated use of corn in cars rather than for food not cause enough heartburn, Tim Wise highlights another problem on his Triple Crisis blog.  While reducing carbon impacts was an early (though not always accurate) selling point of biofuels, current policies have resulted in Brazil and the United States shipping each other ethanol at the same time.  Here's Wise:

Why would the United States, which now devotes 40% of its corn crop to the production of ethanol, import more  than 4 billion gallons of ethanol from Brazil? And why would Brazil at the same time import a projected 2 billion  gallons from the U.S.? Couldn’t we just save all those transactions costs and shipping-related greenhouse gas  emissions by keeping our ethanol and cutting our projected ethanol imports from Brazil in half?

Not if your goal is to game the U.S. biofuel mandate.

The driver is the fact that corn ethanol and sugar ethanol are fall into different categories of the RFS.  Sugar-based fuels, because they supposedly have a lower carbon footprint, fall into a more constrained, and therefore more valuable, category of RINs.  Wise notes that

...the ultimate perversity is the ethanol-for-ethanol trade between the U.S. and Brazil. Under the FAO-OECD’s baseline scenario, Brazil would import 2 billion gallons of corn ethanol from the United States. Why, if it’s a major ethanol exporter and it produces more environmentally sustainable ethanol? To make up for the domestic shortfall created by its exports to the U.S., and to meet its own rising demand from its expanding fleet of flex-fuel cars. They’ll take our low-grade corn ethanol if they can get a higher price for their sugar-based equivalent.

And so it goes.

Just Pass the Wine

The inanity of it all is a bit mind-boggling.  But then I remember it has always been so in this nook of our global marketplace.  My first introduction to ethanol issues was in 1989 when I worked on an ethanol-related US trade case.  It turns out that Europe was producing too much wine due to their complex and wide reaching system of agricultural subsidies.  Wine can also be used to make ethanol fuels, and even then the US had generous subsidies for blending ethanol with gasoline.  Alas, the ethanol-from-wine couldn't come straight to our shores because then we'd have been flooded with supplies from around the world, and that would have hurt US corn farmers and processors.  Thus, a tariff (which ended only last year) was in place to render most imports (including European wine alcohol) far less competitive. 

To solve the problem, the wine was instead shipped first the Carribean basin, which due to a regional economic development plan passed by Congress earlier, had special tariff-free access to US markets.  But to comply, some value-added had to be done to the fuel in the Carribbean -- it couldn't just be transhipped.  So it was dewatered there, and entered our markets tariff-free where it was blended with our gasoline supplies to "green" our transport fleet.

How much easier it would have been if they'd just offered us the wine.

During the early part of 2010, when the volumetric ethanol excise tax exemption (VEETC) looked like it was heading towards elimination, ethanol industry contortionist Bob Dinneen of the Renewable Fuels Association worked hard to paint the subsidy as vital to all things American.  In yet another RFA-sponsored study by the industry's favored economist John Urbanchuk, RFA set out to quantify the bad things that would happen if VEETC expired.  They came up with quite a list, summarized by Ethanol Producer Magazine:

If VEETC is allowed to lapse, the study said, the price to producers would be reduced by 27.4 percent, resulting in a nearly 38 percent cut in supply by producers...

If the VEETC is eliminated, the immediate impact on the industry is expected to be severe," the study said. "A significant amount of capacity would likely go offline quickly. Some of that capacity may come back online as prices rebounded to an equilibrium point, but most of the lost production would not come back.

In Dinneen's own words:

Failure to provide the kind of assurance investors require to continue building out this industry by extending the tax incentives would be shortsighted, relegating future generations to a reliance on both foreign oil and foreign renewable fuels.

With such dire outcomes, how could Congress even consider stripping away the multi-billion dollar tax break? 

The manner in which the RFS and blending subsidies interact, however, paints a very different picture of the likely impacts from elimination.  The RFS sets a mandated consumption floor for favored fuels, in good times or bad, high corn prices or low.  This is great protection if you are an ethanol producer, though quite bad if you happen to be a member of the urban poor in the developing world trying to buy corn for food.  Because the RFS creates a price-insensitive mandate, the rising feedstock prices would not divert supply from fuel to food markets as quickly as without the mandate.  This increases the likelihood of rich world fuel markets outbidding developing world urban poor looking to buy corn to eat.  Not a great dynamic. 

But back to US fuel markets though.  The RFS generates a market-clearing price for providing a pre-set number of RFS-compliant gallons.  With a few exceptions (such as biofuels so environmentally-challenged they can't even meet the weak RFS2 ghg reduction standards), these are the very same gallons eligible to meet the RFS2 mandates. 

So how would the policies overlap?  For a given production cost structure, gallons earning a 45 cpg tax credit are able to remain in production at a lower RFS credit value than would be possible for them to do without the tax credit.  (The RFS credit value in the US is referred to as the RIN value, which is short for "Renewable Identification Number," the accounting units the program uses for RFS-compliant gallons).  Pull the tax credit and the equilibrium RIN prices will rise more or less the same amount.  Increase the credit and the equilibrium RIN prices are likely to fall in response.

And, despite the claims of Urbanchuk and Dinneen, this is exactly what seems to be happening.  Here's an article on what's happening in the biodiesel sector, from Biodiesel Magazine in November 2010:

Although the U.S. biodiesel industry has struggled since the lapse of the $1 per gallon tax credit, renewable identification number (RIN) prices are currently trading high enough to fill that void. One factor that seems to be contributing to the relatively high price of RINs is the volume requirements mandated by the U.S. EPA under the renewable fuel standard (RFS2)...

According to Sam Gray, a renewable fuels trader with VICNRG LLC, 2010 biodiesel RINs hit an all-time high on Dec. 8, trading at 96 cents per RIN. Since each gallon of biodiesel that is produced generates 1.5 RINs, that equates to $1.44 per gallon, which more than offsets the lost value of the expired $1 per gallon biodiesel tax credit. [Emphasis added]...

Current market conditions seem to be indicating tight biodiesel supply in 2011, leading to relatively high RIN prices, but McMartin and Gray agree that this will change if the biodiesel tax credit is reinstated. "If that $1 comes back, there is no way RINs can remain high, the market just wouldn't allow it," Gray said. "The market will correct that, so if the dollar comes back, you are going to see a large percentage of that dollar proportionally wipe away the 2010 and 2011 RIN value."

The policy take-away here?  The very least Congress can do here is kill the blenders' credits permanently.  No transformation of the credits into new or bigger subsidies, such as to ethanol refueling infrastructure and pipelines as industry group Growth Energy has advocated; just kill the blenders credits because doing so will save taxpayers lots of cash, and will have virtually no effect on market structure anyway.

It has been a banner couple of weeks for the ethanol industry.  To my inbox come their daily proclamations and jubilations over a reprieve they have been given in a recent US EPA analysis of GHG impacts of the fuel. Corn-based fuels from new plants had to reach a minimum of 20% GHG reductions relative to gasoline in order to qualify as renewable under the renewable fuel standard mandates.  This reduction, by statute, had to include indirect land use, an effort to recognize that a large surge of land under fuel production would result in loss of carbon sequestering vegetation elsewhere.

While the 20% threshold is the lowest GHG hurdle for a biofuel offered within the mandates, corn ethanol rose to the challenge.  While it may seem unbelievable, the analysts at EPA found that not only did corn ethanol reduce GHG emissions by the required 20 percent under certain conditions, but that new plants would provide not a 20.25% reduction; not even a 20.5% reduction; but a whopping 21% reduction.  Amazing, just amazing, how the framers of the original requirements were able to predict the outcome of this complicated analysis so accurately.

Indirect land use as bunk

Today, lobbyist C. Boyden Gray argues in the Washington Times that the entire idea of indirect land use, "including as far away as Southeast Asia or Brazil," being considered when assessing the impact of biofuels production is just "flat wrong."  His article is titled "Getting a true measure on biofuels," though I assume he is using the word "true" in a lobbyist sort of way rather than its traditional meaning.

He argues in the article that including any evaluation of indirect land use impacts from US fuel production is simply "too difficult" to include.  And, I suppose, if something is difficult to assess easily, the only "true" measure is simply to exclude it entirely-- though only for accuracy of course. 

Technical difficulties in the write-up (more on this below) aside, the Renewable Fuels Association media machine jubilantly delivered me a link to the Gray piece, so here are my thoughts.

Some initial reactions to the politics of all this.  First, I think that any newspaper that publishes an opinion piece from a lobbyist ought to note at the bottom of the article whether the author is actually working for the industry he or she is opining about.  I suspect this is likely for C. Boyden Gray and Associates (despite this article from 1990 where Gray seems to be irked by pressure from the ethanol lobby), but it ought to be stated in black and white.

Second, it's a bit laughable to see Gray refering to Tim Searchinger et al.'s article on indirect land use change as causing a "policy imbalance" -- noting that that "Fortunately, there has been positive action on the congressional front to redress the policy imbalance Mr. Searchinger's article has caused."  So, let's get this claim straight:  Searchinger and his team of academics created a "policy imbalance" by publishing a peer-reviewed article in one of the most respected academic journals in the world, against which one of the most powerful lobby forces in the world -- apparently represented by Boyden himself -- is only now making right?  Uh huh.

Life cycle mapping: complicated, inefficient, and probably biased

Enough with Gray's posturing.  What about his arguments?  I actually agree with some of the concerns he raises on life cycle mapping -- albeit expecting bias in the opposite direction.  It is absolutely true that mapping the life cycle impacts of fuel chains is complicated, sensitive to the assumptions one makes, and subject to a wide range of technical problems as one tries to compress what is really a wide range of values for the same crop (depending, for example, on the specific location, fuels used in processing, the amount of irrigation and fertilizers needed, etc.) into a point estimate.  EPA's own magical 21% reduction value relies on a variety of these assumptions, including crop yields and co-product credits, well described in this Forbes article by Jonathan Fahey.

The estimation challenges are serious.  But they can as easily underestimate climate impacts as overestimate them as Gray implies.  In fact, it is reasonable to expect that when complicated, non-transparent modeling efforts are conducted outside of the public purview, they are much more likely to be influenced to support the politically well-connected than the politically weak.  The weak, after all, have much smaller budgets.  Stated in a more ethanol-specific way:  given the same set of scientific facts and uncertainty, and a 20% GHG reduction threshold for corn ethanol to partake in a large subsidy program, it is much more likely that the outcome will hit reductions of 21% than of 19%.

In addition, the analytic intensity (and cost) of the calculations these models require mean the information set driving regulations is subject to wide ranging accuracy problems simply from the long time delays between when information is collected and updated; by modeling staff turnover and its associated loss of specific knowledge; and by a general inability to capture complex systems with available modeling tools. 

The result?  A detailed round of policy analysis will be repeated only infrequently.  Rules may not be properly updated to integrate adverse effects on the ground that were missed the first time around.  Errors in who makes the initial cut will be canonized through the grandfathering provisions of the RFA.  These lock in facility eligibility under the RFS for life once a plant has passed the GHG test once.  Since the purpose of grandfathering is to avoid the premature obsolescence of capital, a far more logical grandfathering period would be limited to the depreciation period of the investment.  Efforts to provide this reasonable fix to the existing rules failed.

Carbon taxes, which achieve the same endpoints but in a much simpler, more neutral manner, should be preferred over the options now being pursued most heavily:  low carbon fuel standards or emissions trading schemes with difficult-to-validate or distortionary offset rules.  Yet, because the taxes offer far fewer opportunities for political barter and favoritism, policy momentum will not favor the simpler solution.

Land use might not matter if biofuels didn't need land

Gray's basic claim -- that land use displacement doesn't matter -- is just plain silly.  If land is a finite factor of production (which it clearly is), and there is a sharp increase in demand pressure on that resource, there are only a handful of things that can happen.  You can increase the productivity of that land (likely to happen, but not as much as boosters claim, and also with some environmental impacts from soil loss, and increased fertilization and irrigation); your can drive prices up so high that other products not requiring so much land per Btu of energy become more competitive (like oil, perhaps); or you can pull land from other uses into biofuels.

Searchinger talks about international impacts of land use change, and these do partly consist of a loss of forest cover.  Gray's counter-argument focuses only on the US, only on forest cover trends, and only for a period (ending in 2005) that preceded the spike in oil and corn prices, and much of the rapid growth in mandated biofuel consumption.   In fact, short-term impacts are far more likely to be seen in Conservation Reserve Program enrollment (declined during the high price surges), crop rotations (corn/soy rotations ramped down on the soy), and crop substitution (overall corn acreage was up).  Longer-term impacts -- which I suspect we have yet to see in the US, though already evident in Indonesia -- may well cut into forest cover.  In fact, given the rising subsidies to cellulosic production from forest wastes; and for direct burning of biomass for electricity, declining forest cover in the US seems all but inevitable. 

What about the Iowa State CARD study by Jerome Dumortier et al. that Gray cites to discredit the Searchinger team?  This study, "Sensitivity of Carbon Emission Estimates from Indirect Land Use Change," from July 2009, doesn't actually support Gray's claims so far as I can see.  Far from concluding that the Searchinger team is "flat wrong," the authors substantiate the general principle of land use impacts and a "carbon debt" where the land conversion impacts create a carbon hole that can take many years of fuel usage relative to a gasoline baseline to "pay off."  Specifically, they note that:

"We find that the payback period of corn ethanol’s carbon debt is sensitive to assumptions concerning land conversion and yield growth and can range from 31 to 180 years."

While Gray says the CARD used a "better model," Dumortier et al. note that they calculated a similar carbon debt as the Searchinger team when they used similar assumptions -- that is, the two models produced comparable results.  Thus, even if the CARD model is better, the approach used by the Searchinger team is not without merit.  One benefit of raising issues like Searchinger did is to encourage investment into improved models. 

Only when the Dumortier team changed their assumptions about the impact of biofuels growth on US forest cover and yield growth did the payback period decline to below what the Searchinger team predicted.  As Searchinger notes in this reply, uncertainty in how big the carbon debt is does not justify the path C. Boyden Gray recommends of ignoring the issue altogether.  In addition, even the lower bound of the carbon debt in the Dumortier study means that corn ethanol will actually worsen the GHG problem during the critical initial response window for GHG stabilization.  This is hardly something to celebrate.

Good feed, good food?

Gray also points to the value of the corn ethanol byproducts such as dried distiller's grains in boosting the GHG reduction value of ethanol fuel production, noting that they are a better feed than the corn itself.  Again, the issue is not nearly so much in the industry's favor as Gray spins it.  Here is Iowa State again, talking about nutritional value:

"However, feeding distillers grains creates some nutrition management challenges, in part because most of the nutrients in corn become three times more concentrated in distillers grains. Nutrients such as sulfur are often added during ethanol production and can occur at even higher concentrations. Formulating rations to accommodate the nutrient composition of distillers grains is further complicated by the significant variation in nutrient content that has been shown to occur between ethanol facilities and even between batches from the same facility. These nutrient issues can limit or even prohibit distillers grains use in some feeding situations."

And this one, from the FDA, on antiobiotic residues in the feed. 

Finally, there is increased pressure to take these feed byproducts and use them to boost fuel yield.  If more of the DDGs are diverted from feed to fuel, ostensibly EPA should scale down its GHG byproduct credit for corn ethanol.  If that change would pull corn ethanol below the 20% magic number though, EPA's revision will likely be a long time coming.