Monday, February 25, 2008

It's worth considering...

Corn farmers are on the path to a confrontation with the livestock industry. After a remarkably laid-back indifference to legislative action that put the government in direct competition for their feed supply, meat, dairy and egg producers are pushing back.
Last year began with seemingly every Midwest rural community announcing a corn-based ethanol plant. By fall, the bottom fell out of the ethanol and biodiesel expansion. It went from one extreme to the other.

Communities both loved and feared these projects, creating tax incentives, filing lawsuits against projects, or both. Public opposition transitioned from thermodynamic inefficiency to insufficient water supplies and then settled on the food vs. fuel debate. Grain farmers cheered the $4/bushel price of corn. The livestock industry became antibiofuels.

The year ended with apprehension about the future of biofuels, but this is not the end of the story. Economic growth is measured in decades - not in weeks or months. We are just getting started. [More]
None of this would matter as much if the corn market, and ethanol in particular were less subsidized. But if subsidies were ended wouldn't the wonderful word of $5 corn vanish in a puff of smoke?

It turns out, the answer is an unequivocal: it depends.
Tyner analyzed four policy options - the current 51-cent fixed subsidy, the variable subsidy, no subsidy and a renewable fuel standard - at oil prices ranging from $40 per barrel to $120 per barrel. The renewable fuel standard contained in the 2007 Energy Act mandates that energy companies purchase 35 billion gallons of ethanol by 2022, with a maximum of 15 billion gallons coming from corn.

"Regardless of the policy, results become similar at high crude oil prices where the market dominates," Tyner said. "At low oil prices, however, government policies have huge effects, and all the results are enormously different. The policy choices we make will be critical."

With oil at $40 per barrel, for example, ethanol production is not profitable without a subsidy or higher fuel costs. With a fixed or variable subsidy in effect at this oil price, the government spends $5 billion per year to subsidize ethanol production, Tyner said. Ethanol is considerably more expensive than fuel made from petroleum in this scenario, but with the renewable fuel standard in effect, fuel companies are required to buy 15 billion gallons of corn ethanol per year. At $40 crude, the standard would cost consumers an extra $12 billion per year at the pump, Tyner said.

Subsidies are paid out of taxpayer dollars by the federal government, while the renewable fuel standard costs consumers at the pump, Tyner said.

Therefore, the standard does imply costs at low oil prices, when buying ethanol would otherwise be uneconomical. His model calculates the hidden cost of the standard, which tacks on an extra $1.05 per gallon when oil is $40. In such a situation, in other words, ethanol costs $1.05 more per gallon to produce from corn grain than gasoline costs to produce from crude oil, and the consumer indirectly makes up the difference, he said.

If oil surpasses $100 per barrel, however, the renewable fuel standard costs consumers little or nothing extra. That's because at this price, ethanol production costs are very close to gasoline production costs, he said. [More of a complex, but intriguing summary of this study]
I would suggest to corn farmers obsessed with trying to forecast when the good times will end a better approach than divination would be to protect ethanol from as many political shocks as possible. With oil moving above $100, the dollar sinking, and feed customers looking for ammunition, letting go first of the blender credit and then the tariff (remember it won't hurt much as the dollar shrinks compared to the real) could be cheap insurance against a rude political awakening.

But we likely won't. Only a concerted action by political power as great as ours will induce us to consider a free market solution.

Which is why I'm not betting on any change soon. Guys like me have no traction whatsoever compared to those who would rig the market at our best customers' expense and espouse civic virtue in the same breath.

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