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Ethanol
and the Poor
Brian
Trumbore
President/Editor, StocksandNews.com
The debate over ethanol continues to
rage in some policy circles and University of Minnesota
professors C. Ford Runge and Benjamin Senauer have
added to it with an essay for the May/June edition
of Foreign Affairs.
Following
is a summary of their piece titled "How Biofuels Could
Starve the Poor."
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In
1974, in the midst of the Arab Oil Embargo and America's
first real energy crisis involving OPEC, Congress
took the first of many initiatives to promote ethanol
made from corn as an alternative fuel. Additionally,
lead, as a fuel additive, was gradually phased out
at the same time and replaced by ethanol. But the
United States continued to become more dependent on
imported oil and the impact from ethanol was marginal
at best.
Today,
thanks to a combination of excessive subsidies and
high oil prices, corn-based ethanol has taken off
with 110 refineries in operation in the U.S. by end
of 2006 and at least another 70 under construction.
When all are completed ethanol capacity would reach
11.4 billion gallons per year and in his latest State
of the Union address, President George W. Bush called
for 35 billion gallons of renewable fuel per year
by 2017. So the push will continue.
Globally,
in 2005, ethanol production was 9.66 billion gallons,
of which both Brazil and the U.S. produced 45% each.
[Global production of biodiesel (mostly from Europe)
is another one billion gallons.]
But
whereas Brazil gets its ethanol from sugar cane, the
U.S. uses corn and according to some estimates, as
Runge and Senauer note, "ethanol plants will burn
up to half of U.S. domestic corn supplies within a
few years. Ethanol demand will bring 2007 inventories
of corn to their lowest levels since 1995 (a drought
year), even though 2006 yielded the third-largest
corn crop on record. Iowa may soon become a net corn
importer."
[The
United States accounts for 40% of the world's total
corn production and over half of all corn exports.]
Of
course this is sending shock waves through the food
system as corn futures have risen to their highest
level in ten years?now around $3.50 a bushel but earlier
as high as $4.40.
While
this sounds good to corn producers, obviously consumers
are suffering, especially those in developing nations,
who are hit with a double shock if oil prices remain
high. "The World Bank has estimated that in 2001,
2.7 billion people in the world were living on the
equivalent of less than $2 a day; to them, even marginal
increases in the cost of staple grains could be devastating."
And
consider this, as noted by Runge and Senauer. "Filling
the 25-gallon tank of an SUV with pure ethanol requires
450 pounds of corn - which contains enough calories
to feed one person for a year."
In
the United States, ethanol has resulted, directly
or indirectly, in some $8.9 billion in subsidies for
corn farmers, though this figure will decline with
higher corn prices. The federal government then grants
ethanol blenders a tax allowance of 51 cents per gallon
of ethanol that they produce, with some states tacking
on further subsidies of their own.
But
despite a global trend towards biofuels, demand for
crude oil isn't about to go away. In fact it is certainly
going to increase, faster than it can be produced;
let alone the fact much of it remains in politically
risky areas. According to the U.S. Energy Information
Administration's latest projections, global energy
consumption will rise 70% between 2003 and 2030, with
demand from the likes of China and India surpassing
that of the developed world potentially by 2015. In
other words, it's hard to see oil prices falling,
which in turn "will allow ethanol and biodiesel producers
to pay much higher premiums for corn and oilseeds
than was conceivable just a few years ago?.If oil
reaches $80 per barrel, ethanol producers could afford
to pay well over $5 per bushel for corn."
With
growth in the biofuel industry, land used to grow
corn is reducing the acreage of other crops, of course.
This means higher prices, that are in turn hitting
the livestock and poultry industries. Higher feed
costs have caused returns to fall sharply in the pork
and dairy industries, for example. In Iowa, ethanol
producers may feel smug these days, but the state's
pork producers could go out of business over the competition
for corn supplies.
And
"biofuel mania" has fanned the flames of the speculators,
including hedge funds.
Runge
and Senauer comment, though, on the disregard for
the actual consequences.
"It
seems to unite powerful forces, including motorists'
enthusiasm for large, fuel-inefficient vehicles and
guilt over the ecological consequences of petroleum-based
fuels. But even as ethanol has created opportunities
for huge profits for agribusiness, speculators, and
some farmers, it has upset the traditional flows of
commodities and the patterns of trade and consumption
both inside and outside of the agricultural sector."
The
root of the problem on the ethanol front lies with
the fact the biofuel industry has always been dominated
by politics, not market forces. Corn is the raw material
of choice in the U.S., even though biofuels could
be made efficiently from a variety of other sources,
but only if the government initially funds the research
and development.
Take
the example of ADM, Archer Daniels Midland Company.
It positioned itself as the "supermarket to the world"
and "aimed to create value from bulk commodities by
transforming them into processed products that command
heftier prices." In 2006, ADM was far and away the
largest producer of ethanol in the United States,
but the company owes much of its growth to political
connections, going back to the days of Vice President
Hubert Humphrey. As critic James Bovard once noted,
"half of ADM's profits have come from products that
the U.S. government has either subsidized or protected."
Runge
and Senauer:
"Biofuels
may have even more devastating effects in the rest
of the world, especially on the prices of basic foods.
If oil prices remain high?the people most vulnerable
to the price hikes brought on by the biofuel boom
will be those in countries that both suffer food deficits
and import petroleum. The risk extends to a part of
the developing world: in 2005, according to the UN
Food and Agriculture Organization, most of the 82
low-income countries with food deficits were also
net oil importers."
But
even major oil exporters, such as Mexico, can have
their own issues on the consequences of higher food
prices; witness the intense protests late last year
over the rise in the price of tortilla flour due to
the 50% increase in U.S. corn prices. ["Prices rose
even though tortillas are made mainly from Mexican-grown
white corn because industrial users of the imported
yellow corn, which is used for animal feed and processed
foods, started buying the cheaper white variety.]
Consider
that the world's poorest people "already spend 50%
to 80% of their total household income on food."
Runge
and Senauer's conclusion:
"The
future can be brighter if the right steps are taken
now. Limiting U.S. dependence on fossil fuels requires
a comprehensive energy-conservation program. Rather
than promoting more mandates, tax breaks, and subsides
for biofuels, the U.S. government should make a major
commitment to substantially increasing energy efficiency
in vehicles, homes, and factories; promoting alternative
sources of energy, such as solar and wind power; and
investing in research to improve agricultural productivity
and raise the efficiency of fuels derived from cellulose.
Washington's fixation on corn-based ethanol has distorted
the national agenda and diverted its attention from
developing a broad and balanced strategy. In March,
the U.S. Energy Department announced that it would
invest up to $385 million in six biorefineries designed
to convert cellulose into ethanol. That is a promising
step in the right direction."
---
Editor
note: In the interest of full disclosure, I have been
investing in a biodiesel company headquartered in
China, but, this particular play produces its fuel
from vegetable oil and restaurant waste, which Professors
Runge and Senauer note is more energy efficient than
other alternatives.
I
also chose not to write about the debate over ethanol
and greenhouse gas emissions as part of the above.
I have read all sides of this one and to me the evidence
is still inconclusive.
Wall
Street History will return next week.
Brian
Trumbore
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