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Wall Street History
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05/11/2007
Ethanol and the Poor
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.”
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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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