Bioethanol as a Transportation Fuel
Current Status and Future Prospects
Shabaka Gibson, David Jarvis, Melinda Morang
June 2, 2008
Introduction
Ethanol, or C2H6O, is a volatile, colorless, flammable liquid known to most as alcohol. It
is in fact the alcohol one finds in most alcoholic beverages, and its creation is probably one of
the earliest-known chemical processes in history. Ethanol has a great number of uses, including
recreational, medicinal, and industrial. Despite the relatively recent explosion of ethanol as a
fuel onto the national stage, it has been used as such for well over a century. In the 1840s,
ethanol was used in the U.S. to light gas lamps until a tax levied during the Civil War made it
uneconomical. In 1906 this tax was repealed, and in 1908 Ford’s Model T was built to run on
ethanol fuel until 1920, when Prohibition outlawed alcohol use. Since then, it has lain low,
although it experienced a brief resurgence as a gasoline additive in the 1970’s, under the title
gasohol.
Now, with gasoline prices soaring and the U.S. government and populace desperate to
wean themselves off of an addiction to imported oil, ethanol is making a comeback as a gasoline
substitute. The use of ethanol as a gasoline substitute is attractive for a number of reasons.
Firstly, because the biological feedstocks needed to produce ethanol can be grown in the United
States, it has the potential to reduce U.S. dependence on foreign oil – reducing leverage in U.S. /
Middle East relations and heightening energy security. Additionally, a cheaper, renewable
substitute for gasoline would allow the U.S. economy to maintain growth without the
modulations based on oil prices that the U.S. has witnessed in the past several years.
In addition to the potential economic and security benefits of ethanol, the effects could
help with combating global climate change. Because the carbon dioxide absorbed from the
atmosphere by ethanol feedstocks is the same as the amount of carbon dioxide released into the
atmosphere when ethanol is burned in a combustion engine, ethanol has the potential to reduce or
eliminate net greenhouse gas emissions from vehicles with internal combustion engines.
Because of this, (unlike fossil fuels) one does not introduce any new carbon into the carbon cycle
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by burning ethanol. Even if the net emissions are not quite zero, ethanol still affords the
possibility of drastically reducing our greenhouse gas emissions when compared to the high
emissions rates of gasoline-using vehicles. (IEA, 2004)
Ethanol offers a significant advantage over other alternative transportation fuels because
it can be used as a substitute for gasoline in existing vehicles and fueling infrastructure, and only
minor modifications to vehicles and infrastructure are needed. Most existing gasoline vehicles
can already run on gasoline/ethanol blends with a low percentage of ethanol. For higher ethanol
concentration blends, up to 85% ethanol, minor engine modifications are needed to avoid the
corrosive effects of alcohol, but these changes are easy to implement and fairly inexpensive
when making new vehicles. Indeed, many new vehicles are already built to be compatible with
up to 85% ethanol blends. Additionally, further modification to improve engine efficiency can
be done fairly easily. Flexible-fuel vehicles (FFVs) designed to work with a range of ethanol
concentrations can vary engine timing and other processes to optimize engine performance for
whatever blend is put in the gas tank. (IEA, 2004)
It would be much easier to substitute bioethanol for gasoline than it would be to convert
our entire vehicle fleet to hydrogen-powered or electric vehicles, which require a completely
different design for the vehicle and the fueling stations. Thus, bioethanol could potentially begin
to address the problems associated with our dependence on petroleum much sooner than other
alternatives.
Despite its many advantages, there are also many disadvantages and potential problems
regarding ethanol. Its technical, political, and economic feasibility as an alternative
transportation fuel is a complex issue that involves many factors and requires consideration from
many different viewpoints. In this paper, we discuss the technical, political, and economic issues
of ethanol as a transportation fuel and the outlook for the future of ethanol in the United States.
Technical Overview
It is essential to understand the technical prospects and limitations of bioethanol in order
to realistically assess its future as a transportation fuel and to make appropriate policy decisions.
Thus, we begin our discussion of bioethanol with a technical overview of the subject. We
discuss how ethanol is produced and several key technical issues that must be considered and
addressed.
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Ethanol Production
Bioethanol can be produced from a variety of biological materials, or feedstocks; the
process used depends mostly on the type of feedstock. The three main feedstocks for ethanol
production are sugar crops, starch crops, and cellulosic material. The feedstock is the most
important factor in determining the feasibility of large-scale ethanol implementation and its
prospects for reducing greenhouse gas emissions and reducing U.S. dependence on foreign oil.
Ethanol is produced by fermenting and distilling sugar. This sugar can be obtained
directly from plants, such as sugarcane or sugar beets, or the sugar can be produced from other
substances derived from plants, such as starch or cellulose. (IEA, 2004) The conversion and
distillation process requires energy, and the type and amount of energy used contributes
substantially to the net energy production and greenhouse gas emissions of the ethanol that is
produced.
Sugar from sugar crops such as sugarcane or sugar beets can be directly fermented into
ethanol. France and other European Union countries use sugar beets, while Brazil and other
tropical countries use sugarcane. The process is simple and already practiced on an industrial
scale, especially in Brazil, where ethanol provides a substantial amount transportation fuel. This
process is not commonly used in the United States because the climate is not appropriate for
farming sugarcane and tariffs prevent large-scale importation of sugar. (IEA, 2004)
In the United States, most ethanol is produced from corn. The starch from corn is first
converted into sugar, which is then fermented into ethanol. Unfortunately, only the corn kernels
can be used to produce ethanol with this method, leaving the rest of the plant unused. The
starch-ethanol process is well developed and is already practiced on an industrial scale. (IEA,
2004)
Ethanol from cellulosic material can be produced from an enormous number of
feedstocks, including trees and grasses, agricultural and forest waste, leftover plant parts from
corn ethanol production (corn stover), and even municipal waste. Switchgrass, hybrid poplar,
and willows can be grown specifically as cellulosic ethanol feedstock. Unfortunately, the
process of converting cellulosic material into sugar that can be fermented into ethanol is more
difficult than converting starch or directly fermenting sugar from sugar crops. Because of this
difficulty, this technology has not yet been implemented on an industrial scale. However,
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because of its great potential, this process is currently the subject of extensive research and
development. (IEA, 2004)
Key Technical Issues
There are several key technical questions surrounding ethanol, each of which is discussed
in more detail below. First of all, by how much can ethanol actually reduce greenhouse gas
emissions? This depends mostly on how much energy is required to produce ethanol from
various feedstocks and where that energy comes from. Secondly, how much of U.S. gasoline
needs can be satisfied with the amount of ethanol we can actually produce? Finally, what other
environmental effects are associated with ethanol production and use?
Net energy use and greenhouse gas displacement
If ethanol is to reduce carbon dioxide emissions and U.S. reliance on foreign oil, then the
amount of energy that can be derived from the ethanol must be greater than the amount of energy
used to produce it. In other words, the ethanol production process must yield a net gain in
energy. Otherwise, other energy sources must be used to produce ethanol, and these sources
might be nonrenewables such as coal, natural gas, or petroleum products. If this is the case, then
ethanol will fail to address our original environmental and political concerns.
The net energy yield and greenhouse gas emissions of ethanol production are very
difficult to estimate, and, despite numerous studies, especially for corn ethanol, there has been no
real consensus. See, for instance, the tables summarizing various studies in the International
Energy Association’s book on biofuels (2004) and the study by Eaves and Eaves (2007).
Estimates for corn ethanol vary drastically. Some studies conclude a promisingly large net
energy output, while others find that ethanol production requires more energy than it can
produce.
Sugarcane and cellulosic ethanol seem far more promising than corn. Although it has not
been well studied, sugarcane ethanol in Brazil is estimated to reduce greenhouse gas emissions
by about 92% (IEA, 2004). The cellulosic process is still in its infancy and the methods have not
yet been implemented and optimized on an industrial scale, but studies estimate a high energy
output and, consequently, drastic greenhouse gas emission reduction (IEA, 2004). A recent field
study determined that cellulosic ethanol from switchgrass could reduce greenhouse gas
emissions by 94% (Schmer et al, 2008).
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The difficulty in making these estimates arises from the assumptions that must be used
about the energy required to grow the feedstocks, transport them, and process them into ethanol,
and the external effects of these processes. Some things that must be considered are how much
fertilizer and pesticide must be used to grow the feedstocks, how much fuel the farm equipment
needs, how much fuel is used to transport the feedstocks to the ethanol production facilities, and
how much and what type of power is needed for the distillation process. Further assumptions
must be made about typical crop yields and the efficiency of the feedstock-ethanol conversion
process. Additionally, it is extremely difficult, if not impossible, to estimate the effects of land
use change that will occur with increased farming of various feedstocks (Kammen, 2007).
Finally, the uses or effects of the co-products, or other substances produced along with the
ethanol in the conversion process, must be taken into consideration. Estimates differ because the
studies make different assumptions about each of these considerations, and each includes or
neglects certain things that other studies do not based on what the authors believe to be important
or relevant. Thus, there is no consensus on the appropriate methodology, despite attempts to
clarify it (Kammen, 2007). There are simply too many unknown and uncertain factors to
decisively predict the net energy yield and greenhouse gas emissions from ethanol (Kammen,
2007, and IEA, 2004).
Coproducts deserve further mention. In Brazil, the leftover parts of the sugarcane plant,
or bagasse, is burned to power the distillation process (IEA, 2004), unlike in the U.S. where
fossil fuel energy is used to distill corn ethanol (IEA, 2004). This drastically reduces the net
greenhouse gas emissions of Brazilian ethanol production and increases the net energy
production. Some studies suggest that leftover plant matter from the cellulosic ethanol process
(lignin that cannot be converted to ethanol) could similarly be burned to power the conversion
process (IEA, 2004, and Greene, 2007).
Thus, it is very difficult, if not impossible, to accurately predict the true potential of
ethanol to reduce greenhouse gas emissions. The prospects of corn ethanol are indeterminate,
but since there are doubts that its energy efficiency will be sufficient, we should aggressively
seek other options. Cellulosic ethanol has not been as well studied as corn ethanol, but thus far
the prospects for energy yield and greenhouse gas reduction seem unambiguously positive.
Because cellulosic feedstocks are readily available in the U.S., this option is a sensible choice.
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Gasoline Displacement
How much of our transportation fuel needs can bioethanol supply? A 2005 study by the
U.S. Department of Energy (DOE) estimates that the U.S. has “over 1.3 billion dry tons per year
of biomass potential—enough to produce biofuels to meet more than one-third of the current
demand for transportation fuels” (DOE/USDA, 2008). The extremely promising results of this
study have served to make the public and policy makers alike optimistic about the future of
biofuels.
However, this study does not take into account the amount of energy needed to grow,
fertilize, and harvest the crops or to process them into ethanol. It also specifies “current,” or
2005, transportation fuel demand. If U.S. fuel needs increase by the estimated 30% by 2025
(EIA, 2006), then this study is overly optimistic.
Most studies, including this one by the DOE, assume that the energy inputs for growing,
transporting, and processing ethanol will be from non-renewable, fossil-fuel energy sources.
Thus, their conclusions about the amount of gasoline that ethanol can displace do not actually
require ethanol to be a truly renewable energy source. A 2007 study by Eaves and Eaves (Eaves
et al, 2007) requires that all energy inputs for corn ethanol production come from corn ethanol
itself. In their analysis, the authors use the same assumptions as a 2002 study by Shapouri,
Duffield, and Wang (Shapouri et al, 2002) as a sort of best-case scenario because the results of
this study estimated one of the highest energy yields from corn ethanol. With their additional
requirement, Eaves and Eaves found that 100% of the current corn yield would only displace
about 3.5% of the current gasoline consumption, and that to achieve a 15% displacement, we
would need more than 423% of our all-time high corn harvest. This is assuming a best-case
scenario.
Perhaps it is somewhat unrealistic to assume that all the energy inputs have to be from
corn ethanol. For instance, they could instead be derived from other renewable energy sources
or nuclear power. Nevertheless, this study does bring up a valid point about the assumptions
made in other studies and emphasizes the need to consider the entire growing and production
process in our analyses.
Reliability
Because corn can be grown in the U.S., corn ethanol has been pushed as a more reliable
fuel supply than importing oil from politically unstable Middle-Eastern countries. However,
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Eaves and Eaves (2007) suggest that corn ethanol might not in fact be more reliable than
imported petroleum. Based on statistics about variability in the U.S. corn crop yield from 19602006, the authors determined that because of unpredictable weather effects, the risk associated
with relying on corn is about twice the risk associated with relying on imported petroleum from
the Middle East. Furthermore, fuel demand often increases suddenly with hot weather, and
where petroleum production can be immediately increased, corn production cannot, and the same
hot weather could actually have detrimental effects on the corn that decreases yields instead.
Thus, our total gasoline displacement could be quite variable. The reliability problem must be
taken into consideration as we transition to ethanol, and suitable backup plans should be
formulated to ensure a reliable supply during years with poor harvest.
Social and Environmental Effects
In addition to net greenhouse gas emissions reduction and ability to reduce U.S.
dependence on foreign oil, ethanol requires several other social and environmental
considerations. For instance, if we use valuable cropland for energy crops, will we have enough
cropland to grow food? Can we justify using food crops for ethanol if this significantly raises
the price of food? The United States currently supplies over 40% of world’s corn supply (Eaves
et al, 2007), so this is clearly a very important question.
Additionally, increased farming causes a multitude of environmental impacts. It is nearly
impossible to estimate the environmental effects of land use change. Deforestation, plowing, or
growing different types of crops can have very significant effects on greenhouse gas emissions
and the amount of carbon dioxide that can be absorbed by the atmosphere, and it can also be
responsible for drastic local temperature changes (Cite Kammen).
Furthermore, biodiversity loss, soil runoff, and pollution from pesticides and fertilizer
must be considered (Kammen, 2007). Sugarcane and corn ethanol distilleries produce a large
amount of effluent that, in turn, requires extensive wastewater treatment (Giampietro, 1997).
Furthermore, the distillation process requires a significant amount of water (Giampietro, 1997).
Cellulosic ethanol addresses at least some of these concerns. This process does not use
food crops, and feedstocks can be grown on marginal land that is not good for farming food
crops (Schmer et al, 2008, and IEA, 2004). Prairie grasses such as switchgrass do not need to be
replanted every year, so fields do not require plowing, which helps to avoid soil runoff and
provides better wildlife habitat (IEA, 2004). Furthermore, because agricultural, forestry, and
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municipal waste can potentially be used as feedstocks (IEA, 2004, and DOE/USDA, 2008), this
alleviates some of the need for farming and also assists with our waste disposal problem.
Technical conclusions
In conclusion, it is very difficult to estimate how effective ethanol will be in replacing
petroleum products and reducing greenhouse gas emissions in the U.S. However, it is safe to
conclude that corn ethanol alone is not a viable or worthwhile substitute for gasoline. With
industrial-scale cellulosic ethanol, however, we are much more likely to make a significant
impact on U.S. fossil fuel use. Unfortunately, because cellulosic technology is still in its infancy,
its true potential is still uncertain. Regardless of the ethanol source, proper policy is needed to
ensure that adverse environmental and social effects are avoided and that ethanol production and
consumption is as sustainable as possible.
Of course, if bioethanol is combined with other technologies, the prospects for petroleum
displacement are further improved. More efficient vehicles and hybrids will drastically help to
reduce fuel needs, and flexible-fuel vehicles that can run with a wide range of ethanol-gasoline
blend concentrations will help ease the transition from gasoline to ethanol. Genetic engineering
can decrease the need for fertilizer and pesticide and increase crop yields. Good use of
coproducts, such as using bagasse or lignin to power ethanol distilleries, will also make ethanol
more feasible and more sustainable.
Ethanol Policy
As ethanol has become a more pivotal player in the U.S. fuels market, policies
regarding ethanol have become more important, and legislators have focused increasing attention
on it. However, legislators’ main concern is to enact policies that make their constituents happy,
regardless of how their favored policies affect national concerns and regardless of how realistic
these policies are from a technical standpoint.
Legislators seek to influence the market in favor of their constituents, but they have
limited opportunities to do so in a free market economy. The government has two main tools,
subsidies and tariffs, by which it can encourage or discourage market activity. With both of
these legislative tools, there are winners and losers. This is important to note because, as stated
earlier, legislators want to secure gains for their constituents.
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Ethanol Subsidies
Subsidies can be used to support businesses that might otherwise fail or to encourage
activities that would otherwise not take place. Subsidies can be a regarded as a form of
protectionism or a barrier to trade because they make domestic goods and services artificially
competitive against imports. US corn ethanol subsidies were intended to make corn ethanol
competitive to petroleum. As a result, subsidies have been the driving force behind innovation
and development in the US fuels market. However, subsidies also distort markets. In the case of
corn ethanol, subsidies distort the true price and true return on investment.
The political response to corn ethanol subsidies was favorable. Subsidies helped
agricultural political markets. Therefore, they were supported by legislators eager to obtain
votes. Those legislators who did not have ethanol interests were not harmed by ethanol
subsidies, so they took a neutral stance. Thus, supporting subsidies made ethanol-interested
politicians better off, without making the others worse off.
Ethanol subsidies have been beneficial to corn ethanol producers and consumers.
Subsidies reduce the marginal cost of operations for producers. This, in turn, reduces the price
of corn ethanol on the market. With a reduced price, ethanol becomes a more viable alternative
to petroleum. The producers, in turn, produce and sell more. Producer surplus is increased. Just
as important, consumer surplus is increased. There is no surplus loss associated with the corn
ethanol subsidy.
Currently, there are a number of Federal and State legislative subsidies that support
corn ethanol production. For simplicity, the paper will only discuss Federal ethanol legislation.
Many federal agencies affect energy policy. Because energy affects all aspects of society,
legislation that affects energy can be found in most regulator bodies. This paper will highlight
the more important policies.
Internal Revenue Service
Whereas the energy policies of other federal departments are proactive, the Internal Revenue
Service’s energy policies are reactionary. The IRS administers energy-related programs that
affect income and payments that do not fall into the hands of other agencies. However, it is
important to note that the IRS does not enact or actively seek certain legislative actions. Its
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policies are its policies only in name. The concepts and designs were created by Congress and
the President.
Volumetric Ethanol Excise Tax Credit
Gasoline suppliers who blend ethanol with gasoline are eligible for a tax credit of 51
cents per gallon of ethanol. Petroleum currently averages $3.97 per gal (EIA 08,
accessed June 2, 2008), but part of this price is offset by the 51 cents per gallon for the
10% ethanol mix.
Small Ethanol Producer Credit
An ethanol producer with less than 60 million gallons per year in production capacity
may claim a credit of 10 cents per gallon on the first 15 million gallons produced in a
year. This means that each producer with less than 60 million gallons per year can reap a
subsidy of $1.5 million. The drawback to this policy is that provides an incentive to cap
production of 60 million per year. This credit started at 30 million gallons per year.
With demand for ethanol increasing, lobbyist will undoubtedly seek to increase this cap
again.
Because the IRS is not a shaper of tax policy, it would be safe to say that this department’s
effects on ethanol policy will be negligible.
Department of Agriculture
Unlike the IRS, the Department of Agriculture (USDA) actively seeks to create an impact
with legislation. It uses its administrative controls as a member of the Executive branch to curb
and/or increase activities. In addition, most of the programs that operate under USDA are
funded out of the USDA general fund or supplemental budget. This gives them a direct tool for
action.
Bioenergy Program
Reimburses ethanol and biodiesel producers for feedstocks necessary to expand
operations. This subsidy program was funded with $60 million for the purpose of
increasing the number of producers in the market.
Renewable Energy Systems and Energy Efficiency Improvements
Grants, loans, and loan guarantees for the development of renewable energy projects and
energy efficiency improvements. These subsidy tools allow USDA to help spur private
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business activities that are focused on USDA interests. Since USDA is lobbied by many
corn producers, many of these loans, grants and loan guarantees are to ethanol-supporting
ventures, including automobile companies looking to update lines from conventional
engine manufacturing to flexible fuel engine production. USDA has $23 million in funds
for these activities.
Value-Added Producer Grants
These are grants to independent producers for the development of value-added
agricultural activities, including biofuel production. This fund has $20.5 million.
Biorefinery Development Grants - Unfunded
If funded, would provide grants for the development and construction of biorefineries,
including biofuel plants.
Business and Industry (B&I) Guaranteed Loans
Loan guarantees for various projects that could be used for biofuels. There is $1billion in
available funds for this program. This amount covers more than just the ethanol or
transportation industry. However, with the focus placed more on transportation energy
and ethanol, a greater portion of this allotment is going to ethanol-related activities than
in previous years.
Rural Business Enterprise Grants
This program provides grants to finance and facilitate development of small and
emerging rural business enterprises. Approximately $40 million is allotted for this
program. However, as with the previous program, it encompasses more than ethanol
production. However, with much of this funding going to rural areas, it can be assumed
that the majority of this funding is going to ethanol-related expenses.
Because USDA has such engaging powers and a somewhat jurisdictional purpose, its affect on
ethanol policy will continue to be the most significant. The USDA will continue to use its
budget and executive controls to force certain actions. However, it is hard to suggest that
USDA will continue to support subsidies (in the form of tax relief) to increase the production of
ethanol. Three things will most likely occur with USDA ethanol policy:
1. Tax subsidies designed to increase market activity in lieu of reduced market
incentives will not be renewed. With current oil and subsequent petroleum prices at
the current levels, there is no need for additional tax incentives to induce additional
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conventional ethanol production. However, there is not enough solid political support
to repeal the current tax subsidies. Concurrently, it could also mean that there is not
enough support to renew them.
2. Tax incentives and other subsidies will increase for cellulosic ethanol production.
The democratic legislative process to solidify wins is to appease the losers.
Therefore, if those legislators who do not want to renew current ethanol subsidies
want to ensure that they are not renewed (as a way of cooling the market so that corn
prices drop for their constituents), they can do this by increasing incentives for
cellulosic production which may not drive up the price of all other foods.
3. Because USDA is a part of the Executive branch and not the Legislative Branch,
supplemental programs like loan and grant programs will change based on the whims
of the elected Presidential Administration. What is certain is that those loan and grant
programs supporting conventional ethanol production will be funded through
supplemental budgets. It would be hard for these programs to be funded through the
general fund budget process. General funds are overly scrutinized by legislators.
Supplemental budgets, although substantial, are not nearly as big as their general fund
counterparts. Thus, they are less scrutinized.
Department of Energy
The Department of Energy (DOE) is committed to reducing America’s energy dependence on
foreign oil. (DOE 08) DOE focuses its policies on stimulating research and development. It is
the best use of funds because of the potential returns on investment. In addition, these research
and development-encouraging activities subsidize research in the private sector. This is research
that would otherwise not occur because it is too expensive and the return on investment or return
to scale is too low.
Biomass Research and Development Initiative
This program provides grants for biomass research, development, and demonstration
projects. The original funding amount was $12 million. However, this allocation is
expected to be increased massively.
Biorefinery Project Grants
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This program funds cooperative research and development of biomass for fuels, power,
chemicals, and other products. The 2007 allocation was $91 million. The amount was
increased in 2008. In February of this year, the DOE announced that it was awarding
$385 million to six cellulosic biofuel refineries over the course of four years.
Loan Guarantees for Ethanol and Commercial Byproducts from Various Feedstocks
This is several programs of loan guarantees to construct facilities that produce ethanol
and other commercial products from cellulosic material, municipal solid waste, and/or
sugarcane.
The Department of Energy is a very technical branch of the government. Its recommendations
and objectives are less affected by political whims than the other branches. Therefore, the DOE
will continue to advocate and engage in programs that seek to yield returns to scale and returns
on investment. With the externalities of corn ethanol production causing major problems, the
DOE will begin to focus on cellulosic production with more vigor. Corn ethanol does not yield
enough energy in relation to its affect on the market to warrant DOE resource investment.
Therefore, DOE will reduce corn ethanol support and begin to explore the potential of cellulosic
ethanol. The department’s technical nature will allow it to do so with little backlash.
Ethanol Tariffs
A tariff is a tax on goods upon importation. When a ship arrives in port, a customs officer
inspects the contents and charges a tax according to the tariff formula. Since the goods cannot be
landed until the tax is paid, it is the easiest tax to collect, and the cost of collection is small. For
American corn ethanol producers, tariffs have been a barrier to overseas competition. The U.S.
and Brazil are world leaders in ethanol production, with the US capturing about 36% of the
market in 2006 (Gonzales et.al 2007). However, since there is such massive demand, there is
still a market for foreign ethanol. Currently, tariffs put foreign ethanol at a competitive price
disadvantage.
As with subsidies, it is important to understand who wins and who loses in a tariff.
Tariffs increase the price of foreign goods. Unlike with a surplus, price increases and quantity
decreases. In addition, there is deadweight loss. It is important to note that tariffs create an
inefficient market. All possible gains from trade are not realized. Producers receive a surplus
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increase. Consumers see a surplus decrease. That decreased consumer surplus is actually
transferred as additional producer surplus and tax revenue.
The intent of U.S. ethanol tariffs is to price foreign ethanol out of the market. With a
tariff, the cost of ethanol from foreign producers is higher than from U.S. producers. U.S.
suppliers are willing to fill demand until there is a U.S. supply U.S. demand equilibrium. Even
though foreign suppliers would be able to supply additional demand, the price they would have
to charge for ethanol falls outside the demand curve at all points beyond the quantity provided by
U.S. suppliers. Therefore, they do not provide ethanol to the U.S. market. In this case, the
consumers miss out on additional fuel.
The most important ethanol-related tariff is the Omnibus Reconciliation Tax Act of 1979.
Reconciliation is a legislative process of the U.S. Senate intended to allow a contentious budget
bill to be considered without being subject to filibuster. Reconciliation also applies in the U.S.
House of Representatives, but since the House regularly passes rules that constrain debate and
amendment, the reconciliation process represented less of a change in that body (Yacobucci,
2006). They act as a catch-all for items not enacted in other bills. The Omnibus Reconciliation
Tax Act of 1979 included a provision that placed a tariff on all imported ethanol. This tax,
currently at 54 cents per gallon of ethanol, was originally intended to protect the oil companies.
However, it is now a protection tool for U.S. farmers. It expires at the end of 2009.
Politically, the renewal process for this tariff will be quite a contentious battle. However,
there will probably not be enough support to renew this tariff. Once it expires, the cornproducing states will not have enough weight to push it through. This tariff will expire on the
eve of a midterm election year, with the externalities of this tariff being felt by most consumers.
Since the only winners in this legislation are corn producers, and everyone else loses out because
of the high subsequent food prices, collective action will not allow a renewal to go through. As a
result, Brazilian and other ethanol sources will start to flood into the U.S. fuels market.
Political Economy
Public Policy is not a measure of which policies are the most efficient. It is a measure of
preference alignments, informational asymmetries, and re-election strategies. Therefore, before
discussing which policies are best suited to encourage ethanol production, it is important to
understand how legislators decide on which policies to vote for and against.
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Legislators in the U.S. operate under transparency. Because they operate under complete
transparency, voters can decide whether to re-elect their officials based on the official’s actions.
However, there are costs associated with every action. In Congress, those costs could be
anything from lost support on other bills to a lost job opportunity after public service. Therefore,
when making a decision whether or not support a bill, an elected official weighs whether the cost
of supporting that bill is greater than or equal to the benefit of supporting the bill, which, in this
case, is getting reelected. Even with this equation, other actions done by the elected officials
may affect their chances of getting reelected. So if the politician believes that the probability of
getting re-elected by supporting the bill multiplied by the benefit of being reelected generates a
value to the legislator that is greater than the costs associated with supporting the bill, he votes in
favor of it. If the costs are higher, he does not.
In the case of corn ethanol, any politician with constituencies in agricultural regions will
definitely support tariffs and subsidies. For politicians outside of these regions, supporting or not
supporting these bills was traditionally a measure of favors. Since corn ethanol was such a
marginal player in the fuel market, its externalities were not too invasive. As a result, a non-corn
state legislator who supported corn ethanol legislation without a favor returned was still left no
worse off.
This is no longer the case. Elected officials and their constituents outside of corn areas
are now worse off. So, the cost for these legislators to support corn ethanol subsidies is now
higher than the probability of getting re-elected times the benefits of being re-elected. It would
be hard for any of these legislators to support ethanol import tariffs. It would be easier to support
subsidies, so long as they encourage cellulosic processes or encouraged activities in their areas.
In addition, there is an asymmetric information problem. Asymmetric information is
when one knows more than the other person in a partnership. In the classic principal-agent
example, the agent takes an action on behalf of the principal. Either the agent or the principal
uses the asymmetry to make choices that may or may not be aligned with the preferences of the
other. In the case of legislation, elected officials are the agents and the voters are the principals.
If the voters (principals) are not as completely informed as they should be about the total effects
of ethanol, the elected officials (agents) can make legislation on their behalf even when it is not
in their best interests. This was the case in regards to ethanol until recently. The general
population does not have complete information about ethanol’s affects on climate change or the
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amount of oil displacement ethanol is able to generate. The general population does however,
have an understanding of how it affects prices of other goods. This is enough information for
voters to signal to their agents their preferences. This signal is in the form of complaints about
food prices. As a result it turns into a preference for less favorable legislation for corn ethanol
producers. Even though total information about corn ethanol production is still asymmetric, the
preferences of principles and agents are still aligned and the agent knows what is expected.
Thus, when corn ethanol legislation is presented, the elected official can begin an accurate
cost/benefit analysis to determine his/her vote.
Policy Strategy Recommendations
Ethanol is not the sole answer to the future of American energy. Even with cellulosic
ethanol production, ethanol cannot satisfy all of, or even most of, our gasoline needs. Because
of this, it important that all policies enacted take a portfolio approach.
America’s energy portfolio needs to consist of renewable energy from multiple sources.
With the effect of high corn prices on the rest of the American and world food markets, it is
almost imperative that a different alternative to fossil fuels be exploited. Policies that support
this expansive version of an energy portfolio are in the best interest of all politicians. Therefore,
collective action should not be a problem. As the information asymmetries continue to equalize
and food costs continue to rise, the ability of Congress to pass traditional ethanol-supporting
policies will fall. These policies will shift to cellulosic encouraging tools, decreased barriers to
trade, and other, higher energy yielding alternatives.
The Economics of Bioethanol
While many questions surrounding ethanol’s validity as an alternative fuel source to
gasoline have revolve around technical feasibility, environmental concerns, and political issues,
the question that really draws the bottom line is the following: is ethanol economically feasible?
It is true that both supply and demand for ethanol in recent years have soared, making the United
States both the biggest ethanol producer and consumer in the world (Renewable Fuel
Association, "Changing the Climate – Ethanol Industry Outlook 2008."), but it is also true that
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prices for ethanol have risen in the last few years, and that recent public backlash as a result of
increased food prices have not endeared consumers to the product.
The vast majority of ethanol produced in the United States is made from corn (Energy
Information Administration, “Biofuels in the U.S. Transportation Sector.”), and questions have
arisen as to the impact this sudden demand for corn as a feedstock is having on corn prices (and
consequently on global food grain indices). Corn prices have increased sharply in the last year,
sparking global food riots and a general concern that food prices may not be able to recover from
this demand shock (CNN, "Riots, instability spread as food prices skyrocket."). Is ethanol in fact
responsible for these huge price increases, or are these a result of increases in global food
demand in general? Will the continued growth of the ethanol industry worsen the problem, or
will there be a shift in feedstock usage?
The last question that needs asking as far as ethanol goes is: how far can it go? Since
ethanol is produced from biomass, and there is only a finite amount of arable land in the United
States, there exists a glass ceiling after which the industry will begin to witness a rapid series of
diminishing returns that can only be overcome by technological advances. Cellulosic ethanol
provides some hope in this arena, but even it has its limits – no matter how “renewable” ethanol
may be, a certain quantity of feedstock must be generated every year in order to fuel that
renewable source of energy.
Food vs. Fuel
In April of this year, corn reached $6 a bushel after years of being priced below $2
(Associated Press, "Corn Hits $6 a Bushel on Tight Supplies.") Many have blamed the ethanol
industry for this, and with good cause - In 2007, U.S. corn growers produced 13M bushels, of
which 2.3M bushels were used by ethanol producers, or approximately 18%. This transfer of
nearly a fifth of the corn harvest from food to ethanol has greatly increased demand for corn, and
has caused other farmers to begin planting corn instead of other crops (which has increased
prices for almost all grain foods). These increased food prices have resulted in global food riots
(CNN, "Riots, instability spread as food prices skyrocket."), and the release of millions of dollars
of food aid from agencies such as the World Bank. While there is a consensus that increased
ethanol production bears some responsibility for the increased food prices, exactly how much of
the price change is being caused by ethanol is subject to debate. There is unquestionably
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increased demand for food itself, which is driving up prices across the board. Additionally, the
huge increases in gasoline prices over the last few years (and last few months in particular) have
driven up the cost of production at every stage – from processing and packaging to
transportation.
Although food prices may remain high, it seems improbable that ethanol will be the most
critical factor in any long-term high price level for food. There are a number of reasons for this.
First of all, the introduction of cellulosic ethanol will allow for a vast shift for the ethanol
industry from corn-based feedstock to more attractive and higher-yield per acre crops. If this is
done for crops like switchgrass (which cannot be used for food) it will greatly reduce the
influence that the ethanol feedstock market currently has on the food market, effectively
eliminating the food vs. fuel debacle. Secondly, high food prices will encourage entrepreneurs to
enter the corn production market (although if high gasoline prices are in fact the reason for the
high prices, then since the costs of production will have risen significantly others may be
discouraged from entering). The real barrier to overcoming the food vs. fuel problem in this
case is the corn industry itself, which has had organizations such as the National Corn Grower’s
Association (NCGA) lobby Washington aggressively to ensure that corn remains the primary
feedstock for ethanol produced in the U.S.
As discussed previously, in 2005, the U.S. Department of Agriculture and the Department
of Energy teamed up to work on a long-term renewable feedstock estimation study. The purpose
of the study was to provide a rough estimate of how much biomass could realistically be
produced at a renewable rate for bioenergy production (note that the study does not limit
feedstock use to grain-based ethanol). Currently, only 18M tons of biomass are used to produce
grain-based ethanol and similar biofuels – the study estimates that in the short run, the U.S.
could foreseeably produce up to 56M tons (moderate estimate with perennial crops and land
change use) and potentially up to 87M tons just for grain-based biofuels. In the long run, the
study estimates a potential for between 73M – 113M tons of biomass being renewably produced
for grain-based biofuels consumption – or between four to six times the current amount of
feedstock (U.S. Department of Energy, United States Department of Agriculture, “Biomass as
Feedstock for a Bioenergy and Bioproducts Industry: The Technical Feasibility of a Billion-Ton
Annual Supply.”) for grain-based biofuels alone. This study assumed that current ethanol
production technologies would remain more or less the same, and therefore does not take into
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account the possibilities provided by cellulosic ethanol, which given the same amount of
feedstock has the potential to produce much more ethanol. It also did not address the potential
for this renewable quantity of fuel to disrupt prices or other demand, assuming ceteris paribus
conditions (raising questions as to how much biomass could realistically be renewably generated
without disrupting the food market).
Ethanol demand in the United States
As ethanol in the United States serves no other major industrial purpose than that of
vehicle fuel for the moment, demand for fuel ethanol can be derived by looking at the demand
for vehicle fuel in the U.S. in general. Looking at the Energy Information Administration’s
statistics on gasoline demand in 2007, U.S. consumers purchased an average of 9,290,000
barrels/day (Energy Information Administration, "U.S. Product Supplied for Crude Oil and
Petroleum Products."). With 365 days in a year and 42 gallons to the barrel, this roughly equates
to about 142BG/Y (billion gallons per year in 2007). While exact figures have yet to be
computed for the U.S.’ ethanol consumption in 2007, the Renewable Fuels Association reported
that there were 6.5BG/Y produced in the U.S. last year with only a token 450MG/Y net imports
(Renewable Fuel Association, “Industry Statistics.”). Since ethanol has approximately 70-80%
(depending on the type of ethanol used, vehicle used, etc.) of the fuel economy of gasoline in
terms of mileage (D.O.E. - Fueleconomy.gov, "Ethanol"), this means that the amount of ethanol
produced in the U.S. in 2007 equates to about 4.8BG/Y in terms of gasoline equivalence – or
3.4% of the U.S.’ vehicle fuel demand.
U.S. ETHANOL DEMAND (MILLION GALLONS)
2002
2003
2004
2005
2006
2007
2,130
2,800
3,400
3,904
4,855
6,500
Imports
46
61
161
135
653.3
450
Exports
n/a
n/a
n/a
7.99
n/a
n/a
Stocks Change
-91
39
-31
-17.98
108.1
-
Demand
2,085
2,900
3,530
4,048.9
5,377.4
-
U.S.
Production
SOURCE: RFA, INTERNATIONAL TRADE COMMISSION, JIM JORDAN & ASSOCIATES
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Looking at the increasing demand for ethanol in the past four years (see table above),
there is no question that the industry is in a period of rapid growth. Much of this growth can be
attributed to the U.S. government’s ban on MTBE, a gasoline additive, which gasoline suppliers
have sought to replace with ethanol (Energy Information Administration, “Biofuels in the U.S.
Transportation Sector.”). Further, even if the demand for a gasoline fuel replacement did not
already exist in the market, the recent signing into law of the 2007 Energy Independence and
Security Act (H.R. 6) mandates that U.S. producers generate 36BG/Y of renewable fuels by 2022
– giving the ethanol industry the full backing of the U.S. government (Renewable Fuel
Association, "Changing the Climate – Ethanol Industry Outlook 2008.").
However, there are still two large roadblocks that lie between the state of the industry
today and the 36BG/Y target. First, requiring that 60% of that 36BG/Y, or 21BG/Y of the
renewable fuels be “advanced biofuels” or cellulosic ethanol is problematic insofar as that there
currently are not cellulosic ethanol plants operating at commercial capacity in the United States
(and, as noted above, initial capital costs could be extremely prohibitive). While the bill
admittedly does earmark $500M annually to aid those in production of advanced biofuels with
80% green house gas (GHG) emissions, the lack of a working and established technology
presents a serious barrier to such a mandate (Renewable Fuel Association, "Cellulosic Ethanol.").
The Department of Energy’s Energy Information Administration has cautiously suggested that
there may not be enough cellulosic biofuels being generated in 2022 to meet H.R. 6’s
requirements, in which case H.R. 6 includes a stipulation that would introduce a subsidy
specifically for cellulosic ethanol at that point and would also lower required total production to
32.5BG/Y (Energy Information Administration, "Annual Energy Outlook 2008."). Secondly, by
increasing mandated ethanol production by such a large gap without an established cellulosic
technology, corn-based ethanol production is liable to be ramped up substantially as well - which
would be extremely problematic for the U.S. grain market, consumers in general, and the
probably the environment.
The E.I.A. has projected that U.S. petroleum consumption will increase by about 30% by
2025, meaning that projected U.S. gasoline demand in 2025 would be approximately 185BG/Y
(Energy Information Administration, "Annual Energy Outlook 2006 - Table A4, World Oil
Consumption by Region, Reference Case 1990 - 2030"). Assuming that the E.I.A. is incorrect in
its projections and that the ethanol industry is able to meet H.R. 6’s requirements, annual ethanol
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production of 36BG/Y would replace approximately 27BG/Y worth of liquid fuel demand, or
14.5%. This number should hopefully make clear the fact that ethanol is not a replacement for
gasoline in terms of liquid fuel. That said, it does offer the potential to greatly reduce U.S.
overall fuel consumption, lowering U.S. reliance on foreign fuel and potentially lowering
gasoline prices by decreasing global demand for petroleum.
Economic feasibility
In the E.I.A.’s February 2007 analysis of the biofuels industry, they noted that,
“Assuming corn prices of about $2 per bushel and excluding capital costs, corn-based ethanol
can be produced by the dry-milling process for approximately $1.00 to $1.06 per gallon” (Energy
Information Administration, “Biofuels in the U.S. Transportation Sector.”). Since that time, corn
prices have more than tripled to over $6 (Associated Press, "Corn Hits $6 a Bushel on Tight
Supplies"), and fuel costs have continued to rise. A study done in 2002 by the U.S. Department
of Agriculture noted that the last time corn prices peaked (to $3.92/bu) in 1996), the feedstock
cost to produce a gallon of ethanol alone rose from around 60¢ (when corn was $2.20/bu) to $1,
and other costs were estimated to be at around 41¢, raising the cost of ethanol production to
around $1.41 (U.S. Department of Agriculture, "USDA's 2002 Ethanol Cost-of-Production
Survey"). Presumably, with corn prices now at $6/bu and fuel costs at practically $4/gal, a quick
estimate for feedstock costs would be around $1.45/gal and likely upwards of 55¢ for other
production costs, for a minimum of $2/gal costs (at the bottom end). This cost per gallon
estimate is also provided by the Renewable Fuel Assocation in their most recent Industry
Outlook 2008 publication (Renewable Fuel Association, "Changing the Climate – Ethanol
Industry Outlook 2008.").
Since ethanol is currently selling for about $2.86 (DTN Ethanol Center, “DTN Ethanol
Center Latest News.”), one would be inclined to think that this disparity indicates a healthy profit
margin. In fact, it does not. For starters, it does not include transportation costs to the pump,
which can be considerable – particularly when one considers the fact that the vast majority of
ethanol is produced in the Midwest and requires transportation to the other states for retail.
Inclusion of such transportation costs causes ethanol to be priced at $3.40/gal in Alabama, which
is not cost-competitive with gasoline (ethanol has only about 75% of the fuel efficiency of
gasoline) (D.O.E. - Fueleconomy.gov, "Ethanol").
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Additionally, the bigger question that needs to be asked is whether or not this level of
profitability is enough to cover the initial capital costs of an ethanol plant. Going off of the
estimated cost of $2/gal, plant construction costs become a big problem – especially since fuel
costs are variable. It is easy to envision a scenario where even a $1 drop in fuel prices could put
an end to ethanol’s economic viability – as $2.86/gal ethanol is no match for $3/gal gasoline
(even if the fuel portion of ethanol’s production costs were to drop to pre-2000 levels, it would
still cost too much to make with transportation costs factored in). However, it is difficult to
construct a scenario describing the problem facing those seeking to construct a new plant as
construction costs are not widely available – suffice it to say that those seeking to bring new
plants online face a serious feasibility question that depends strongly on the price of fuel.
The bottom line in terms of ethanol’s economic feasibility is ultimately a matter of
feedstock costs and the costs of other fuels – petroleum in particular. For every dollar per gallon
that petroleum prices increase, the cost of ethanol production (not including transportation)
seems to increase by about 8¢. Because transportation costs vary depending on the destination, it
is safe to say that ethanol’s profitability also depends a great deal on the distance between the
plant and the point of sale. It is important also to keep in mind that as fuel costs increase, ethanol
becomes more attractive as an alternative – increasing demand.
The last question that needs to be asked in regards to the ethanol industry is as follows –
if the math provided above is correct, why is the U.S. ethanol industry being subsidized so
heavily? Even with high transportation costs, it is improbable that said transport costs would be
responsible for upwards of $1.40 a gallon, as seems to be the case in Alabama. While subsidies
for cellulosic ethanol development (mentioned in the technical part of this essay) are
understandable due to high estimated initial production costs – potentially up to $375 million for
a first-of-a-kind plant (according to the E.I.A.) (Energy Information Administration, “Biofuels in
the U.S. Transportation Sector.”), it seems that corn-based ethanol is no longer in need of the
plethora of subsidies it has been granted. Taxpayers would do well to look to where the money
for the development of this industry is being spent – it need no longer be directed to corn
producers and corn-based ethanol manufacturers, but rather to those seeking to truly develop the
technology to improve the industry as a whole.
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Conclusions
In the long run, there is no question that ethanol looks promising as a gasoline
replacement. Demand and supply are both growing at an unprecedented rate, largely because it
has the potential to reduce U.S. dependence on foreign oil, to lower greenhouse gas emissions,
and can be used as fuel with little to no engine modifications. That said, there are some major
hurdles the ethanol industry will need to overcome if it wishes to be truly feasible – the first of
which will be finding a replacement for corn as a feedstock. Greenhouse gas emissions vary
greatly depending on the feedstock type used and how the feedstock is grown, and corn is one of
the worst relative to potential feedstock sources such as sugarcane. Reducing U.S. dependence
on foreign oil may not be an improvement if corn crop yields turn out to be even more volatile.
In fact, a closer examination of corn as a feedstock in general seems to indicate that corn’s time
as the primary feedstock in U.S.-produced ethanol may be coming to a close.
The two reasons that corn has survived for so long as the primary feedstock in U.S.produced ethanol have been technical and policy-related. For one, it is difficult to make ethanol
out of feedstock sources other than corn in the U.S. because sugarcane does not grow well in the
U.S. climates and cellulosic technologies do not exist at the commercial level yet. Secondly,
U.S. ethanol producers have been subsidized heavily for using corn as a feedstock, further
incentivizing the use of home-grown corn as opposed to imported sugarcane or other
alternatives.
All of this is about to change. The Energy Independence and Security Act of 2007 has
devoted huge swaths of money to the development of cellulosic processes, as well as mandating
that U.S. producers be capable of creating 36BG/Y. The tax subsidies for corn are likely to run
out soon, and while in the past they might have been renewed without much fus,s there is now
too much attention on the corn growing industry as a result of the food vs. fuel crisis.
Constituents outside of corn-growing regions are not happy with the increased food prices, and
as a result their representatives will likely push against any renewal of the corn subsidies. Lastly,
the Omnibus Reconciliation Tax Act of 1979 will run out in the near future, and it is probable
that it will not be renewed for the same reasons, allowing for an influx of Brazilian sugarcanebased ethanol, destabilizing the corn-based ethanol market.
Before the increased attention to ethanol and the food vs. fuel crisis, politicians could
support corn-based ethanol without repercussions. Now, that is no longer the case. The
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increasingly damaging effects of corn-based ethanol have come to light, and while the industry is
certainly far from demise, it is safe to say that its growth is about to experience a sharp falloff.
In its place will rise cellulosic ethanol production technologies, imported Brazilian feedstocks
and ethanol, and higher-efficiency methods of corn crop growth. In the end, the future for
ethanol looks bright – even as the future for corn-based ethanol looks darkest.
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