Private businesses shut down mistakes that can’t be fixed. Governments make hopeless programs bigger and claim success.
With tax incentives and a market mandate, the US government has stirred up a national craze over fuel ethanol. Politicians from both major parties, including President George W. Bush, have oversold ethanol as a way to reduce US dependence on foreign oil and improve air quality. In truth, the purpose is political: to stimulate agricultural businesses and farm-state economies. There’d be nothing horrible about that if the help came at no one else’s expense. But the ethanol program costs fuel consumers and taxpayers plenty.
The craze, however, has begun. Automakers enticed by tax breaks have co-opted the ethanol lobby’s environmental exaggerations to tout flexible-fuel vehicles. Politicians claim to have done something for energy independence. And ethanol plants, some of them helped by tax breaks, are proliferating.
Overshooting standards
In fact, total US capacity to produce grain ethanol probably will overshoot the generous renewable fuel standards Congress set when it passed the Energy Policy Act of 2005. The law increases the ethanol mandate to 7.5 billion gal/year by 2012. According to Senate committee testimony last month by Keith Collins, chief economist of the Department of Agriculture, if many of the ethanol plants now planned come into being, capacity might reach 8.5 billion gal/year by 2008-09 and exceed 10 billion gal/year by 2010.
The tendency of manufacturing capacity to overshoot demand typifies any profitable industry with low barriers to entry. Lately, the production of ethanol has been very profitable. And tax breaks for blenders and small producers of ethanol encourage plant construction. With a government-sponsored boom under way, ethanol production capacity could be 33% overbuilt relative to the 2012 mandate within 3 years.
What then? According to Collins, if crude prices remain above $50/bbl, keeping gasoline and therefore ethanol prices high, and if corn prices don’t rise “considerably,” ethanol will stay competitive with gasoline and allow consumption to exceed the minimum levels set by Congress. But the wrong combination of oil and corn prices could make a lot of ethanol capacity surplus to demand. If that happens, ethanol prices will slump. At last report, of course, oil prices were falling. In his statement, Collins said corn prices could set record highs during the next 5-6 years.
When market-wrecking surpluses hit private business, manufacturers respond by idling capacity. They permanently close plants that show no hope of regaining profitability. Eventually, demand restored by low prices combines with supply lowered by capacity withdrawals to bring prices back to profitable levels. The process is painful. But it’s business.
This won’t happen with ethanol, which is not a real business. The fuel ethanol industry is a creature of government. Investors in ethanol plants threatened by adverse corn and ethanol price movements will naturally resort to government for protection against the types of market risks real businesses must manage on their own. And the government will respond.
Lawmakers in both houses of Congress already have proposed bills that would, in various ways, require more ethanol. There will be no overbuilding of ethanol capacity relative to the mandate, which Congress will just keep raising to prolong the building craze. Politicians take care of the industries they create. In response to potential problems with ethanol profitability, they’ll simply make the industry bigger. And they’ll claim success-reduced oil imports, environmental improvements, and all the other hokum that led to this mistake.
Program will expand
Ethanol won’t deliver on the hype. Its manufacture and distribution, coupled with the increased fertilization required to boost crop yields to meet growing needs for grain, will require as much energy-most of it from fossil sources-as ethanol supplies. And rising use of gasoline-ethanol blends will, in many areas, aggravate ozone smog.
The program, however, will expand. Congress has made a political investment. There’s no turning back. The ethanol mandate will grow. And the oil and gas industry should not let anyone forget that the expansion will occur to prop up the price of an already costly component of vehicle fuel.