Ethanol and oil prices
Anyone mystified by oil prices need wonder no more. An economics professor at Northwestern University's Kellogg School of Management offers an explanation for sluggish prices of the past decade: ethanol.
Yes, ethanol, the gasoline additive that wouldn't be economic without large federal subsidies. Among other wondrous feats, says a study by Michael K. Evans for the Midwestern Governors' Conference, ethanol is holding down the price of oil.
Ethanol boosters are using the study, The Economic Impact of the Demand for Ethanol, to parry a March report by the General Accounting Office critical of tax incentives for fuel ethanol produced from grain. Rep. Bill Archer (R-Tex.), chairman of the House ways and means committee, cited the GAO study in a call last month for an end to ethanol tax breaks, which include a partial exemption from the federal motor fuel excise and credits against income tax of as much as 54¢/gal.
Prices and production
The Northwestern study says 1997 ethanol demand totaling 1.52 billion gal will raise demand for grain by 600 million bushels. A consequent price jump will trim demand for corn elsewhere, leaving a net gain in corn production of 420 million bushels. The corn price is 45¢/bushel-18.6%-higher than it would be without the demand lift.
Many good things happen in farm states as a result, says the study. In 1997, gross farm income rises by $5 billion, net farm income by $4.5 billion. Employment rises by 195,200. Tax receipts rise in farm states. Federal tax receipts rise by $3.6 billion. Federal unemployment payments drop by $600 million, offsetting subsidy costs. The trade balance improves by $2 billion because of increases in exports of ethanol by-products and declines in imports of gasoline and oxygenates.
But what about that 45¢/bushel increase in the price of corn? This is, after all, essentially a tax on food, estimated by the study at $3.2 billion/year.
"The increase in food prices caused by the demand for ethanol will be fully offset by a decline in the price of energy," says the study. "Hence there will be no negative impact on the cost of living caused by the demand for ethanol."
Ethanol's suppression of the price of energy, especially oil, thus is crucial to the findings. The study assumes that energy prices drop by 1% because domestic ethanol production reduces the volume of imported oil by 1%. No such relationship exists. But the assumption that one does enables energy costs in the study to fall by $3.2 billion, exactly the amount by which food prices rise due to federally stimulated corn demand.
If ethanol really is suppressing energy prices by some measurable amount, income and employment should suffer in oil and gas producing states. Drilling should be some degree less than it would be otherwise. So should oil field employment and tax revenues. If the Northwestern study is correct, the grain price effects of ethanol subsidies create jobs in states that produce grain and depress employment in states that produce oil and gas. The politics of this should raise alarms.
What if oil state lawmakers employed the same logic? What if Archer, for example, requested federal measures to lift wellhead oil and gas prices by 18.6% so more roughnecks and toolpushers in Texas could find work? He'd be laughed off the House floor.
Flawed proposition
The Northwestern study's basic proposition is flawed beyond repair. The notion, so critical to the study, that ethanol restrains energy prices is unreasonable. In a 17.4 million b/d oil market, an import swing of 36 million bbl/year means very little. It certainly cannot suppress energy prices enough to offset the effects on food of an 18.6% cushion under corn prices. The study crumbles around this point.
There is no way to camouflage the ethanol subsidy's economic distortions. It is a costly political favor to ethanol producers. For his efforts to kill it, Archer deserves the oil and gas industry's vigorous support.
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