Ethanol in the Tank

by Richard T. Stuebi

The news seems everywhere these days that ethanol is dead as a doornail:

October 21, Financial Times: “Investors Suffer As U.S. Ethanol Boom Dries Up”
November 5, Bloomberg: “VeraSun Doomed; Goldman Stops Ethanol Stock Coverage”

It’s easy to pin the tough times for ethanol on the left-right combination of precipitous declines in oil/gasoline prices and the global credit crunch. True, ethanol plants are capital-intensive, and a reduction in product price is never a good thing for any producer.

But I believe the issue is less about fuel prices and capital markets than about corn.

Many have long been skeptical about corn-based ethanol purely from an economic perspective. Of course, as has been amply documented, corn ethanol has been the beneficiary of some pretty substantial subsidies, without which much less ethanol would have made it to market. But earlier this year, even when oil was nearing $150/barrel and gasoline was over $4.00/gallon, a number of U.S. ethanol producers were having financial difficulties.

Why? Because corn prices were rising even faster than fuel prices. Remember: these refineries make money as a function of the spread between feedstock and product price, not of the product price itself. If the feedstock price is rising faster than the product price, then even if the product price is at historical highs, producers can be squeezed.

Until ethanol demand surged in recent years (propelled by increasing government mandates), the linkages between corn and fuel prices were weak. However, as a recent article by columnist Doug Saunders of The Globe and Mail in Toronto points out, “food is no longer just food”. In Saunders’ terms, “there has been a “bushels-to-barrels-to-Btus convergence”. After all, both oil and bread have calorific content, and technologies now are allowing one to be swapped for the other, depending upon which is more economic in a particular market.

This then leads to the other “black mark” against (corn-based) ethanol: the so-called “food vs. fuel” debate. To many observers, it is unethical to be using products fundamental to human food consumption as a substitute for petroleum-based fuels, as this added demand for foodstuffs bids up prices and makes eating more expensive — especially problematic for the world’s poor (see 2007 article on this topic by C. Ford Runge and Benjamin Senauer in Foreign Affairs). This has led Jean Zigler of the United Nations to recently declare that biofuels are a “crime against humanity”.

A strongly argued counterpoint is offered by Robert Zubrin and Gal Luft. With pretty significant substantiation, they claim that increases in the price of corn have not been driven by any push to produce ethanol. Instead, they find that all of the increase in corn prices has been due to the combined factors of increased natural gas prices (thereby raising the price of fertilizer), increased transportation and processing costs (due to higher gasoline/diesel prices), and increased demand for corn in massive rapidly-growing developing economies (e.g., China). In short, according to Zubrin and Luft, ethanol is not to blame for woes facing corn consumer.

That may or may not be so. But, it seems unarguable that corn is to blame for the woes facing ethanol.

President-elect Obama may be a “supporter” of ethanol, but unless and until cellulosic ethanol technologies become viable, ethanol will have a hard time becoming — and staying — a major player in the transportation fuel game.

This is especially the case when factoring in the massive investment required to convert the U.S. infrastructure of distribution, retailing and vehicle tanks from gasoline to ethanol-capable. And, this is even more so the case considering that biofuels innovators are actively working on technologies that enable biogasoline — gasoline from bio-feedstocks.

With all these strikes against ethanol, it’s no wonder all the obituaries are being written.

Richard T. Stuebi is the BP Fellow for Energy and Environmental Advancement at The Cleveland Foundation, and is also the Founder and President of NextWave Energy, Inc.

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