The Dismal State of Biofuels Policy

Biofuels policy in the United States remains controversial and much debated. In the months since BP’s catastrophic deep-water oil rig explosion, the international debate over energy, ever inclined to drift on the winds of current events, has been captured by the fiasco in the Gulf of Mexico and the environmental destruction caused by the errors of BP, Transocean, and Haliburton. Not knowing how to respond, politicians, including President Obama, have called for new, non–petroleum-based “clean” energy.

The pall cast over the U.S. energy future by the ruptured well in the Gulf has worked in odd ways. On the one hand, petroleum extraction and consumption, on which the entire industrial enterprise is clearly staked for now and in the reasonably foreseeable future, have risks. We already knew about the air pollution and climate hazards of an oil economy, but the risks of undersea extraction were largely ignored. Part of the reaction to what happened in the Gulf has been increased interest in alternative energy sources such as ethanol. Yet the irony is that well before the BP disaster, the use of petroleum-based nitrogen fertilizer to grow corn, nearly a third of which now goes to make ethanol, had polluted the Gulf of Mexico. After the surge in corn plantings in 2007 and 2008, largely for use in ethanol production, the hypoxic or “dead zone” in the Gulf caused by the runoff of nitrogen reached its largest extent in 25 years. The BP spill simply added to the Gulf’s ecological problems.

Meanwhile, the non–market-based stimulus to the U.S. biofuels sector shows no sign of abating, despite the fact that even if every bushel of corn produced domestically were dedicated to biofuels, it would support only about 15% of vehicular energy demand. Congressionally mandated usage requirements have diverted corn from food and feed uses to fuel uses regardless of supply conditions or price levels. Far from moderating this policy, President Obama has called for an increase in the currently mandated level of biofuel production, from 36 billion gallons by 2022, including 15 billion gallons of corn ethanol, to 60 billion gallons by 2030.

According to estimates by Earth Track founder Douglas Koplow, if current laws are maintained until 2022, the biofuels industry will receive more than $60 billion per year in subsidies, more than six times the $9.5 billion in support received in 2008. Cumulative subsidies between 2018 and 2022 are expected to total $420 billion. If the Obama plan to require 60 billion gallons by 2030 comes to pass, subsidies in that year would be $125 billion, and cumulative support from 2008 to 2030 would be in excess of $1 trillion.

Congress intended that corn would be used for only 15 of the 36 billion gallons of mandated ethanol production. The rest is supposed to come from cellulosic alternatives based on feedstocks such as switchgrass. However, the 2010 mandated cellulosic blend had to be scaled back by 95% because the cellulosic fuel was commercially unavailable.

In May 2010, the U.S. Department of Agriculture (USDA) issued a critical assessment of the difficulties of cellulosic alternatives. U.S. production capacity for cellulosic fuels was estimated to be only 10 million gallons in 2010, compared to the 100 million gallons mandated for the year. In addition, the cost of producing cellulosic ethanol is estimated to be three to four times that of corn ethanol. The report noted that the cost of growing feedstocks for cellulosic plants is probably underestimated and that “dedicated energy crops would need to compete with the lowest value crop such as hay, which has had a price exceeding $100 per ton since 2007.” The leading cellulosic ethanol producer, Fiberight, is expected to have a production capacity of 130 barrels a day in 2010. Even a small oil refinery produces 60,000 barrels per day. The USDA estimates that production capacity for cellulosic biofuel will be 291.4 million gallons by 2012, compared with a mandated 1,000 million gallons.

In our previous assessments of biofuels policy, we have emphasized the effects of displacing corn for feed and food use by fuel use and the consequent upward pressure on corn prices. A cursory examination of corn prices shows that, after 2007, corn prices achieved highs in 2008 and have now settled at a higher plateau in the range of $3.50 to $4.00 per bushel. Early in June 2010, the Food and Agriculture Organization (FAO) of the United Nations noted that although the FAO Food Price Index fell from 174 points in January 2010 to 164 points in May 2010, it remained 69% higher than in 2004. The specific role of biofuels in rising food costs is significant: The inflexibility of mandates helps cause price spikes when supplies are tight, and the increasing diversion of corn to fuel over time pushes up long-term prices. Biofuels policy has done little to provide more flexibility in response to such price effects. Nor has it confronted the fundamental question of an efficient distribution infrastructure, because ethanol is water soluble and cannot be moved in petroleum-dedicated pipes or containers.

U.S. biofuels policy has also had disproportionate effects globally. The decision in 2007 to double the corn-based ethanol mandate from 7.5 to 15 billion gallons pushed global use of grains for fuel sharply upward because the United States accounts for nearly 90% of world ethanol consumption. As a result, grains used for biofuels reached 125 million tons in 2009–2010, with annual growth rates in the three preceding years of 15, 24, and 36% as compared to non-industrial demand growth averaging about 2% per year. Roughly 8% of global grain production is now committed to heavily subsidized fuel use.

Yet corn-based ethanol produces little net energy gain—20 to 30% by most credible estimates. And its effects on greenhouse gas emissions are seen as increasingly troublesome, both because of heavier nitrogen fertilizer use adding to nitrous oxide emissions and because of pressure to convert new lands to cropping, resulting in a carbon debt measured in decades or centuries, depending on the land converted and the conversion method used.

Finally, current U.S. biofuels policy is neither a cost-effective strategy for reducing greenhouse gases nor a reliable bridge to the supposed promise of second-generation biofuels. Koplow estimates the cost of reducing carbon emissions through U.S. ethanol policy at $500 per ton, which is among the most expensive of all available options. And the current structure of the U.S. ethanol industry—fermentation plants clustered largely in the heart of the Corn Belt—is ill-suited to a cellulosic-based strategy because it will probably require the chemically based breakdown of cellulose and lignin from wood or grass products grown on marginal lands far from the Corn Belt or the use of waste by-products or algae, also sourced far from existing plants.

The current dismal state of U.S. biofuels policy should prompt a return to the drawing board. Consider the following:

• In a newly debt-burdened United States, the excessive cost of current biofuels policy will prove troublesome, relying as it does on operating subsidies to specific companies and commodities rather than on public goods investments accessible to all and favoring the least-cost solutions.
• In a national debate over the appropriate regulatory role of government, biofuels policy will look increasingly disruptive, relying as it does on mandates that displace market signals with unrealistic political goals that have already spiked food prices, driving tens of millions in poor countries into debilitating hunger.
• In a reexamination of alternative energy sources, biofuels will be found wanting on two scores, being both an inefficient replacement for petroleum as an energy source and a high-cost strategy for reducing greenhouse gas emissions.
• In a reconsideration of environmental pollution problems, biofuels will emerge as a major contributor to pollution through nitrogen runoff, as a threat to biodiversity through pressure on land conversion and water scarcity, and as a worrisome contributor to nitrous oxide emissions, which are almost 300 times more forcing as a greenhouse gas than is carbon.
• In an assessment of long-term solutions, biofuels will look less attractive because of the need for a costly separate distribution system to avoid problems from their water solubility.
• As more is understood about next-generation biofuels, corn-based ethanol will come to seem more like a barrier than a bridge, given the likely differences in location, processing technologies, and feedstocks for the two industries and the necessity of overcoming current ethanol and farm subsidies to launch a new industry.
• As skepticism mounts over the technological and economic feasibility of next-generation biofuels and as commercial production proves elusive and its costs increasingly burdensome, the whole biofuels pathway will be reexamined.
• As practical, medium-term solutions become more attractive, attention will probably shift away from quickly replacing petroleum-based liquid fuels to finding more efficient ways to improve fuel use. Already-rising fuel economy means that U.S. gasoline use probably peaked in 2007 and will decline in the future. A McKinsey study showed that most reductions in carbon emissions between now and 2030 can come cheaply and from existing technologies; the decarbonizing of the U.S. economy will be gradual and incremental in nature.

How could policy changes be made in a thoughtful way? A first step certainly would be to freeze the mandates and end their escalation. The ethanol industry’s share of transport fuel usage can be grown more reliably through market-based competition than through mandate-based sourcing shifts. This is especially true given all of the technological and economic uncertainties surrounding next-generation biofuels.

Second, the blender’s tax credit should continue to be lowered in measured but clearly committed steps. The credit is paid to those who blend ethanol with petroleum fuels and acts as an indirect price support for corn. It was recently reduced from 51 to 45 cents per gallon. Further, policymakers should consider replacing the credit with a subsidy that varies inversely with corn prices. It would rise to promote surplus disposal when corn prices fall but be phased out as corn prices rise. This would make corn-based ethanol more of a balancer than a destabilizer in food policy.

Third, the biofuels market needs to be opened and internationalized to promote greater efficiency and competitiveness. This would reward low-cost producers while also providing more breadth and diversity to the potential market. The United States, because of its dominance in ethanol consumption, needs to set the tone and direction if it is serious about ethanol as a transport fuel.

In addition to putting ethanol on a more realistic foundation, these changes would free up substantial resources for research into a broader array of clean energy alternatives. These should include not just new energy sources but also improved energy storage and distribution technologies and more efficient energy usage approaches. Dedicating the current $10 billion annual cost of the biofuels program (let alone the sixfold increase in spending that is looming under a continuation of the current course) to such a three-pronged research agenda should produce more usable, cost-effective energy and climate change solutions.

This approach requires moving government out of its current role of distorting or replacing market signals and back into its more appropriate role of investing in public goods to create new market opportunities. Although the transition may be difficult, the resulting policy course should enjoy more broad-based support.