Politics & Policy

The Corn Threat

President Bush's dreams of alternative-fuels will prove quite costly and impracticable.

President Bush proposed in his State of the Union speech a plan for renewable energy that his own press shop and their surrogates called “bold.” A better description would be “reckless.” A history of how Bush got to this point is instructive.

In the summer of 2005, President Bush saw one of his greatest domestic-policy victories — the passage of the Energy Policy Act of 2005, a victory that was four full years in the making. Indeed, enacting a comprehensive energy policy was one of Bush’s key campaign points during the 2000 presidential campaign.

Opponents in Congress denied Bush this goal his whole first term; after his reelection he had the political capital to get his plan through — though not without some shortcomings, the lack of authority to explore for oil offshore and in the Arctic National Wildlife Refuge being the biggest deficiency, and a last minute exercise in political logrolling that mandated 7.5 billion gallons of motor fuel come from renewable sources.

A GROWING SOLUTION

The original Bush plan had accommodated the ethanol lobby’s request for a three-billion gallon mandate — a provision justified by the “infant industries” argument, though by this time ethanol was a 30-year-old “infant” supported by more than 16 statutes granting it preferences and subsidies.

Through the congressional obstruction period of 2002-04, when Bush’s energy plan was held political hostage, the renewable-fuels mandate was expanded to five-billion gallons in a consensus handshake agreement among all parties — ethanol makers, oil refineries, corn growers, and other stakeholders. At the eleventh hour, before the bill was passed, the mandate was upped to 7.5 billion gallons at the insistence of the ethanol lobby.

Ironically, that particular level was chosen because the Governors’ Ethanol Coalition — a group of governors that was once headed by now Bush secretary of Agriculture and then Nebraska governor Mike Johanns — had commissioned a study to try to pinpoint the practical upper limits of ethanol demand for corn. The study concluded that beyond eight-billion gallons, ethanol demand for corn would be detrimental to the other traditional — and larger — uses of corn: livestock feed, food, and exports. Hence the mandate of 7.5 billion gallons, to be reached by 2012.

THE SAUDI ARABIA OF CORN

Indeed, this is a critical balance of food versus fuel, not only for U.S. livestock farmers and food consumers, but for a larger global economic order. The U.S. heartland is to corn as the Saudi Arabian desert is to petroleum. The U.S. produces 40 percent of the world’s corn and is the largest global supplier. Newly affluent and emerging middle classes in developing countries — who in turn bring more political stability to the developing world — have for the past two decades demanded better diets in terms of protein, i.e., meat, milk, and eggs. That demand has been met in no small part because of U.S. corn.

Economic forecasters of all stripes should be impressed by the accuracy of Governors’ Ethanol Coalition study. It was virtually spot-on. In August of 2006, the sum of actual ethanol production-capacity in place, plus the planned capacity of those ethanol facilities that were already under construction passed the eight billion gallon mark as ethanol plants overshot the 7.5 billion gallon mandate. The average corn price in August 2006, at the end of the last crop year, was $2.09, but when current and prospective ethanol capacity hit the eight billion gallon level, corn prices started a bull trend, still in place. On January 23, the day of the State of the Union speech, corn was $4.09 per bushel. Many analysts expect $5.00 per bushel before this is over.

Some context on corn prices. For the past ten years, the average price has been $2.05 per bushel; in only three years have corn prices ever topped $3.00 per bushel. The all-time record-high season-average corn price is $3.24 per bushel in 1995/96 — a year that saw many ethanol mills shut down because of too high corn prices. But now, the use of ethanol is mandated by law, and as such price does not necessarily impact demand. Instead, the burden of record corn prices falls on the livestock and meat sector — typically the economic engine of the rural and farm economy.

STICKING IT TO THE LIVESTOCK

In early December, the Nebraska Cattlemen’s Association — the group of cattle ranchers and farmers from Secretary Johanns’ home state — passed a resolution at their convention calling for ethanol to “transition to a market based approach,” and opposing “any additional federal or state mandates for ethanol usage and/or production.” The National Cattlemen’s Beef Association passed a similar resolution at their convention in February calling for an end to ethanol subsidies. The National Turkey Federation and the National Chicken Council — producers of turkey and chicken meat — had both testified before congressional panels as early as the summer of 2006 that ethanol mandates posed a threat to their industries’ economic viability.

According to Professor Ron Plain of the University of Missouri, U.S. pork producers can expect to lose money this year, and a herd reduction is inevitable. Heretofore, the U.S. has been a large next-exporter of pork, which is the world’s most demanded meat. Alas, for the pork exporters, there is no law that says foreign consumers must buy U.S. pork no matter what the price, like the law on the books saying that gasoline refiners and blenders must buy at least 7.5 billion gallons of ethanol — price notwithstanding.

Interestingly, because of the growing meat demand overseas, corn exports have held up well so far — but that is largely because, first, there is no alternative to U.S. corn yet (but Brazil and Argentina have increased their corn crop substantially) and, second, the relatively low value of the dollar has offset some of the domestic price shock on corn in the global market. But if corn prices continue in this vein, the long run of the approximately $4 billion corn export business — not to mention the foreign policy benefits it provides — is in jeopardy.

THE PLAN’S TOO CORNY

Now, back to the State of the Union plan. It was amidst this upheaval in the commodities world that the Bush administration conceived and communicated the president’s blueprint to increase the renewable-fuels mandate by almost five-fold in a another five years — that is, a mandate of 35 billion gallons by 2017, instead of the 7.5 billion gallons by 2012 mandate. For some context, were this renewable-fuel mandate to be met by corn, it would require 12.5 billion bushels. The all time record U.S. corn crop was 11.7 billion bushels. This year’s U.S. crop was 10.7 billion bushels.

Drafters of the Bush plan, however, put in a couple of policy nuances intended to finesse this shortage of motor fuel feed stocks. First, it expands the eligible fuels for this mandate from just renewable (read: ethanol) to renewable and “alternative.” So fuels such as hydrogen, propane, electricity, and butanol also qualify. It was a good effort to make the plan feasible, but currently there is somewhat less than 500 million gallons equivalent of alternative fuels in the market — and very practical economic, infrastructure, and even safety reasons why that level doesn’t grow. Hydrogen development is handicapped by the fact that every refueling station has hydrogen under enough pressure to make each auto refueling a potential threat to the very existence of the neighborhood in which it is located.

In fact, this alternative-fuel proposal is a sort of Dickensian visit from the “ghost of State of the Union past.” Alert citizens will recall that in the 2003 State of the Union, President Bush promised “a new national commitment…so that the first car driven by a child born today could be powered by hydrogen, and pollution free.” One quarter of the way into that 16-year timeline, no progress has been made, and that “national commitment” has become a mere supplement to the ethanol grand plan.

In short, both alternative- and renewable-fuel plans remain fantasies at this point; hydrogen is like the tooth fairy — a nice story, but few really believe in her. Ethanol, on the other hand, is like Santa Claus. Virtually everyone, at least somewhere deep down, wants to continue to believe, despite the disappointments more mature thought on the topic — and stark reality — has wrought.

THE CORN CAN’T BE REPLACED

Much of the renewable fuels on which his plan relies is assumed to be from cellulosic biomass (e.g., corn stalks). Nonetheless, today, there is no ethanol commercially produced from cellulosic biomass feedstock in the U.S. To put that in further context, in the Bush administration’s own 2007 Annual Energy Outlook, produced by the Energy Information Agency of the Department of Energy, cellulosic biomass ethanol is projected to reach 300 million gallons by 2030 — 13 years after Bush’s deadline of 35 billion gallons of mandated ethanol-use in the U.S. motor fuel supply.

Moreover, the cellulosic ethanol production which is still being developed is far less efficient than corn ethanol. One metric ton of corn produces about 110 gallons of ethanol currently; the only existing cellulosic ethanol plant in operation is a test facility in Canada, where they produce about 84 gallons per ton. Unless the technology and efficiency change dramatically in the next ten years, there still will be no incentive to use cellulosic ethanol over corn based ethanol.

In short, based on current technology, and the government’s best-educated projections, corn is still practically on the line for 34 billion of the 35 billion mandated-, renewable-, and alternative-fuel gallons in the next ten years. Still an impossible level to meet. Of course, the bottom-line policy blunder is this: Bush’s plan mandates the near-term future use of motor fuels that today are not available. That is utterly irresponsible. Especially considering the consequences, which are far wider than just the agricultural sector.

THE BAD EFFECTS OF REQUIRING ETHANOL

For example, any mix of fuel that includes ethanol at more than ten percent technically requires a retooled auto engine. To hit the Bush plan of 20-percent renewable and alternative fuel by 2017, the U.S. auto fleet would, for all intents and purposes, have to completely turn over within about five years — and that is not considering one of the other aspects of the Bush State of the Union energy plan — the improved mileage standards for all new cars. But greater use of alcohol as a fuel is generally inconsistent with improving mileage as ethanol is less fuel-efficient.

Consider the case of Brazil. In 1979 the oil price shock (which spurred the Gasohol Competitiveness Act in the U.S., Public Law 96-493, already the seventh U.S. statute intended to develop more ethanol use) spurred the so-called Pro-Alcohol program in Brazil. By 1981, auto manufacturers had started to deliver new alcohol cars to Brazil; by 1986, 96 percent of new car sales were alcohol-fuel-engineered cars.

At that time, alcohol was priced at 57 percent of gasoline and had a fuel equivalency of 75 percent (one tank of alcohol in an alcohol car would go 75 percent as far as one tank of gas in a conventionally engineered car). By the late 1980s the cost of alcohol was about 64 percent of gas, and was the same price from 1990 through 1996. Sales started to drop at that time, and by 1999, alcohol engineered new car sales had dropped to one percent of the total (from 96 percent 13 years earlier). Such a massive rollover in the domestic auto fleet is not an insignificant economic cost. But at least President Bush has provided the answer to every car salesman’s favorite question: “What’s it gonna take to get you to leave this lot in a new car?”

As long as there is a war in Iraq and trouble and instability in the Middle East, the administration believes it needs a pie-in-the-sky, bold sounding, take-charge initiative on domestic energy, something that satiates the focus group derived demand for “energy independence” and “energy security.” This proposal provides that political fig leaf. In reality, however, there is not enough feedstock to ever be energy independent. Furthermore, there is nothing secure about relying on a corn crop (for food and fuel) that can be wiped out by hail, drought, pests, or floods in any given year.

President Bush worked so hard to get the political capital he needed for the Iraq war and the broader War on Terrorism during his first term that he allowed domestic spending to skyrocket around him and issued no vetoes — and this a candidate who was branded as, and campaigned as, a fiscal conservative. In similar fashion, the president is now willing to throw the commodity economy into virtual chaos over biofuels vs. petroleum. It is a very dangerous gamble with serious potential macro-economic consequences — inflation, or worse, the stag-flation type of slow-growth, high-inflation economy we saw in the early to mid 1970s when policymakers were last obsessed with finding easy answers to these issues.

–Dave Juday is a commodity-market analyst.

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