Ethanol Mandates Distort Corn Market

A recent Bloomberg article underscores the government distortions in the fuel and food sectors. The piece discusses the rising price of ethanol because of expected supply problems:

Ethanol’s discount to gasoline narrowed to a four-month low on speculation that the slowest pace of corn planting since 1986 will make it difficult to replenish supplies.

The price difference, or spread, shrank 3.75 cents to 21.9 cents a gallon. The Agriculture Department said in a report yesterday that 5 percent of the crop was planted as of April 28, compared with a five-year average of 31 percent. Ethanol stockpiles are at the lowest for this time of year in records dating to June 2010…

“With the strong corn market, and we don’t have a huge inventory of product anyway, it just freaks people out,” said Jim Damask, a manager at StarFuels Inc., a Jupiter, Florida- based brokerage.

Here, the article is somewhat misleading, since it doesn’t explain that ethanol’s “discount to gasoline” goes hand in hand with lower energy content (ethanol contains 1/3 less energy per gallon than gasoline). In other words, a gallon of ethanol is indeed cheaper than a gallon of conventional gasoline, but that doesn’t mean it’s a better buy for motorists—you still get more miles-per-dollar using gasoline than ethanol.

The article goes on to explain the woes of the refiners:

Ethanol-blended gasoline made up 93 percent of the total U.S. gasoline pool in the week ended April 19, the lowest level since March 29….Ethanol is mixed with the motor fuel to stretch supply and meet federal mandates.

The tightening spread may discourage refiners from blending beyond government obligations, Damask said.

“There’s money, but not as much,” he said. “When you factor in delivery, storage, rail, that starts to whittle that down more than we think.” [Bold added.]

Here too the article is somewhat misleading. It makes it sound as if the ethanol mixture in the nation’s gasoline stock is a market outcome, with profit-maximizing decisions leading refiners to meet and surpass the mandatory floors. (The Renewable Fuel Standard requires the use of 16.55 billion gallons of ethanol this year.) Yet a closer analysis shows that this isn’t right.

In the past, refiners received a 45-cent-per-gallon ethanol tax credit until the end of 2011. This gave a definite advantage to ethanol, making it appear more profitable (after-tax) to refiners than it really was. In conjunction with federal mandates for ethanol, these policies spurred the growth of ethanol refining capacity and retarded the growth in conventional refining capacity compared to what it otherwise would have been. Thus, the current market landscape is still carrying the distorted infrastructure from years of the explicit tax advantage given to ethanol.

In addition, there are still some policies in place giving federal tax advantages to corn ethanol refiners, with the hope of future support. Listen to how its advocates describe the situation:

The American Taxpayer Relief Act of 2012, that was approved by both the Senate and House, included extension of three key ethanol related tax credits, Bob Dinneen, president and CEO of the Renewable Fuels Association, said.

…

“In addition, and equally significant, is the extension of the alternative fuel infrastructure tax credit which will accelerate E15’s entry into the marketplace this coming year. The extension of these important provisions demonstrates the Obama Administration’s stalwart support of biofuels and Congress’s belief in the promise of energy independence and job creation through domestic renewable energy resources,” claims Dinneen. [Bold added.]

Thus, even setting aside the explicit federal mandates, there are still tax advantages not only for cellulosic biofuel but also corn ethanol, and it would not be surprising if more explicit “stalwart support” from the federal government returned, once the dire fiscal situation has subsided.

Especially in a time of tight corn supplies, federal mandates on ethanol distort the fuel and food markets. The apparent “discount” on ethanol overlooks the fact that it has lower energy content by volume than conventional gasoline, and the existing market landscape for refiners has been distorted by years of massive government intervention. If ethanol is really such a wise and farsighted investment for America, we can rely on private capital markets to make these decisions, rather than supposed experts in Washington.