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Thursday, December 4, 2008




Smashing through the Blending Wall

Last updated: May 9, 2008

December 4, 2008


The US regulators are raising the mandatory ethanol blend for the next year to 10.21% from the 7.76% established for this year in what appears to be the final phase of the first stage of this remarkable expansion. In a span of a few years a whole biofuels market was created from scratch. To use blends higher than 10% the car fleet should be switched to flex engines as ethanol is more corrosive than gasoline. The US biofuels industry has thus hit the blending wall.

To be sure, these percentages are misleading. The ethanol market is actually shrinking right now and the 2009 renewable fuel standard (RFS) of 10.21% will be imposed on a contracting market as the US drivers are driving less and switching to more energy efficient cars. Nevertheless the achievement is obvious. But for this expansion to continue the blend wall has to be brought down. The question is how.

The ethanol industry lobbyists are calling on preliminary studies of E15 and E20 blends. The E20 blend will double the ethanol market while replacing 20% of the gasoline market that accounts for 70% of the US total oil consumption. However, the probability of such a blend to be approved is very low. So until the regulators find ways to make flex engines mandatory, the industry will be stuck. Another question, and one that has direct bearing on the first one, is how much of America's gasoline market can be switched to ethanol. It's basically whether going into so much trouble is worth at all.

Recently ethanol was variously accused of being inefficient in energy terms, environmentally dubious and responsible for the food crisis. The last claim was adopted with equal enthusiasm both by many fanatics of free markets and the leaders of green squads to unleash attacks on this first generation biofuel with a view to discredit it. Clearly, if ethanol is making people die from hunger, then expanding its production becomes problematic from the ethical point of view. It's on this claim that I would like to say a few words.

For starters, the so called food crisis has disappeared as the prices of corn and wheat followed the rest of the commodities on their way to the bottom. Thus this particular argument has simply lost the main body of evidence that supported it. In fact, the situation seems to be so dire that economists have started discussing in serious the possibility of a prolonged deflation in the US and other countries. In such a situation markets need any help they can get to lift themselves. Anything that can stir the markets up pass for good these days.

However the primary reason to doubt the validity of the ethanol vs food competition is the fact that the global trade talks continue to be stuck around the Western farm subsidies and the West dumping subsidized agricultural products onto global markets suppressing prices and destroying producers in the third world. A significant part of the developing world led by Brazil is more preoccupied with the fact that the prices are low rather than they are too high. It's technically possible that while ethanol is ravaging food markets, in other commodities such as cotton, Western subsidies are harming third world producers. But this does not discredit ethanol as such. Far from this, it points out to a structural problem for which ethanol may be the only ready solution around. The billions spent on subsidizing farmers growing cotton and other stuff can be used to encourage those very farmers to move to biofuels. Such a move would basically get two rabbits with one bullet - on one hand the biofuel production can be expanded, on the other the subsidies eliminated and global trade talks unlocked. At any rate it's important to bear in mind that the third world is not necessarily benefited by low prices. Many third world countries are major producers of various agricultural stuff or want to be one. It's not in their interests to have super cheap agricultural products being continuously dumped on their markets by the first world.

The correct resolution of the ethanol vs food debate is vital as it may remove a major hurdle on the way to ethanol's wider adoption. Ethanol should not be considered in isolation from the rest of the market. It should be actively promoted as a tool to effect a major structural reform of American agriculture. Farm subsidies should go just as it was demanded by the block of developing nations led by Brazil during all last rounds of global trade talks. In fact, they should not be abolished, but rather redirected to those farmers who want to switch to biofuels. The mandatory blend should be expanded to absorb all those farmers ready to adopt ethanol. How much ethanol can be added to the market in this way is hard to know. But I would bet that the current volume can be easily doubled and tripled.

Finally, the real advantage of having a big biofuels market has nothing to do with corn or whatever based ethanol as such. Ethanol may be not particularly energy efficient, and not even environmentally friendly, but this is not the point at all. The point is that it's much easier to create a market for a certain technology to allow it to mature itself in the wild rather than to try to mature this technology in a laboratory and then to create a market for it. Ethanol is a viable solution that can easily take over from 1/4 to 1/3 of the US autofuel market. The next generation cellullosic ethanol is expected to hit the market in the first half of the next decade. It will allow some producers to triple their production per acre. But possible breakthroughs don't start and neither end with cellullosic ethanol.

Algae is generally held to be the most promising field for research as it may allow to ramp up production per acre by dozens of times. But even regular ethanol is far from having said its last word. Roughly about 25-30% of corn mass can be converted to ethanol by the current non cellullosic methods. But it's theoretically possible to play with the corn's genetic code to expand this part to 50-60% of the plant's total mass. This would create a very different ethanol economics and genetic surgery is perfectly capable of such miracles these days. In short what really counts here is the existence of a big biofuels market as such, big enough to stimulate big companies to move in and invest into research in search for better methods of production and biofuels with superior characteristics to the regular ethanol. Such a market created, all the US has to do is to wait for this market to mature. Of course subsidies and support from the regulators are welcomed but they are not strictly necessary if the regulators just take care to reserve a big share of the autofuel market for biofuels.

It remains to be seen what steps the regulators take to move the market beyond the 10% barrier. I am no big fan of subsidies and cheap energy concepts and would prefer specially crafted taxes on any single day. One such a tax can be a special tax on blends that fail to mix biofuels in a proportion required by law. Say the mandatory blend is 15% and a gas station sells a 10% blend to consumers without flex engines. Such a tax would target the missing 5%. Owners of cars equipped with flex engines would use a 15% blend and thus save themselves the biofuels tax. This would create an incentive for the public to switch to flex engines while at the same time encouraging everybody with or without flex engines to use as much biofuel as their cars can handle.

A properly implemented biofuels market can work wonders for the US economy and even more for its standing in the world (I may say a few words about this in my next post, though some people may already know what I am going to say). Having a big ethanol market is good for the US and it's good for the rest of us. But for this market to become possible the regulators will have first to bring down the blending wall.


May 9, 2008

Making sense in Mississippi

The NYT about cotton growers of Mississippi switching to corn...

By CLIFFORD KRAUSS
Published: May 5, 2009

Farmers working land that has bloomed a dazzling snowy white every September since before the Civil War are switching to corn and soybeans. As gleaming silver corn silos go up on farm after farm, cotton gins are laying off workers or shutting down.

“We’re closer than we’ve ever been to looking like Iowa,” said Danny Hargett, a veteran farmer who has decided for the first time not to grow any cotton this year on his 3,000 acres of fertile, well-irrigated land. “It was extremely hard for me to make this decision, but the economics have made it almost impossible to make cotton a profitable crop.”

Source: The New York Times

Some readers may start getting hopeful on reading this thinking that the US energy/agriculture policies have finally acquired a semblance of common sense - farm subsidies to cotton growers and others were reduced or discontinued and the ethanol mandate expanded resolving the long standing trade dispute with Brazil and the rest of the third world and reducing US dependence on foreign oil at the same time. Well, the actual reason is more prosaic.

The most immediate cause of King Cotton’s decline is that people around the world are buying less clothing and home furnishings. Global cotton production and consumption are dropping, and the Agriculture Department expects the nation’s exports to fall by $1.2 billion this year.

Regardless whether the current debate over expanding the ethanol mandate succeeds to move it beyond the 10% limit, it's amazing that even when the life itself is pushing the US policy makers into taking such a sensible and logical step, they still can't do it. Making sense plainly does not come easy to some people.

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