Will GOP Gains Mean Ethanol Producer Losses?
Roubini Global Economics
November 10, 2010
Following the Republican Party’s capture of the House of Representatives in the midterm elections, U.S. policy on the use of biofuels for transportation could be about to change. Current policy is based on the use of "blender credits" to encourage the mixing of biofuels with gasoline and a US$0.54/gallon tariff levied on imports of ethanol, the most widely used biofuel. These policies are due to expire at the end of this year, and Republican deficit hawks do not want them renewed, though the ethanol industry generated US$2 billion-3 billion in tax revenues (net of subsidies) in 2009. In "Ethanol Subsidies: Adding Fuel to the Fire?"—available exclusively to clients—we examine the possible consequences of repealing this legislation.
A repeal would fly in the face of a number of new initiatives the Obama administration introduced in October to speed up ethanol production and demand. The U.S. Environmental Protection Agency (EPA) increased the cap on the amount of ethanol that can be blended with gasoline from 10% (E10) to 15% (E15) for vehicle models from 2007 and later. Soon after, Agriculture Secretary Tom Vilsack announced a series of new initiatives to boost the biofuel industry, including providing farmers with 75% of the startup costs of biomass crop production and funding retail installation of “blender” pumps that can handle ethanol-gasoline mixtures.
After U.S. ethanol production and demand hit record levels in August, the U.S. Department of Agriculture (USDA) forecast production for 2010 to reach approximately 13 billion barrels from 10.8 billion in 2009. But the GOP takeover of the House calls that forecast into question. Current U.S. legislation calls for the volume of ethanol that must be mixed with gasoline to increase annually, and in the past, tax credits and the higher price of gasoline relative to ethanol have encouraged fuel blenders to surpass these quotas. But both of these incentives—and, worse, the mandate for a graduated increase in quotas for ethanol use in fuel blends—may soon disappear.
At present, it is not clear where Republican consensus lies on these issues, though Sen. John McCain and the Republican Party in 2008 came out against ethanol mandates in a reversal of Bush-era policies. The bill to extend subsidies had bipartisan support in the Senate in early 2010, but any attempt at a renewal would likely be blocked should deficit hawks dominate proceedings. With job creation a priority, it is highly likely that the import tariff will survive as the prospect of a flood of cheap ethanol from Brazil is too great.
A push to allow individual states to opt out of these Federal mandates or a scrapping of this mandate altogether could lead to upward pressure on the price of ethanol if supply falls and the transportation market created for ethanol remains. Ultimately, demand for ethanol blends will be driven by the price of oil and oil products. Ethanol prices regularly surpass oil prices and would be more likely to do so should government incentives disappear. Although oil prices are forecast to rise in the long term, supply shocks could easily drive ethanol prices up, and demand destruction could drive oil prices down. Temporary factors that led to ethanol trading at a premium for five months this year—high corn prices and low gas prices due to reduced driving—could recur. The transportation market for ethanol will not grow if the price of domestic production of ethanol outweighs the price of gasoline.
(c) Roubini Global Economics