EPA biofuel rule: why it needs reform(Read article summary)
We are in a far better position now to consider scaling back our use of ethanol produced from grain biofuel than we were when the EPA biofuel rule was established, Styles writes. With shale gas, tight oil and various renewables, the energy scarcity that has defined our policies for the last four decades is far less relevant to our policy choices going forward.
Janet S. Carter/The Free Press/AP/File
US Ethanol Policy Should Reflect Circumstances and Consequences
This April, two separate bills were introduced in the US House of Representatives toÂ reform, orÂ repeal, the federalÂ Renewable Fuel StandardÂ (RFS) that mandates how much ethanol and other biofuels must be blended into gasoline.
To understand why reform or repeal makes sense now, we should recall the factors that led Congress to enactÂ this standard six years ago andÂ consider how many of the basic assumptions underlying its design have changed since then. That requires a review of US fuel consumption and import trends, commodity prices, and the impact of the RFS on food prices. After summarizing the other points I want to focus on the last one, based on an interview I conducted withÂ Dr. Yaneer Bar-Yam, an expert on complex systems who has developed a model that explains the behavior of food prices since the introduction of the first,Â less ambitiousÂ RFSÂ in 2005.
Origins of the RFS
In the fall of 2007, when Congress was debating theÂ Energy Independence and Security ActÂ that included the current, enhancedÂ RFS, the US energy situation looked dire. For four years oil prices had beenÂ rising more or less steadilyÂ from their historical level in the low-to-mid $20s per barrel (bbl) to around $90, on their way to an all-time nominal highÂ of $145/bbl the following summer.Â USÂ crude oil productionÂ was in its 22nd consecutive year of decline, while our crude oil imports had climbed toÂ 10 million bbl/day, twice domestic production that year.Â
Even more relevant to the thinking behind the RFS, USÂ gasoline consumptionÂ stood at a record 142 billion gallons per year and had been growing at an average of 1.6% per year for the previous 10 yearsâ€“another 2 billion gallons added to demand each year.Â In its annual long-term forecast for 2007, the Energy Information Administration (EIA) of the US Department of Energy had projected that gasoline demand would grow toÂ 152 billion gal/yr in 2013 and 168 billion gal/yr by 2020.Â Meanwhile, US net imports ofÂ finished gasolineÂ andÂ blending componentsÂ had reached a million barrels per day in 2006, equivalent to 15 billion gal/yrâ€“equal to the corn ethanol target set by the 2007 RFS for gasoline blending in 2015.Â And by the way,Â US corn pricesÂ for the 2006-7 market year averaged $3.04 per bushel (bu). In this environment, policy makers regardedÂ ethanol as a crucial supplement to dwindling hydrocarbon supplies, from a feedstock that was cheap and readily expandable.Â
Without belaboring the events of the last five years, virtually every one of those trends has reversed course. That has occurred partlyÂ as a result of the recession and the lasting changes it produced in the US economy, and partly due to an energy revolution that was largelyÂ invisible in 2007 but had already begun.
US gasoline consumption peaked in 2007 and has since declined toÂ 133 billion gal/yrÂ last year. The EIA forecastsÂ itÂ to fall toÂ 128 billion by 2020 and 113 billion by 2030. US crude oilÂ outputÂ is the highest in 22 years and is set to exceed imports this year, while the US has become a net exporter of gasoline and other petroleum products.Â Since 2007 US ethanol production has grown fromÂ 6.5 billion gal/yrÂ to 13.3 billion gal., andÂ it seems more thanÂ coincidental that corn prices had doubled to an average of $6.22/bu by last year.
Food vs. Fuel
That brings us to the controversy that has been widely referred to as â€śfood vs. fuelâ€ť. In the last several years Iâ€™ve read numerous papers attempting to determine by correlation or other empirical methods whether and to what extent the increase in US ethanol production from corn has affected food prices.Â To put this in context, since 2005 the quantity of corn used for US ethanol production has grown fromÂ 1.6 billion bu/yrÂ to 5 billion bu/yr, or from 14% to 40% of theÂ annual US corn crop.
Some studies, such as thisÂ 2009 analysisÂ from the non-partisan Congressional Budget Office found a significant influence on food prices.Â Others, including anÂ Iowa State studyÂ recently cited in aÂ blog postÂ from the Renewable Fuels Association, found a negligible influence.Â What differentiates the work of Dr. Bar-Yam is that he and his colleagues haveÂ developed a quantitative modelÂ based on two key factors â€” corn consumed for ethanol and commodity speculation â€” that closely fits the behavior ofÂ a global price index.Â Their model also accounts for the â€śdistillers dried grainâ€ťÂ byproduct from ethanol plants, which returns about 20% of the corn used in the form of protein-upgraded animal feed.
Before speaking with Dr. Bar-Yam last week, I was a bit skeptical of his results.Â Aside from skepticism being my default mode in such situations, I had spent a lot of time looking at claims of speculator influence on crude oil prices in the 2006-8 period and was never convinced that they were more than the â€śfoam on the beerâ€ť, rather than a basic driver of prices.Â However, as I was reviewing his paper prior to our call, a light went on.
Rising Corn Demand Spurs Increased Speculator Activity
The curve his model predicted, which closely matched food price behavior, looked very much like the behavior of a process control loop responding to a ramped change in the set pointâ€“forget the jargon and think about how the temperature of your home responds to a steady increase in your thermostat setting: overshooting, then undershooting, before converging.Â We discussed this analogyÂ and he confirmed that theÂ effect couldÂ be characterized the same way whether it related toÂ an electrical circuit or a market.Â In effect, the steadily increasing corn demand from the ratcheting up of the RFS started corn prices rising, and the presence of lots of speculators, including â€śindex fundâ€ť investors, caused the price to successively overshoot and undershoot the equilibrium price trackÂ one would expect.
Dr. Bar-Yam explained that he had arrived at these two factors by eliminating factors that other groupsÂ had investigated, but that turned out to have no predictive value.Â These includedÂ shifting exchange rates, drought in Australia, a dietary shift in Asia from grains to meat, and linkages between oil and food prices.Â In his view the focus on ethanolÂ and speculationÂ is validated by the shift in dialog on this issue away from other, extraneous causes.
He also emphasized that his main concern is not the price of processed foods in developed countries such as the US, for which commodity grain costs are only one input, but rather the price paid for simple foods by poor people in the developing world.Â From that standpoint he doesnâ€™t just want to see the RFS reformed.Â â€ťIt is important not just to repeal, but to roll back the amount of ethanol used in the US.â€ťÂ He would prefer not 10% ethanol in gasoline, let alone 15%, but about 5%. â€śThe narrative has to shift,â€ť he said, â€śto recognize that people are going hungry.â€ť Those are powerful words, and Iâ€™m still thinking about them.
Conclusion: Timing is Right for RFS Reassessment
At currentÂ production levelsÂ ethanol from corn contributesÂ the energy equivalent of 6% of US gasoline consumption and about 2.5% of total USÂ liquid fuel demand. Thatâ€™s not trivial, and thereâ€™s a whole domesticÂ industry of investors, employees andÂ suppliersÂ who made that happen at our collective request.
However,Â If Dr. Bar-Yam has accurately captured the relationship between ethanol and global food prices, then we urgently need to reassess what weâ€™re doing with this fuel.Â We are also in a far better position nowÂ to consider scaling back our use of ethanol produced from grain than we wereÂ when the RFS was established. With increasing productionÂ of shale gas, tight oil and various renewables, the energy scarcity that has defined our policies for the last four decades is far less relevant to our policyÂ choicesÂ going forward. Iâ€™ll tackle the practical aspects of RFS reform, in terms of the so-called â€śblend wallâ€ť and its impact on gasoline prices, in a future post.