The emerging conflict between food and fuel

During the mid-1930s, the allocation of resources between re-armament and the betterment of life gave rise to the “guns or butter” characterization of government spending. We are now witnessing a similar conflict which can best be described as “food or fuel”. As with many well intentioned initiatives which governments introduce, the goal of energy independence has run foul of the “Law of Unintended Consequences.” The policy to convert corn into ethanol was intended to please everyone but the consumer. The farm constituency, supported by corn-state legislators was assured of higher crop prices, the refiners received a subsidy and the entire system, which is assuming the proportions of an expensive bubble, was further protected by tariffs against imported ethanol. Five years into the program we are experiencing the downside of the initiative. Federal Reserve Chairman Ben Bernanke has called for elimination of the import tariff to restrain inflation in domestic food prices. President Bush has acknowledged the results of the policy of his administration. “Now we got a problem with renewables—and it is affecting the price of food and hurting hog farmers and a lot of folks” he naively opined. His Secretary of Energy, Sam Bodman has suggested a reduction in the blending subsidy on the basis that the ethanol industry can “stand on its own feet.”

Economists, policy wonks and even we “folks” (“Bush-speak” for our country’s citizens/consumers/taxpayers) recognize the problems with artificially promoted ethanol production. The first is that the diversion of corn to fuel does not result in any meaningful net gain in energy efficiency and requires prodigious quantities of water. There are profound problems relating to distribution of ethanol from the Midwest production sites to refineries on our coasts. Ethanol cannot be transported in pipelines and requires tank cars. Only 10% of refineries are equipped to receive ethanol by rail. The current safe and practical addition rate to gasoline is 10% other than for modified flex-fuel vehicles and the distribution and retail delivery infrastructure for other than 10% gasohol is negligible. Effectively there is more ethanol production capacity than demand. It is estimated that 10 to 11 billion gallons could be added to gasoline in 2007 compared to a potential output of 13 billion gallons. This is the reason for declining prices of ethanol, cancellation of proposed plants and a precipitous drop in the share price of public traded ethanol refiners.

The direct consequence of the headlong and ill conceived diversion of corn to fuel has been the unprecedented escalation in the price responding to the immutable laws of supply and demand. The cost impact in 2007 and projections for 2008 have been in part moderated by good harvests and carryover stocks. Despite availability of corn supplies, partly due to displacement of soybean acreage, prices have increased from a long term average of $2.50/bushel to $5.00/bushel. This has had a direct inflationary effect on livestock production through 50% to 60% increases in feeding costs, with the possibility of passing only a proportion of the rise to consumers. Many developing Nations reliant on U.S. corn exports are now experiencing the effects of our domestic policies through decreased availability leading to increased cost.