May 5, 2011 10:19 pm

Success fuels ethanol subsidy changes

For any form of renewable energy, the ultimate objective is to compete on equal terms with fossil fuels, without subsidy.

The US corn ethanol industry is not there yet. Its future still depends heavily on government regulation, in particular the mandates for fuel suppliers to sell set volumes of biofuels. However, the principal subsidy targeted on ethanol appears to be on its last legs.

The reform plan backed by the industry would not mean the end of all government support. Import duties, a credit for petrol stations to invest in new pumps and a safety net triggered by low oil prices would remain.

However, the principal credit of 45 cents per gallon for blending ethanol into road fuel, at a cost of $6bn per year, would be very likely to disappear. The Renewable Fuels Association, an ethanol industry group, says it is also open to the idea of the import duty going if oil prices stay high.

Higher crude prices have meant that even before the tax credit, ethanol has been trading at about 80 cents per gallon less than petrol – although that volume-based comparison does not take into account ethanol’s lower energy content. Adjusting for that, ethanol is still more expensive in terms of the cost to deliver a given amount of energy.

Thursday’s volatility notwithstanding, oil prices seem set on a long-term upward trend because of constraints in supply and rising demand in emerging economies.

In Congress and in the ethanol industry, there is a growing acceptance that – particularly at a time of intense pressure on the government’s finances – the blenders’ credit can no longer be justified.

That is the context behind this week’s proposed legislation from two senators, Republican Chuck Grassley from Iowa and Democrat Kent Conrad from North Dakota, to pare back almost to nothing the tax breaks available for ethanol.

The legislation calls for a three-year transition period, at the end of which the tax credit would be linked to the price of crude, and not paid at all if oil is above $90 per barrel, as it is today.

The industry faces the prospect of more aggressive moves. Senators Tom Coburn, a Republican from Oklahoma, and Dianne Feinstein, a Democrat from California, have introduced legislation that would end the blending tax credit by July 1 and scrap the import duty.

With petrol at close to $4 per gallon on average and oil company profits rising sharply, while the public finances are strained, there is political pressure to end tax breaks for the energy industry.

Chuck Woodside, the RFA’s chairman, said the group was backing the Grassley/Conrad bill because “we appreciate the budget constraint in Washington”.

Another argument for the ethanol industry to drop its support for the blending tax credit is that the benefit does not go to producers, but to the refiners and blenders that add it to petrol.

Jerry Taylor of the Cato Institute, a free-market think-tank, said that view was “not challenged among academics”.

The real support for the industry, he argues, comes from the volume requirements, and the Grassley/Conrad bill would retain those.

“If you are being chased by a bear and you throw something out of your knapsack, then maybe the bear will get distracted,” he said. “Getting rid of the blending credit would be a positive development, but the ethanol industry does not stand or fall on it.”

Indeed, Mr Woodside suggested that by backing a rundown in ethanol subsidies, the industry was taking a “very responsible stance”, which might put pressure on the oil industry’s tax allowances and deductions as well.

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