Benefit-Cost Analysis of Ethanol

Issue Background

As gasoline prices continue to rise and the prospect of peak oil looms on the horizon, there is high demand for an alternative source of fuel for use in automobiles. One possible replacement is corn-based ethanol (ethyl-alcohol) (Yacobucci 2003). The popularity of this domestically produced fuel has been rapidly increasing over the past decade. In 2010 alone, an estimated 863,000 barrels of ethanol were produced per day. Currently, ethanol is used in two ways: as a fuel additive to improve the performance of internal combustion engines and as replacement fuel for gasoline. Because of its clean-burning characteristics, ethanol is seen as a viable replacement for the anti-knocking agent MTBE (Methyl tert-butyl ether) which has been classified as a potential human carcinogen (Toccalino 2005). Additionally, ethanol is increasingly blended with gasoline in gas supplies across the United States.

Manufacturing Processes

Corn ethanol can be manufactured using two simple fermentation techniques. The first, “dry milling” involves crushing the harvested corn and saturating the grain with water to create a “mash.” The mash is then injected with two enzymes (alpha-amylase & glucoamylase) and heated to break down the corn’s starch molecules into glucose. After the mash has cooled it is transferred to holding tanks containing water and yeast, the process of fermentation takes between 48-72 hours. Finally, the liquid mash is heated to 78°C to evaporate the ethanol (Bothcast 2005). The ethanol is then denatured to prevent human consumption.

Wet milling involves chemically separating the corn germ (the material inside the corn shell) from the shell and fermenting the remaining starches to form ethanol. The wet milling ethanol production process is far less common than dry milling. While wet milling has several beneficial byproducts (corn oil, corn gluten meal), it is more expensive and energy intensive than its dry counterpart (Brent 2006).

Ethanol Legislation & Subsidies

To remain cost-effective, corn-based ethanol is heavily dependent on federal subsidies. Currently, federal ethanol subsidies come from the Energy Policy Act of 2005 and the 2007 US Energy Independance and Security Act.

US Energy Policy Act of 2005

President Bush signed the U.S Energy Policy Act of into law on August 8, 2005. The goal of the act was to increase U.S energy independence while simultaneously reducing pollution through greater reliance on bio-fuels. The act established for the first time a Renewable Fuel Standard (RFS)(Cox 2010). The policy mandated an increase in U.S consumption of renewable fuels to 7.5 billion gallons by the year 2012 (Tyner 2008).

Due to the high capacity, and low cost of growing corn in the U.S, corn based ethanol production has been the major renewable energy choice to satisfy this goal. As part of the act, ethanol blend producers receive a fixed federal subsidy of 45 cents per every gallon of ethanol gasoline blend produced. Small producers of corn-based ethanol receive 10 cents per gallon for the first 15 million gallons produced (CBO 2010). This is significant, as the subsidy does not fluctuate with oil prices or corn prices. This subsidy is known as the Volumetric Ethanol Excise Tax Credit (VEETC)(Cox 2010).

US Energy Independence and Security Act

In 2007 the U.S Energy Independence and Security Act, revamped many of the provisions of the 2005 act, such as increasing the amount of the RFS to 36 billion gallons by 2022. Of this 36 billion gallon total the act mandates that 21 billion gallons of the RFS come from Ethanol (Capeheart 2009) . This in effect saturated the market as it provided incentive to firms to increase ethanol production to meet the federal mandate. An unintentional consequence of this ethanol production mandate has been the adoption of E10 gasoline by many refueling stations due to the amount of Ethanol available on the market, as well as the EPA allowing the use of E10 in light utility vehicles like cars and trucks (Wood 2007).For the protection domestic corn-based ethanol production, the government has levied a tariff of 54 cents per gallon on any imported ethanol. The biggest source of foreign ethanol is Brazil, whose production actually poses a threat to the U.S ethanol industry because of their use of sugar cane as a feedstock. Sugar Cane based ethanol is much cheaper and more efficient production source than sugar, hence the reason for the subsidy (CBO 2010). State subsidies also provide substantial subsidies, and many mandate the use of E10 or E15 blends of gasoline (Pimentel 2003).

Effects and Consequences of Subsidies

Although corn-based ethanol appears to be politically viable due to perceptions of increased fuel economy, energy independence, and decreased reliance on global warming inducing fossil fuels, the legitimacy of these incentives are brought into question. For this reason, ethanol is generally considered a bad investment and is currently the source of much political controversy. Corn-based ethanol subsidies cost the American taxpayers approximately $6 billion a year annually (Dwyer 2011). In terms of oil reduction, the subsidies cost taxpayers spent nearly 17 billion dollars to offset an amount of oil equivalent to a 1.1 mile per gallon increase in national fuel economy between 2005-2009. In 2009 it cost 4.8 billion dollars to replace 7.2 billion gallons of gasoline with 10.6 billion gallons of ethanol (Cox 2010). Due to these inefficiencies many politicians want to cut out the subsidies, especially in light of the recent federal budget crisis (Dwyer 2011). If the government were to end subsidies in with in the next months it would provide a 4 billion dollar boost to the federal budget. If the policy is left intact it will have the cost the government approximately 30.5 billion since 2005 (Dywer 2011).

Corn Belt Politics

The politics of mass-produced corn ethanol are highly intricate. Politicians who are sensitive to constituent job loss claim that ending the subsidy would result in a job loss of 400,000 within the industry (Gies 2010). The corn belt region where most of the ethanol is produced represents a powerful political constituency in terms of lobbyist and the amount of electoral votes the region carries. For this reason the Obama administration has been sensitive to immediately cutting the subsidy, as he was sensitive during the election due to the importance of the Iowa caucuses of the prevalence of the industry there (Gies 2010). In October 2010 the Obama administration in conjunction with the EPA allowed E15 blend Ethanol to be sold at refilling stations. If the subsidy were to end, increasing the permitted blend to E15 would provide support to the industry (Meier 2010).

Economic Viability

Impact of Government Regulation

The economic viability of corn based ethanol production can be based largely on a cost-benefit analysis of the production process. Based on current production technologies the costs of producing corn based ethanol far outweigh how much it is worth in the market, however this is offset by the close to $3 billion per year in government subsidies that are applied to the industry. Without the support from state and local governments it is likely that the production of corn based ethanol would cease completely.

On a firm level the production of corn based ethanol is also seen as economically inefficient. A study by the University of Nebraska found that even when tax credits are subtracted from the costs for a 100- MGY plant profits are only predicted to exists until 2012 at which point costs will begin to outweigh the benefits. This will push the plant past the break even point and make the continued production of ethanol economically unviable. This is due in part to forecasts that corn prices will continue to rise while ethanol prices will fall. It is also important to note that the market price of ethanol is largely a result of the Renewable Energy Standard which creates a demand for ethanol which would otherwise not be present (Peters 2007). Without this government regulation the demand, and therefore the price for ethanol would likely drop significantly, further reducing profit margins.

Effects on Pump Price

The cost of ethanol production has a large impact on the cost incurred by consumers at the gas pump. In 2008 ethanol prices surpassed those of gasoline and blending resulted in higher prices for gas. In early 2009 corn prices reached record levels at $4.10 per bushel and when combined with ethanol prices of $1.66 per gallon (in comparison to gasoline which was priced at $1.68) blending resulted in higher prices at the pump. Although the price paid by consumers is largely dependent upon the price of ethanol verses gasoline, given current production technologies and the market prices of corn, it is unlikely that blending will result in lower costs to consumers in the near future (Yacobucci 2003).

Impacts on Other Markets

In 2008 it was predicted that approximately 3.7 billion bushels, or 1/3 of the corn produced in the United States will go towards the production of corn based ethanol. It is predicted, based on current consumption patterns that by 2018 the production of corn based ethanol will consume approximately 44% of all US corn. However despite the large portion of corn going towards the production of ethanol, ethanol only represents approximately 2%-3% of the total gasoline utilized by US vehicles. The increase in demand for corn has resulted in a shift in agriculture, and displaced other important crops such as soybeans; it argued that these shifts will result in significant negative consequences for many rural/agriculture based communities.

The increase in demand for corn to produce ethanol has also led to rising prices for corn both for human consumption and as a input for other agricultural. The causes of this are two-fold. First, as the demand for corn rises while the supply remains constant (although the supply of corn, like other crops, fluctuates from year to year depending upon the conditions during the growing season) the prices are pushed upward. Second, many farmers have seen the subsidies for yellow corn (the type used in the production of ethanol) to be very appealing and have switched from growing white corn to growing yellow corn. This decrease in supply has caused prices for products containing white corn (such as tortillas) to rise (Nierengarten, 2011). The cost of other agriculture products have also been affected by the increased demand for corn to produce ethanol. For example, it has been estimated that ethanol production is resulting in a total of increase of $1 billion in the meat production industry, since corn is used to feed livestock. This results in consumers not only experiencing higher prices for beef, but also an increase in prices of related goods, such as dairy products (Pimentel, 2005). In a time when food security is a concern in many parts of the world, the production of corn based ethanol is reducing the supply of corn and driving up food prices, significantly decreasing the chances of global food security.

Environmental Viability

Energy Efficiency

One way to determine if ethanol is an environmental improvement over other energy sources if to examine the energy efficiency of ethanol. Energy efficiency is evaluated by looking at a fuel’s net energy balance (NEB), or the ratio of energy produced during production relative to the energy used in the production process. A NEB of 1.0 would mean that energy output is equal to energy input. A NEB over 1.0 would mean that more energy is generated than is used in the production process. When evaluating ethanol’s NEB there are three primary factors to consider: (1) corn yields per acre of farmland (higher yields mean increased energy efficiency), (2) how efficient the process of growing the corn is (how much energy is consumed by inputs such as fuels, pesticides, fertilizer etc.), and (3) the efficiency of the process by which the corn is converted to ethanol.

Recent technological advances that have increased corn yield and reduced the amount of inputs needed to grow corn have increased ethanol’s NEB. In 2007 a government report summarizing recent studies of corn based ethanol found that although results varied widely, most reports using similar assumptions found that corn based ethanol had a positive NEB. Assuming best available production practices, the average NEB for corn based ethanol was found to be 1.67 (67 percent more energy was produced than was used in the production process). However, reports conducted using less optimistic production assumptions (for example, reports accounting for an over reliance on chemicals and fertilizer in the production process) generally found ethanol to have a NEB below 1.0. Most scientists contend that the best available practices are rarely used in ethanol production, meaning that the energy efficiency of ethanol is largely exaggerated by studies assuming the use of best available practices. For example, a study claiming to take a more realistic look at ethanol’s energy efficiency found that ethanol production required 29 percent more energy input than was produced. The energy efficiency of ethanol is completely determined by the efficiency of the production process; not all ethanol production processes are energy efficient.

Net Greenhouse Gas Emissions

A second way to measure the environmental benefits of ethanol is to measure ethanol’s lifecycle greenhouse gas emissions, or the total quantity of greenhouse gases that are emitted during all stages of production. Fully inclusive estimates of ethanol greenhouse gas emissions will include factors such as emissions involved in producing the raw materials involved in the production process as well as those emissions produced from delivering the ethanol to the consumer. While some argue that corn based ethanol reduces greenhouse gas emissions, and thus should be used to combat global climate change, others argue that the emissions benefits derived from the use of ethanol either do not exist or are negligible.

As with the calculation of NEB, the emissions related benefits of ethanol vary widely depending on the level of optimism embedded in the calculations. Research reviews have concluded that a 10 to 15 percent reduction in emissions from corn based ethanol compared with gasoline can be expected. However, most studies do not take the full range of emissions sources into account, such as emissions due to land use change from the production of corn. Furthermore, emissions differ widely depending on the production process used. For example, emissions vary depending on the energy source used to convert the corn to ethanol. Ethanol advocates argue that since there is no completely objective way to calculate the range of indirect emissions sources in the production process indirect sources should not be included in estimates of ethanol’s lifecycle greenhouse gas emissions. Others argue that all emissions, both direct and indirect, should be included and that when this is done the reduction in emissions from ethanol use is quite lower, or nonexistent.

Impact on Direct Environmental Degradation

There are a number of environmental pollution costs associated with the production of corn based ethanol that are not included in calculations of energy efficiency or net greenhouse gas emissions. In the U.S. corn production causes more total soil erosion than any other domestic crop. Furthermore, more pesticides are used in the production of corn than in the production of any other crop in the U.S, resulting in more water pollution than any other crop. These factors lead to serious environmental degradation, especially in the U.S. Corn Belt where corn production is centralized, and support the claim that corn production is not environmentally sustainable. Because corn is the main raw material involved in ethanol production if the corn production system is not sustainable then ethanol cannot be considered a truly sustainable source of energy. There are also several problems associated with the plants that convert corn to ethanol. These include the air pollution emissions in ethanol plants, the large amount of wastewater that these plants produce, and the amount of water involved in the production process. For example, one study found that every gallon of corn based ethanol produced resulted in the production of anywhere from 6 to 12 gallons of potentially harmful water. This wastewater must be processed before it can be discharged, which is another source of energy use in the production process. Combined, these factors lead to serious environmental degradation and support the claim that ethanol production is not environmentally sustainable. Although calculations of ethanol energy efficiency and lifecycle greenhouse gas emissions do not consider many of these direct environmental impacts, they are nonetheless important to consider in discussions regarding the impacts of corn based ethanol.

References

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