The Renewable Fuels Disaster

January 10, 2012

Deficit hawks, environmentalists and food processors are celebrating the expiration of the ethanol tax credit.  This corporate handout gave $0.45 to ethanol producers for every gallon they produced and cost taxpayers $6 billion in 2011.  However, the continuation of the Renewable Fuel Standard (RFS), which creates government-guaranteed demand for corn, will limit the effectiveness of the tax break expiration and continue to distort the market for corn, says Aaron Smith, an associate professor at the University of California, Davis.

  • The RFS mandates that at least 37 percent of 2011-2012 corn crops be converted to ethanol and blended with the gasoline.
  • The RFS has artificially stimulated the ethanol market for years, such that only a year after its introduction, 1.8 billion gallons of additional ethanol capacity was under construction.

The demand created by the RFS drives up the price of corn and related goods by diverting the use of corn toward non-food ends.  While the specific market distortion is debated, careful estimation can offer insight:

  • In the 2005-2006 crop year (before the implementation of the RFS), 1.6 billion bushels of corn were used to produce ethanol; in 2010-2011 5.0 billion bushels were used, suggesting that 3.4 billion bushels are diverted to ethanol by the RFS.
  • Because one-third of the caloric value of the corn is retained and redirected after ethanol production, only 2.3 billion of this 3.4 billion is moved away from food consumption (16 percent of total corn production).
  • Estimates suggest that the market can absorb 5 percent more corn for every 10 percent price reduction, and this implies that the loss of 2.3 billion bushels of demand would drive down prices by 32 percent.
  • It is also estimated that this price reduction would decrease the price of other commodities such as soybeans, wheat and rice by 20 percent as well.

The true cost of this price increase is not born by domestic grocery shoppers, but by international consumers of commodities; namely, the world's impoverished.  Final estimates suggest price increases from 2005-2008 forced 105 million people below the extreme poverty line ($1.25 per day).  Thus, while the retirement of the ethanol tax breaks is a success, true relief lies in the elimination of the RFS.

Source: Aaron Smith, "Children of the Corn: The Renewable Fuels Disaster," The American, January 4, 2012.

For text:

http://www.american.com/archive/2012/january/children-of-the-corn-the-renewable-fuels-disaster

 

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