Ethanol Debate Will Heat Up as Subsidy Nears Expiration (ADM, VLO, PEIX, ANDE, BIOF

The federal subsidy of $0.45/gal for domestic ethanol is set to expire at year’s end, and the sparks are flying now as the embattled industry seeks to renew government payments. On one side are the producers arguing that continued subsidies are necessary to help wean the country from its addiction to oil. On the other side, critics point out that 30 years of subsidy payments haven’t helped and that corn-based ethanol has proved that it simply can’t compete on its own.

The industry attracted a lot of interest and money in the early to mid 2000s, but almost all the pure-play ethanol companies have foundered. Large agricultural players such as Archer Daniels Midland Co. (NYSE: ADM), Valero Energy Corp. (NYSE: VLO), and privately held Cargill now control the bulk of ethanol production with small, cooperatively owned plants mostly in the Midwest. High-fliers like Verasun, Aventine, and now Pacific Ethanol, Inc. (NASDAQ:PEIX) have filed for bankruptcy. The only viable small players remaining are The Andersons, Inc. (NASDAQ: ANDE) and BioFuel Energy Corp. (NASDAQ: BIOF).

As might be expected, the disaster at BP plc’s (NYSE: BP) Gulf of Mexico well has provided fuel for the ethanol makers’ demand for continuing the federal subsidy. This push coincides with a coming decision from the US Environmental Protection Agency on whether or not to raise the blend rate for ethanol from 10% (called E10) to 15% (E15). The EPA has delayed its decision, again, until September. Producers, naturally, support the E15 blend rate.

More impetus for ethanol producers comes from seeing the impact of lost subsidies and tax credits on the production of biodiesel. Since Congress allowed the subsidy for biodiesel to expire last year, biodiesel production in the US has fallen nearly 90%. Congress is considering renewing the biodiesel tax credit of $1/gallon.

The US produced about 11 billion gallons of ethanol in 2009 (about 262 million barrels), which the industry’s main lobbying group, the Renewable Fuels Association, said displaced the need to import 364 million barrels of oil “from places like Venezuela and the Middle East.”

That’s absurd. A barrel of ethanol contains about 40% less energy than a barrel of oil, as measured in BTUs. It is impossible for less ethanol to replace more oil.

Phony arithmetic aside, the largest problem with corn-based ethanol is the cost of its two major inputs: corn and natural gas. For the past year or so, both have been priced very low and ethanol producers have profited. But both prices are rising now, and this will put a crimp in profits. Earlier this week ADM noted a bit of recovery in its ethanol business as corn prices head downward again.

Depending on two volatile commodity inputs and federal subsidy payments for profitability just doesn’t make good sense. If the federal subsidy is not renewed, corn-ethanol production in this country will essentially dry up. That would open up the US to imported sugar cane-based ethanol from Brazil, provided that the $0.54/gal tariff is dropped.

The argument over the ethanol subsidy is sure to be loud and long, but in the end, farm lobbies and renewable fuel lobbies will prevail. It’s too bad.

Paul Ausick