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The Biofuels Fiasco

Even Rube Goldberg would recoil in horror from this regulatory contraption.

Oct 31, 2011, Vol. 17, No. 07 • By DAVE JUDAY
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Biodiesel production dropped more than 40 percent in 2010 from 2009 levels​—​down to 311 million gallons, even though there was a mandate to use 650 million gallons that year. The reason for the production shortfall was the expiration of the $1 per gallon blenders’ credit. That production drop-off provides a glimpse of the economics of biodiesel. Without the tax subsidy, production was not quite half the minimum mandated consumption level. Congress then restored the tax credit for 2011​—​and did so retroactively, providing a windfall subsidy to the 2010 production, which had already occurred without the credit. The tax credit is due to expire again at the end of this year.

Another category of so-called advanced ethanol is cellulosic, made from grass, wood, and other nonstarch feedstocks. Cellulosic producers now get a net tax subsidy of 56 cents per gallon. Plus, there’s a small-producers’ tax credit of 10 cents per gallon for ethanol producers who make less than 60 million gallons per plant. For context, 60 million gallons is about five times the most robust market projection for total cellulosic ethanol production in 2012, so effectively all cellulosic producers qualify for the additional subsidy.

Indeed, cellulosic technology has not hit the break-even point yet. So, despite the mandate that fuel retailers use it, there is no commercial supply available. The shortfall is so acute that the prescribed 100 million gallon mandate for 2010 was reduced to 6 million gallons; the 250 million gallons mandated for 2011 were reduced to 7 million. That is a 337 million gallon shortfall in meeting the mandate.

While the cellulosic portion of the advanced biofuel mandate was waived, the overall mandate for advanced biofuels was not. So with corn-based ethanol not eligible, the difference has to be made up by a third category of advanced ethanol referred to as “undifferentiated,” which includes biodiesel and imported Brazilian sugar-based ethanol.

So the United States now imports ethanol from Brazil to meet the federal mandate for ethanol use, and yet those imports are subject to a 54-cents-per-gallon tariff to protect the U.S. domestic ethanol industry. Ethanol is also imported from Canada, which is not subject to a tariff, and owing to trade agreements and foreign policy considerations, the United States is committed to importing ethanol from all Caribbean Basin countries, with special set-asides for El Salvador and Costa Rica. Remember: Despite all this import and export activity, ethanol policy was justified on grounds of U.S. energy independence.

Yet, just as the shortfall of advanced biofuels has created a new demand for Brazilian sugar ethanol imports, Brazil has reduced its ethanol production. In fact, Brazil has even begun to import ethanol to meet its own biofuel mandates. Imports into Brazil so far in 2011 include corn ethanol from the United States. Before long, ships carrying U.S. corn ethanol southbound could regularly pass ships carrying Brazilian sugar ethanol northbound​—​a sort of splash and dash part two, driven by the U.S. mandate for “advanced” biofuels rather than by a tax credit.

On top of all the complexity of the tax credits, tariffs, and the import quotas, the federal mandate by feedstock category creates an intricate compliance system. Energy companies who comply with blending regulations to meet the mandate are issued a “renewable identification number,” known as a RIN. These are 38-character numeric codes to trace the transfer of biofuels. Even the National Biodiesel Board itself confesses that “a RIN may look, at first glance, like a wicked advanced algebra problem,” but “in reality, it is the basic currency for .  .  . credits, trading, and use by obligated parties and renewable fuel exporters to demonstrate compliance, as well as track the volumes of renewable fuels.”

There is a sophisticated secondary market for RINs among “obligated parties”​—​i.e., energy companies who must blend biofuels into petroleum-based fuels to meet the standards. Companies who earn RINs may sell them to companies who don’t. It is a miniature cap and trade regime.

Energy companies who cannot procure advanced biofuels on the market because supplies are not available are forced to buy RINs. Given the production situation​—​overproduction of corn ethanol combined with severe underproduction of advanced bio-fuels—it came as no surprise to industry observers when a Maryland biodiesel producer was indicted for fraudulently selling counterfeit RINs.

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