This morning I attended a briefing on “The Renewable Fuel Standard: Pitfalls, Challenges, and the Need for Congressional Action in 2013.” Steve Ellis of Taxpayers for Common Sense moderated a panel of six experts. Although each expert spotlighted a different set of harms arising from the RFS, reflecting the core concern of his or her organization, this was a team effort, with panelists frequently affirming each other’s key points. Collectively, they made a strong case that the RFS is a “costly failure.” The briefing’s purpose was to demonstrate the need for reform rather than outline a specific reform agenda. Panelists nonetheless agreed that, at a minimum, Congress should scale back the RFS blending targets for corn ethanol.

Kristin Sundell of ActionAid explained how the RFS exacerbates world hunger, undermining U.S. foreign aid and international security objectives. The RFS diverts 15% of the world corn supply from food to fuel, putting upward pressure on food prices. A recent Tufts University study estimates that U.S. ethanol expansion during the past 6 years cost developing countries more than $5.5 billion in higher prices for corn imports. In Guatemala, the additional expense ($28 million) in 2011 effectively cancelled out all U.S. food aid and agricultural assistance for that year. Food price spikes, partly due to the RFS, were a factor in the recent turmoil in the Middle East. ”Congress can’t control the weather, but they can control misguided energy policies that could cause a global food crisis,” Sundell said.

Kristin Wilcox of the American Frozen Food Institute discussed the RFS’s impact on food consumers. Corn is both the chief animal feed and an ingredient in about 75% of all frozen foods. Consequently, RFS-induced increases in corn prices drive up “the cost of producing a wide range of foods and leads to higher food bills for consumers.” In addition, when corn prices go up, so do the prices of other commodities that compete with corn such as wheat and soybeans. ”Our position is very simple,” Wilcox said: “food should be used to fuel bodies, not vehicle engines.” She concluded: “Trying to change the price at the pump should not burden consumers with increased prices in the grocery check out aisle.”

Actually, as Geoff Moody of the American Fuel & Petrochemical Manufacturers pointed out, the RFS aggravates rather than alleviates pain at the pump. Graphs from the Energy Information Administration show that biofuels are more expensive than gasoline on an energy-content (per-mile) basis. The higher the ethanol blend, the more expensive it is to drive, which is why fewer than 4% of flex-fuel vehicle owners fill up with E85 (motor fuel blended with 85% ethanol).

Moody’s major point was that the RFS is becoming increasingly unworkable. Already the 135 billion gallon U.S. motor fuel market is nearly saturated with E10. By 2022, U.S. motor fuel consumption is projected to be about 25% lower than Congress assumed when it expanded the RFS in 2007. If Congress does not revise the RFS, refiners will have to sell E20 or higher, but the existing retail infrastructure is not equipped to handle blends higher than E10. A typical service station may clear a profit of only $45,000 on motor fuel sales, but replacing pumps and storage tanks to handle higher blends can cost $50,000 to $200,000.

Scott Faber of the Environmental Working Group discussed the RFS program’s environmental impacts, especially changes in land use. From 2008 to 2011, high crop prices and crop subsidies contributed to the conversion of 23 million acres of wetlands and grasslands, an area the size of Indiana. About 8.4 million acres were converted to corn production. “We have lost more wetlands and grasslands in the last four years than we have in the last 40 years,” Faber said. If lawmakers knew in 2007 what we now know about the RFS’s many serious unintended consequences, they would not have enacted the program, Faber opined.

Tom Elam of Farm Econ LLC discussed the RFS program’s impacts on livestock producers and meat and poultry consumers. Since Congress created the RFS in 2005, annual feed costs have increased by $8.8 billion for chicken producers and $1.9 billion for turkey producers. Consequences of those higher costs include an 8 billion pound decline in poultry production, eight major bankruptcies, a half billion dollar loss in farm income, and higher prices for consumers.

Retail broiler prices, for example, increased from $1.74/lb in 2005 to $1.97/lb in December 2012. Turkey prices similarly rose from $1.07/lb in 2005 to $1.80/lb in early 2012. Beef and pork prices too rose along with feed costs, with the result that U.S. per capita meat and poultry consumption declined by about 10% since 2008.

The RFS may be good for corn farmers, but it fosters economic inefficiency. For every $1 of added ethanol production, food production costs increased $2.89. In other words, food producers bear a cost “more than twice the value of the ethanol created.”

Jim Currie of the National Marine Manufacturers Association explained the perils of E15 to the $72 billion per year U.S. recreational boating industry. Boats and other small gasoline-powered engines are designed to run on motor fuels blended with 10% ethanol or less. Consequently, “anything above E10 poses serious problems, including performance issues like stalling, corrosion leading to oil or fuel leaks, increased emissions and damaged valves, rubber fuel lines and gaskets.”

Higher blends are trouble for two reasons. First, ethanol is a solvent and at increased concentrations eats away at engine components. Second, ethanol is an oxygenate, and the higher the oxygen content of a fuel, the hotter the burn. Tests supervised by the Department of Energy’s National Renewable Energy Lab prove “time and time again that marine engines and, by extrapolation, other types of engines, simply cannot tolerate the high levels of additional oxygen that this fuel blend forces into the engine.” Currie presented lab test photos of such engine damage (pp. 3-7 of this Power Point).

Valve rupture from E15

Touching on the potential risks E15 poses to automobiles, he quoted the AAA’s statement of last December: “Only about 12 million out of the more than 240 million light-duty vehicles on the roads today are approved by manufacturers to use E15 gasoline.”

Currie’s conclusion drew applause from the Hill crowd:

As I am the last presenter today, let me offer a hypothetical scenario, based on what you have heard. Suppose an organization approached the Hill today and said, “We have a great idea for a new policy. It will largely benefit a small number of people in one part of the country, and members of Congress from there will support it wholeheartedly. The downside is that it will hurt the environment; and conservation practices; and will drive up food costs; and hurt people in developing countries; and will potentially damage every small engine in the country, including those in motorcycles and snowmobiles and ATVs and lawnmowers and generators; and it will damage boat engines; and it will potentially damage most automobile engines and will void your engine warranty if you use it. But we want you to enact a law requiring the American consumer to use it anyway.” That’s where we are today, and we think this law needs to be changed.

Today, FarmEcon LLC released RFS, Fuel and Food Prices, and the Need for Statutory Flexibility, a study of ethanol’s impact on food and fuel prices. FarmEcon prepared the study for the American Meat Institute, California Dairies Inc., Milk Producers Council, National Cattlemen’s Beef Association, National Chicken Council, National Pork Producers Council, and National Turkey Federation.

The study argues that the Renewable Fuel Standard (RFS), commonly known as the ethanol mandate, is detrimental to both non-ethanol industry corn users and food and fuel consumers. The program should therefore be reformed. The RFS has “destabilized corn and ethanol prices by offering an almost risk-free demand volume guaranty to the corn-based ethanol industry.” Consequently, food producers who use corn as a feedstock “have been forced to bear a disproportionate share of market and price risk” when corn yields fall and prices rise. This has become painfully obvious in recent weeks as drought conditions in the Midwest depress yields and push corn prices to record highs.

Appropriate reform* would assure food producers ”automatic market access” to corn stocks “in the event of a natural disaster and a sharp reduction in corn production.” Ethanol producers should “bear the burden of market adjustments, along with domestic food producers and corn export customers.” The study also recommends that the RFS schedule ”be revised to reflect the ethanol industry’s inability to produce commercially viable cellulosic fuels.”

Pretty tame stuff. An argument for flexibility to avoid the RFS’s worst market distortions and the cellulosic farce rather than an abolitionist manifesto. Nonetheless, the study paints a fairly damning picture of the RFS as a whole:

• Increases in ethanol production since 2007 have made little, or no, contribution to U.S. energy supplies, or dependence on foreign crude oil. Rather, those increases have pushed gasoline suplies into the export market.
• Current ethanol policy has increased and destabilized corn and related commodity prices to the detriment of both food and fuel producers. Corn price volatility has more than doubled since 2007.
• Following the late 2007 increase in the RFS, food price inflation relative to all other goods and services accelerated sharply to twice its 2005-2007 rate.
• Post-2007 higher rates of food price inflation are associated with sharp increases in corn, soybean and wheat prices.
• On an energy basis, ethanol has never been priced competitively with gasoline.
• Ethanol production costs and prices have ruled out U.S. ethanol use at levels higher than E10. As a result, we exported 1.2 billion gallons of ethanol in 2011.
• Due to its higher energy cost and negative effect on fuel mileage, ethanol adds to the overall cost of motor fuels. In 2011 the higher cost of ethanol energy compared to gasoline added approximately $14.5 billion, or about 10 cents per gallon, to the cost of U.S. gasoline consumption. Ethanol tax credits (since discontinued) added another 4 cents per gallon.

Some other key points presented in the study:

• Ethanol typically sells for less per gallon than gasoline, but “engines do not run on gallons, they run on energy,” and a gallon of ethanol has only 67% of the net energy in a gallon of gasoline.
• Consequently, on a per-mile basis, ethanol is more expensive than gasoline. This accounts for the failure of E85 (motor fuel blended with 85% ethanol) to achieve significant sales. ”According to recent Department of Energy statistics, ethanol blends of more than 55 percent account for only 2,000 barrels per week out of total gasoline production of about 8.7 million barrels per week.”
• The RFS has dramatically altered U.S. corn markets. Corn prices have increased from $2.00 a bushel in 2005/2006 to $6.00 a bushel in 2011/2012. Corn use for ethanol increased from 1.6 billion bushels in 2005/2006 to 5.0 billion in 2011/2012. Feed use of corn declined from 6.2 billion bushels in 2005/2006 to an estimated 4.6 billion in 2011/2012. Corn exports declined from 2.1 billion bushels in 2005/2006 to an estimated 1.7 billion bushels in 2011/2012.
• The RFS creates risks as well as benefits for ethanol producers. “Since the first RFS schedule in 2005, the corn cost in a gallon of ethanol has increased from about 50 percent to more than 80 percent of total ethanol production costs. Corn costs for ethanol producers have also been much more volatile. . . .This higher volatility [after the 2007 RFS] has increased business risks for all corn users. The result has been the bankruptcy of a number of ethanol companies and food producers.”
• Corn is a key commodity used by meat, poultry, and dairy producers. Corn prices also influence wheat, soybeans, and other commodities, because corn competes with those crops for customers and/or land. The cost of corn, wheat, and soybeans used in U.S. food production has risen from $26.5 billion in 2005, when the first RFS was enacted, to $69.5 billion in 2011. “The cumulative cost increase over 2005-2011 was $141.9 billion.” Higher energy prices also played a significant role. Nonetheless, the RFS mandates were an important factor.
• The cost of food has increased much faster than overall inflation since the 2007 RFS was enacted. “Overall price inflation of items other than food, even including energy, declined dramatically after December, 2007. The decrease was largely due to the 2008-2009 recession. In 2005 to 2007, food prices were increasing slower than all items other than food. However, post-RFS food price inflation accelerated, even in the face of the recession.”
• “Higher corn prices (and associated increases in wheat and soybean prices) have dramatically raised the costs of producing meat and poultry.” Unspurprisingly, per capita meat and poultry consumption “has declined to the lowest level since 1990.”
• Like the MIT study I reviewed earlier this week, the FarmEcon study rejects the ‘finding’ of Iowa State University researchers that ethanol, by expanding the U.S. motor fuel supply, reduced the crack spread (refiner profit margin) by $1.09 per gallon in 2011, sparing consumers an equivalent increase in pain at the pump.
• FarmEcon offers a critique based on statistical models but also presents an Econ 101 argument: “The 2000-2011 average gasoline crack price spread was 27.8 cents per gallon. The 2011 margin averaged 37.1 cents. A $1.09 increase in that margin would lead to refineries quickly increasing gasoline production and reducing gasoline exports. The increase in gasoline supply available to the U.S. market would largely, likely entirely, wipe out the higher gasoline price.” In other words, the market is self-correcting. Refiners don’t need big-daddy government to tell them to produce more fuel when demand increases faster than supply and prices rise.

* The reform examined in the study, proposed by Rep. Bob Goodlatte (R-Va.), would relax the RFS targets as the corn stocks-to-use ratio declines below 10%. Stocks-to-use measures the quantity (“stock”) of a commodity at the end of a particular time period as a percentage of total use of the commodity during that time period. TradingCharts.Com explains how a stocks-to-use ratio is calculated.

The stocks to use ratio indicates the level of carryover stock for any given commodity as a percentage of the total demand or use. The mathematical formula for this relationship is as follows:

 Beginning Stock + Total Production – Total Use ÷ Total Use

. . . . beginning stocks represent the previous year’s ending or carryover inventories. Total production represents the total grain produced in a given year. Total usage is the sum of all the end uses in which the stock of grain has been consumed. This would include human consumption, export programs, seed, waste, dockage and feed consumption. By adding carry-over stocks to the total production you will obtain the total supply. From the total supply, subtract the total use and the resultant figure will be the year ending carryover stock. The carryover stock divided by the total usage can be expressed as a ratio which when compared with previous years gives the market analyst an indication of the relative supply/demand balance for a particular commodity. This ratio can then be used to indicate whether current and projected stock levels are critical or plentiful.The ratio can also be used to indicate how many days of supply are available to the world marketplace under current usage patterns ( eg. a 20% stocks to use ratio for wheat indicates that there are 75 days supply of wheat in reserve).

TradingCharts.Com notes that historical stocks-to-use data provide “bench mark ratios” useful for predicting movements in commodity prices: “On a world basis a stocks/use ratio for wheat under 20% has typically led to strong price advances. For corn, the comparable number appears to be under 12% . For soybeans, the critical level is below 10%.”

The Goodlatte proposal adjusts the RFS targets as follows:

• No reduction in the mandated quantity of renewable fuel if corn stocks-to-use is above 10%;
• a 10% reduction if stocks-to-use is 10.0%-7.5%;
• a 15% reduction if stocks-to-use is 7.49%-6.0%;
• a 25% reduction if stocks-to-use is 5.99%-5.0%; and,
• a 50% reduction if stocks-to-use is below 5%.

According to FarmEcon, corn stocks-to-use in 2010/2011 was 6.2% and in 2011/2012 is 6.7%. In both crop years, the RFS target would be reduced by 15% under Goodlatte’s proposal.