On the heels of last year's close call for the corn and ethanol lobby (which barely managed to get the ethanol tax credit and import tariff extended for one more year) and the recent bipartisan Ethanol Subsidy and Tariff Repeal Act introduced by Senators Tom Coburn (R-OK) and Dianne Feinstein (D-CA), former Minnesota Governor Tim Pawlenty's call for the gradual phase-out of the ethanol subsidy — a 45-cent-per-gallon tax credit — is raising eyebrows and being called politically courageous.
The truth is that the ethanol subsidy currently has little if any impact on the U.S. corn and ethanol industries because the Renewable Fuel Standard (RFS) requires Americans to consume an increasing amount of biofuels each year. As a mandate, the RFS acts as a built-in market for U.S. ethanol producers. The demand for ethanol will therefore not drop significantly when the subsidy is eliminated.
Pawlenty's rationale for eliminating the subsidy is that the government cannot afford it, which is fair enough — the subsidy costs $6 billion per year. But there's a better reason to end the subsidy: since the RFS and high ethanol prices in Europe have been for the most part determining ethanol market prices, the subsidy is simply subsidizing gasoline consumption and U.S. ethanol exports. This contradicts all of the political rationales for the subsidy (that it's good for the environment; that it raises farm incomes; and that it increases U.S. energy security).
Since the economic rationale for the ethanol tariff is to offset the subsidy, if the subsidy is eliminated, the tariff should be as well. Although he didn't mention it in his speech, presumably Pawlenty is in favor of eliminating the highly protectionist, 54-cent-per-gallon ethanol tariff. Even Senator Grassley (R-IA), the darling of the corn and ethanol lobbies, admits that both the subsidy and the tariff have to go. The tariff also provides little protection to the U.S. corn and ethanol industries; the U.S. became the world's largest ethanol exporter in 2010, and is on track to export substantially more this year.
There are three primary reasons why the tariff will provide little protection for the foreseeable future.
First, record world sugar prices have incentivized Brazilian sugarcane mills to focus on producing and exporting sugar. Brazil's mills produce both sugar and ethanol but can adjust their dials annually in favor of the product that offers the highest returns. Therefore, until sugar prices drop, the capacity for Brazil to expand ethanol exports in the near term is very limited.
Second, the tariff will be redundant for some time because imported sugarcane ethanol from developing countries has been classified under the new RFS mandate as a non-cellulosic advanced biofuel, and therefore will not compete with corn-ethanol producers for U.S. market share for years to come.
Third, Brazil is having difficulty meeting its own domestic demand for ethanol as demand for domestic transportation fuels has been growing 15 percent per year because of the booming Brazilian economy. Meanwhile, sugarcane production has been increasing only 10 percent per year and this growth will drop in the short term due to weather-related factors and the need to renew elderly cane. Expanding sugarcane production will require time and huge investments, but the latter are being stymied by a series of government policies directed at the ethanol industry.
While the Brazilian government is actively interfering in its ethanol industry, this is a good time for the U.S. government to do the opposite. There is waning public support in the U.S. for biofuel subsidies and mandates. The ethanol lobby is divided, as a broad coalition of organizations like value-added agricultural industries, environmental groups and the oil industry are lobbying strongly against current ethanol policy that distorts the economy and fails to meet environmental goals.
So if calling for the elimination of the ethanol tax credit and ethanol import tariff will have little if any impact on the corn and ethanol industries, what can Pawlenty do to prove he's a courageous political leader with statesman-like qualities? In addition to calling for the elimination of ethanol subsidies and tariffs, he can call for the immediate elimination of biofuel mandates.