With federal RFS, ethanol producers would likely survive without federal subsidies, economists say, as US$0.45/gallon tax credit -- set to expire at year's end -- not primary driver of demand, primarily incentive for blenders

Rachel Carter

CHAMPAIGN, Illinois , June 23, 2011 (Associated Press) – If a $5 billion-a-year federal subsidy that helped build the ethanol industry comes to an end, it will likely mean two things, experts who have followed its development say.

First, it doesn't guarantee an end to the high prices that corn farmers have enjoyed and livestock producers and other food manufacturers have endured.

That's because of the second point: the ethanol industry likely would be fine without the subsidy and keep using just about as much corn as it has the past few years.

As the experts point out, the 45-cent-a-gallon tax credit set to expire at the end of the year doesn't even go directly to ethanol producers, but instead has been an incentive for oil companies like BP, Valero Energy Corp., and ExxonMobil Corp. - known in the ethanol industry as blenders - to buy ethanol and blend it with gasoline.

And the tax credit isn't even the primary driver of ethanol demand. That, economists note, has been the federal requirement that the country produce an increasing amount of renewable fuels like ethanol.

"What do you need a tax credit for when you have this built-in huge market in the United States?" asked Bruce Babcock, an economist at Iowa State University. "The U.S. ethanol industry is very competitive; they don't need the (subsidy)."

The U.S. Senate voted last week to end the tax credit and an accompanying tariff on ethanol imports in July, half a year ahead of schedule. The move was mostly symbolic - Republicans on Tuesday blocked the jobs bill it was part of - but it showed that lawmakers may be ready to let the subsidy die in December rather than renew it as they did last year.

Ethanol producers and corn farmers had hoped to preserve the tax credit, but now seem willing to compromise.

Many in the ethanol industry now are pushing for a smaller credit designed to encourage sales when economic conditions dictate that ethanol producers really need it, and money to pay for the installation of gas pumps that would let drivers fill up with fuel containing up to 85 percent ethanol.

Republican Sen. John Thune of South Dakota and Democratic Sen. Amy Klobuchar of Minnesota are sponsoring such a compromise bill the industry favors. Both senators are from states with thriving ethanol industries.

"We think cooler heads will prevail and we'll get something rational" from Congress, said Vincent Kwasniewski, vice president of GTL Resources. The company owns the Illinois River Energy ethanol plant in Rochelle, Ill. "We think we're in a strong position to prosper under that kind of legislative situation."

The tax credit, known as Volumetric Ethanol Excise Tax Credit, or VEETC, was created in 2004 to help encourage the use of ethanol, most of which in the United States is made of corn.

It gave oil companies financial incentive to buy ethanol and blend it with their gasoline - using more of the alternative fuel - at a time when there was little financial incentive to do so. The credit and the renewable fuels mandate - a requirement that refiners use 12 billion gallons of renewable fuels in 2011, 15 billion by 2015 and 36 billion by 2022 - have worked together to drive up ethanol production. The U.S. produced 13.2 billion gallons of ethanol in 2010, up from 3.4 billion in 2004, according to the Washington-based Renewable Fuels Association.

Last year, it took about one-third of the U.S. corn crop to meet the ethanol demand. When coupled with increased orders from livestock producers, who rely on corn for feed, and growing exports to China and elsewhere, the demand for corn has soared and caused prices to reach historic highs.

Given that, corn farmers aren't sure what to think about the latest development. If demand remains strong, prices should remain high, but they're uneasy about a dramatic change in federal policy.

"I guess I was hoping there would be a more orderly reduction. Maybe a phase-down," said Greg Bartz, who grows corn and soybeans near the southern Minnesota community of Sleepy Eye.

Leon Sheets, who raises 1,200 hogs in northeast Iowa, was among those who have had to buy a lot of high-priced corn the past few years. The president of the Iowa Pork Producers Association has watched in disbelief as corn prices rose, past $4 a bushel and on through five and six.

"All the sudden, geez, we jumped over seven and crowded 8," he said. "It didn't necessarily mean that I was losing (money), but my opportunity to show a profit on the operation has been extremely challenged."

Scott Irwin, the chairman of agricultural marketing at the University of Illinois, sees the loss of the tax credit as "moderately bad news" for farmers but a change that likely wouldn't change prices much.

Although Irwin said the ethanol producers could manage without the tax credit, he speculated that it would cut down on the industry's growth potential. Without some sort of subsidy or oil prices pushing $150 a barrel or more, there's not much incentive right now for anyone to use more ethanol than the mandate requires.

That, some in the industry believe, is where the new gas pumps come in.

Chris Thorne, spokesman for the trade group Growth Energy, said that there are roughly 8 million flex-fuel vehicles on U.S roads now, but relatively few gas pumps that sell gasoline blended with the higher levels of ethanol they can burn.

New Jersey, he said, has about 186,000 flex-fuel vehicles, but no flex-fuel pumps.

"The (subsidy) did a great thing in building up demand and encouraging production of ethanol," Thorne said. "Well, we don't have a production problem anymore, we have a market access problem."

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Associated Press writer Steve Karnowski in Minneapolis contributed to this report.

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