Can The Ethanol Market Stand On Its Own Two Feet?

from the etha-what? dept

Soaring energy prices have created an ideal climate for alternative energy investment, as evidenced by the boom in that space. You'd think, then, that with the market doing a good job of sorting things out, there'd be little need for the government to intervene. But while entrepreneurs and VCs are seeking to build sustainable, profit-making businesses, the ethanol industry has sought to profit from the largesse of the US taxpayer. The industry has been helped by direct subsidies as well as indirect ones, such as laws that impose added costs on its rivals. While many people champion higher CAFE standards in order to protect the environment, the ethanol lobby has been a particularly big booster of them, because of a 1988 law carved out an exception for vehicles that could run on ethanol. Meanwhile, this favorable treatment towards the industry causes problems in other pockets of the economy. Increasingly, companies have to be concerned with "agflation", the soaring price of agricultural commodities due to the heightened demand for corn (which, as you learned in econ 101, increases prices for corn substitutes, like rice and wheat). If ethanol is going to be a meaningful energy source in the future, it needs to stand on its own in the market. Otherwise, the existing setup appears to be just more counterproductive agriculture subsidies, cynically concocted in the name of national security and the environment.

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  1. identicon
    David Sternlight, 5 Jul 2007 @ 1:55am

    OPEC can ..crush us overnight

    The notion that OPEC can crush us is nonsense. It was argued during the earlier OPEC oil embargo as well. It was claimed that if we didn't tilt away from Israel and toward the Arabs, they would destroy our economy.

    What actually happened (I studied the data extensively at the time) was that oil prices moved in response to the tightness or looseness of oil markets in Western Europe. The correlation was perfect. On several occasions we took pro-Israel steps and OPEC did nothing; in contrast, on several occasions we took no action with respect to Israel yet OPEC raised prices in response to high demand in Western Europe. There was zero correlation between US policy toward Israel and oil prices.

    Another factor that affects oil prices is the extent of reserves. Saudi Arabia has big reserves and doesn't want high oil prices to kill their long-term market by stimulating conservation and efficiency. Iraq has much more limited reserves and wants high prices; they don't care if the long-term market is ruined because they won't have any oil to sell, relatively speaking, in the long term. By taking advantage of this insight, Prof. Dermot Gately of NYU built an oil price model that was able to forecast OPEC pricing decisions six months in advance.

    Finally, we use domestic oil first, then nearby oil, only then if demand isn't satisfied do we use Arab oil (OPEC is not just the Arabs; the Arabs are OAPEC). Similarly in Europe; first they use oil from the North Sea and then from further away. It's pure economics, driven by transportation costs which vary with distance. Oil is fungible; the Arabs have tried to "tag" oil to enforce a boycott, but cannot. Once an international oil trader gets his hands on oil it can go anywhere. We could, for example, stop selling Alaskan Oil to Japan if OPEC tries to embargo us, and let the Japanese buy from the Arabs.

    It is OPEC that lives in mortal fear of things like US energy conservation and efficiency increases. If we use less gasolene, the reduction comes entirely out of the Arabs hide; we're not going to reduce our use of Alaskan oil. Thus a small percentage drop in consumption here is a big percentage drop in imports from the marginal producers (the Arabs).

    Every so often the Arab Oil producers become desperate aa demand weakens and prices fall. To save them, we bought a lot of oil and dumped it into the ground, calling it the "Strategic Petroleum Reserve".

    Please stop making snide remarks about my Ph.D. I spent about 10 years as the Chief Economist of a major international oil company, and this is an area of my expertise.

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