In business, there is a phenomenon known as “The Virtuous Cycle”. As an investor, I put my capital at risk to open a new company. I may manufacture a product or provide a service to my customers. I may hire additional workers and trade my money for their time and production to produce even more of a profit. I make a return on my investment that I use to buy goods and services that create profit for someone else. My employees use their paychecks to do the same. My customers purchase my goods or services. This frees them up from the labor required to produce these things and allows them to use their time more profitably. The cycle goes on and on. It is a virtuous cycle because everyone benefits – the investor, the employees and the customers.
When government begins to intrude into markets, the “Virtuous Cycle” is destroyed. A good example of this is the mandated production of ethanol and other biofuels here in the US. The Energy Policy Act of 2005 laid out a series of government mandates for the increased production and consumption of biofuels through 2012. The Energy Independence and Security Act of 2007 expanded these regulations and extended them for another decade through 2022. Both of these rules were passed by Congress and signed into law by President George W. Bush. We were told that the real reasons for passing these laws was to help reduce greenhouse gas emissions and create a more prosperous, energy-secure future for our country, help us make the transition from unsustainable fossil fuels to sustainable alternatives and create a cleaner world for our children. But is this actually the case?
Ethanol is produced from sugar crops. In Brazil, the world’s largest producer of ethanol, production is derived mainly from sugar cane or sugar beets. In the US, these crops do not grow effectively throughout much of the nation due to climate conditions. Instead, ethanol is largely produced from one of our staple food crops – corn. Corn is used in a wide variety of food products, sweeteners, preservatives, etc. and is also one of our chief sources of livestock feed. Annual price variations in corn due to weather-related production losses, demand, disease and more can create a tremendous ripple effect that spreads across our economy. In addition, mandating large amounts of our crop produce to be used in alternative fuel production has had a similar effect. According to the Congressional Budget Office (CBO) the increased demand for corn to be used in Ethanol production between April 2007 and April 2008 caused prices to rise between .50 to .80 per bushel. This accounts for somewhere between 28-47% of the total increase in corn prices during that time. Other factors that impacted crop prices were increased global demand for meat (corn is a staple in livestock feeds), the devaluation of the US Dollar and weather-related crop concerns. During this year alone, corn prices increased from $3.39 to $5.14 per bushel. Demand for corn just to produce ethanol during this same time period was up by 43%. Unfortunately, the costs don’t stop there.
When corn prices rise, demand for cropland also increases. When the cost of land increases, all crop prices must increase. Other food crops are competing for the same arable land and higher land prices are reflected in the prices of these crops. As food prices rise, the Consumer Price Index (CPI) goes up. As the CPI rises, government benefits like Social Security, civilian and military pay are adjusted accordingly which creates higher government spending. Even federal assistance programs like SNAP (formerly Food Stamp Program), child assistance and WIC have to increase as well.
What about the promise of saving our atmosphere and reducing greenhouse gas emissions? According to 2007 research by Argonne National Labs, the amount of greenhouse gas emission from the use of ethanol is directly related to how the ethanol is produced. In the US, ethanol facilities are largely powered by natural gas and coal. Natural gas plants burn cleaner and according to the study actually produce a positive reduction in greenhouse gas emissions of ethanol vs. gasoline. Coal-fired plants actually produce more greenhouse gas emissions than the production and consumption of gasoline. Fortunately, most ethanol production plants are powered by natural gas. So how much did we reduce our carbon footprint in the transportation sector by substituting ethanol for gasoline in the 2007-2008 time period? By the most optimistic estimates, it was probably reduced by around 0.7%.
Another issue is the economic viability of using ethanol as a substitute for gasoline. Since 1978, companies that blend ethanol with gasoline have received a tax subsidy from the federal government. Today, that equates to about .45 for every gallon of ethanol blended into gasoline. According to the CBO study, the price of a gallon of gas must be roughly equivalent to 90% of the price of a bushel of corn for ethanol production to be financially sensible with no government subsidies. As of this writing, the cost of a bushel of corn is roughly $6.98. Gasoline (regular) currently averages $3.65 nationwide. In other words, gas costs 52% as much as a bushel of corn. It makes no economic sense to turn corn into ethanol unless it is subsidized by taxpayer dollars. This means the government must forcibly take your money and give it to the owners of a refinery in order to make ethanol economically viable. There is no win-win in this type of artificial cycle.
What about the looming threat of running out of fossil fuels? In the last few years, technology has advanced to allow the removal of vast oil reserves that was formerly trapped in tar/oil sands and shale. On the North Dakota/Montana border, the Bakken formation is currently being exploited profitably by using methods such as fracturing, lateral drilling, moveable platforms and more. A 2011 report indicates that up to 24 Billion Barrels may be harvested using current technology and the total size of the oil reserve may be as large as 300 BBbls. Much of that oil is not extractable using these new technologies but may be harvested in the future. A recent interview on CNBC stated that as long as oil stays above $40 barrel, current drilling technologies are leading to profitable oil extraction. In one interview, a geologist estimated that with the current pace of drilling technology advancement, as much as 150BBbls of oil may one day be extracted from the Bakken formation.
Government certainly has a role in funding the research and development of new technologies and energy sources that may one day have a positive impact on our environment and economy. Advancements in wind, wave, nuclear and solar energy are important as we look for ways to produce cleaner, cheaper energy to meet our national interests. However, government should not be involved in subsidizing the production of these technologies. For a new commodity or technology to be produced, it should be viable in the marketplace and able to stand on its own. Anything else is counter-intuitive and diminishes viable and profitable markets.
Isn’t it immoral to use food to make fuel when so many go hungry every day? Doesn’t artificially increasing the cost of food for consumers reduce a family’s ability to provide for itself? Who is hurt the most by government intrusion in the markets? It is ultimately the poor and lower income households that feel the greatest economic pain from this type of intervention because food and fuel prices represent a much larger portion of their take-home pay than the middle and upper class. There is nothing virtuous in this “Cycle of Destruction.”
© 2011, Angelica Wolf
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