My Loathing of Ethanol Finally Aired - the Economist's Perspective

I'm not a fan of ethanol either. Sure, there are greenhouse gas benefits from using ethanol rather than petroleum, but those may very well be offset by the environmental degradation caused by pulling marginal land into production and increased use of fertilizers. On top of that, ethanol has very limited ability to actually replace gasoline, given the current inventory of automobiles the citizens of the United States own (more on this later). Sure, thermochemical conversion processes that generate cellulosics are tempting to think about and may actually go a long way in making biofuels feasible, but we currently don't have the technology to make large-scale thermochemical conversion possible. Therefore, what we're currently stuck with is ethanol, a fuel that most cars can't use in concentrations of 15% or more, can't be transported using normal fuel distribution infrastructure, and sucks up government funding like it's going out of style. Given all of this, I agree with raftercm's earlier criticism that ethanol is merely a crutch that the agriculture industry is plugging because it jacks up the value of their output; real advances in renewable fuel technology are out there, but all of this focus on ethanol is a huge distraction.

As raftercm wrote, the Senate voted yesterday to maintain the ethanol subsidy. I'm not a fan of agricultural subsidies to begin with, but the ethanol subsidy is the worst of the bunch. The American Journal of Agricultural Economics recently published a paper [1] that nicely explains the basic economics of ethanol. The figure below shows the generalized supply and demand curves for ethanol, with the demand+subsidy curve representing the demand curve with the ethanol subsidy. 

Demand for ethanol is inherently limited by a technical constraint known as the "blend wall." It turns out that car engines can't use any fuel that's mixed with greater than 10-15% ethanol; otherwise, the ethanol will corrode the fuel system (which is also the reason that ethanol can't be transported using the same infrastructure as gasoline). This means that, for a given quantity of gasoline demanded, the quantity of ethanol demanded can be only around 10-15% for most cars. In essence, this means that once the quantity of ethanol demanded bumps up against Q^BW, the value of additional ethanol drops to the value of the corn used for grain (the alternative for using the corn for ethanol).

So what happens when we remove the subsidy? Assuming we're at the blend wall (which we are), nothing. The price of the initial quantity of ethanol demanded (Q^BW - 0) goes down, but the value of the ethanol at the blend wall stays essentially the same.

In conclusion, I'm all for pulling the subsidy. It will save the government a bundle and may drive innovation away from ethanol and towards a more sensible renewable fuel.



1. Tyner, Wallace E., Frank J. Dooley, and Daniela Viteri. 2011. Alternative Pathways for Fulfilling the RFS Mandate. American Journal of Agricultural Economics 93.2, 465-472. The figure in the present post was pulled from this article.