Claims for Environment, Energy Use Draw Fire; Fighting on the Farm

The Wall Street Journal
November 28, 2007
By LAUREN ETTER

Little over a year ago, ethanol was winning the hearts and wallets of
both Main Street and Wall Street, with promises of greater U.S. energy
independence, fewer greenhouse gases and help for the farm economy.
Today, the corn-based biofuel is under siege.

In the span of one growing season, ethanol has gone from panacea to
pariah in the eyes of some. The critics, which include industries hurt
when the price of corn rises, blame ethanol for pushing up food prices,
question its environmental bona fides and dispute how much it really
helps reduce the need for oil.

A recent study by the Organization for Economic Cooperation and
Development concluded that biofuels "offer a cure [for oil dependence]
that is worse than the disease." A National Academy of Sciences study
said corn-based ethanol could strain water supplies. The American Lung
Association expressed concern about a form of air pollution from
burning ethanol in gasoline. Political cartoonists have taken to
skewering the fuel for raising the price of food to the world’s poor.

Last month, an outside expert advising the United Nations on the "right
to food" labeled the use of food crops to make biofuels "a crime
against humanity," although the U.N. Food and Agriculture Organization
later disowned the remark as "regrettable."

The fortunes of many U.S. farmers, farm towns and ethanol companies are
tied to corn-based ethanol, of which America is the largest producer.
Ethanol is also a cornerstone of President Bush’s push to reduce
dependence on foreign oil. But the once-booming business has gone in
the dumps, with profits squeezed, plans for new plants shelved in
certain cases, and stock prices hovering near 52-week lows.

Now the fuel’s lobby is pleading with Congress to drastically boost the
amount of ethanol that oil refiners must blend into gasoline. But
formidable opponents such as the livestock, packaged-food and oil
industries also have lawmakers’ ears. What once looked like a slam-dunk
could now languish in pending energy legislation that might not pass
for weeks, if ever.

Ethanol’s problems have much to do with its past success. As profits
and production soared in 2005 and 2006, so did the price of corn,
gradually angering livestock farmers who need it for feed. They allied
with food companies also stung by higher grain prices, and with oil
companies that have long loathed subsidies for ethanol production.

The U.S. gives oil refiners an excise-tax credit of 51 cents for every
gallon of ethanol they blend into gasoline. And even though it’s the
oil industry that gets this subsidy, the industry dislikes being forced
to use a nonpetroleum product. The U.S. ethanol industry is further
protected by a 54-cent tariff on every gallon of imported ethanol.

Ethanol prices peaked at about $5 a gallon in some markets in June
2006, according to Oil Price Information Service. The price soon began
to slide as the limited market for gasoline containing 10% ethanol grew
saturated. New plants kept coming online, increasing supply and
dropping prices further. Today, the oil refiners that purchase ethanol
to blend in need pay only about $1.85 a gallon for it.

The low ethanol prices help some oil refiners. "I’d pay a hell of a lot
more for ethanol than I am right now…. I’m getting a windfall because
it’s priced so much less than its value to me," Lynn Westfall, chief
economist for refiner Tesoro Corp., told investors recently. The
ethanol tax credit will bring refiners an estimated $3.5 billion this
year. Some oil companies use ethanol to stretch gasoline supplies or
meet state requirements to make gasoline burn more cleanly. Ethanol
that’s voluntarily blended into gasoline reached a high this month,
according to the Energy Information Administration.

The low prices reflect soaring output. Global ethanol production has
grown to a projected 13.4 billion gallons this year, from 10.9 billion
gallons in 2006, according to the International Energy Agency. The U.S.
production is more than half of that total, or about seven billion
gallons this year, up 80% in two years. It equals less than 4% of U.S.
gasoline consumption.

Analysts expect U.S. production capacity to keep growing, encouraged
both by high oil prices and by the hope that Congress will stiffen the
mandate for refiners to use ethanol. Some observers regard the profit
squeeze as part of an ordinary industry shakeout that will ultimately
leave the best producers in a position to thrive. As ethanol prices
were pushed lower and corn prices stayed high, ethanol profit margins
dropped from $2.30 per gallon last year to less than 25 cents a gallon.

Turning Up the Heat

This year, even as the production glut was driving down ethanol’s
price, critics and opposing lobbyists were turning up the heat.
Environmentalists complained about increased use of water and
fertilizer to grow corn for ethanol, and said even ethanol from other
plants such as switchgrass could be problematic because it could mean
turning protected land to crop use. Suddenly, environmentalists, energy
experts, economists and foreign countries were challenging the
warm-and-fuzzy selling points on which ethanol rose to prominence.

"Our love affair with ethanol has finally ended because we’ve taken off
the makeup and realized that, lo and behold, it’s actually a fuel,"
with environmental and various other drawbacks, says Kevin Book, an
analyst at Friedman, Billings, Ramsey Group Inc.

Against all the criticism and lobbying, "we’re David in this fight,"
says Bob Dinneen, the ethanol industry’s top lobbyist. Mr. Dinneen says
the industry has been made a scapegoat for food price increases that
are due to many factors, including higher oil prices and growing
overseas demand for grain. He also faults the lack of a mature U.S.
distribution network that would make it easier for consumers to get
ethanol. His group, called the Renewable Fuels Association, and the
National Corn Growers Association have formed a coalition to "unify the
voices" in the ethanol community, he says.

Back in early 2005, President Bush gave ethanol a boost in his State of
the Union speech by calling for "strong funding" of renewable energy.
Energy legislation that summer required oil companies to blend a total
of 7.5 billion gallons of "renewable" fuels into the nation’s fuel
supply by 2012. The legislation also effectively extinguished ethanol’s
chief competitor as a clean-burning additive, methyl tertiary-butyl
ether, which had groundwater-pollution issues. The bill anointed
ethanol as the default additive and instantly created demand nearly
double what was produced that year.

"That was when the floodgates started coming open," says attorney Dan
Rogers of the Atlanta law firm King & Spalding LLP, which arranges
financing for ethanol plants. Hedge funds, private-equity investors and
East Coast bankers started pouring money into ethanol. Producers such
as VeraSun Energy Corp. and Pacific Ethanol Inc. went public. Mr.
Dinneen, the lobbyist, hopscotched the country attending
ribbon-cuttings at new plants that popped up in corn-growing states.

Local farmers who’d invested soon were cashing handsome dividend
checks, even as new demand pushed up the price of corn. After
languishing roughly in the $2-a-bushel range for three decades, corn
jumped to above $4 early in 2007. So far this year, it’s averaging
$3.35.

In the past, livestock farmers supported ethanol because it was good
for the overall farm economy. But now they began to complain that the
higher corn price cut sharply into their profits. A meat-producer trade
group called the American Meat Institute took a stand against federal
support for biofuels last December, joined soon after by the National
Turkey Federation and the National Cattlemen’s Beef Association.

The farm fissure widened when livestock, meat and poultry groups
started coordinating their lobbying with the oil industry, in
discussions helped along by former Texas Congressman Charles Stenholm,
who now lobbies for both industries.

Packaged-food companies, too, began pushing back, as one after another
blamed biofuels’ effect on grain costs for hurting earnings. In June,
Dean Foods Co., H.J. Heinz Co., Kellogg Co., Nestle USA, PepsiCo Inc.
and Coca-Cola Co. sent a letter to senators saying that requiring
greater use of ethanol would affect their "ability to produce
competitively available, affordable food."

Ethanol’s opponents also began to highlight reasons why ethanol might
not be such a boon to the environment, citing some recent research
studies.

Strain on Water Supplies

One by the National Research Council said additional ethanol production
could strain water supplies and impair water quality. A spring 2007
report by the Environmental Protection Agency said that "ozone levels
generally increase with increased ethanol use."

A study coauthored by Nobel-prize-winning chemist Paul Crutzen said
corn ethanol might exacerbate climate change as the added fertilizer
used to grow corn raised emissions of a very potent greenhouse gas
called nitrous oxide. The ethanol industry replies to that one with an
Energy Department study concluding that use of ethanol reduces
greenhouse-gas emissions by 18% to 28% on a per-gallon basis, provided
that coal isn’t used to run ethanol plants.

Opponents of ethanol also have hammered on an Agriculture Department
projection that by 2010, less than 8% of the U.S. gasoline supply will
come from corn-based ethanol — and 30% of the corn crop will be used
to make it. That suggests to some that the tradeoff between food and
fuel is unbalanced.

At the same time, some foreign countries have been increasingly
questioning ethanol. Mexico blamed it in part for contributing to
rising prices of corn-based tortillas. China barred new biofuel plants
from using corn, and Malaysia trimmed its biofuels production mandates.
Cuban President Fidel Castro has called using food crops for fuel a
"sinister idea." President Hugo Chávez of Venezuela ordered troops to
secure his oil-producing nation’s grain supplies, saying corn was to be
used for food, not fuel.

The government of Quebec, which has offered loan guarantees for corn
ethanol plants, recently decided not to initiate any new ones. Instead
it will turn its attention to so-called cellulosic ethanol, which would
be made from switchgrass, wood chips or other plant matter. It
concluded that "the environmental costs of corn ethanol are higher than
expected," says a spokesman for the province’s minister of natural
resources.

In recent months, U.S. lawmakers appear to have become more receptive
to the anti-ethanol arguments. "People never thought they would have to
make a trade between energy security and food security," says Jesse
Sevcik, a lobbyist for the ethanol-opposing American Meat Institute.

The ethanol industry, accustomed to getting its way in Washington,
hadn’t faced such opposition before. It may not have helped that Mr.
Dinneen, in a close echo of former Vice President Spiro Agnew’s famous
line, for months brushed off his foes as "nattering nabobs of
negativity."

Mr. Dinneen says arguments about ethanol driving up food costs are
overblown, in part because corn farmers will produce so much grain that
corn prices will ease. But even though U.S. farmers this year planted
their biggest crop since World War II, prices have stayed well above $3
a bushel, thanks to rising demand in developing countries and poor
weather in some grain-growing nations. The price is expected to stay
well above $3 next year as farmers shift some land from corn to two
other crops whose prices have risen sharply, wheat and soybeans.

Bigger Plants

New and bigger ethanol plants, spurred by money from investors far from
the Corn Belt, have contributed to production capacity that’s expected
to approach 12 billion gallons next year. But annual U.S. demand stands
at just under 7 billion gallons.

So it’s easy to see why the industry supports the Senate version of
pending energy legislation, which includes a requirement that gasoline
blenders use 36 billion gallons of renewable fuels by 2022. Up to 15
billion gallons of this would come from corn-based ethanol. The rest
would come from cellulosic ethanol — an industry that now barely
exists — or other fuels. A similar bill passed in the House has no
such provision.

Mr. Dinneen, who has been lobbying on ethanol so long he’s known as the
"reverend of renewable fuels," says he’s "reasonably confident"
Congress will raise the ethanol mandate. He says he’s talking with the
military, labor groups, Southern black churches and others about how
ethanol can help them. "We’ve got to build the biggest, baddest
coalition we can."