Government MPs plan to rip millions off in subsidies for ethanol producers
Gerard Jackson
Trade Minister Mark Vaile recently called on the government to introduce ethanol fuel. Vaile was joined by the Nationals senator-elect Barnaby Joyce who has now decided that ethanol use is a vital concern for the bush. In other words, this pair of economic illiterates are proposing a massive boondoggle that will cost Australian taxpayers billions of dollars.
As for those who argue that these things should be left to the market, these idiots have the usual answer of those bereft of any sense of economic responsibility. A conspiracy by oil companies has prevented the market from working. Yep, it’s all the fault of those stinking oil companies.
As proof of these companies evildoing Vaile pointed out that ethanol is used in the US, Europe, Japan and Brazil. What this genius didn’t point out is that these countries only use ethanol because it has been heavily subsidised. Unfortunately for Australia the moron twins clearly imagine that subsidised energy sources is proof that the market is not working.
Oh, the wonders of ethanol! Not only will it solve our current account deficit, it will save the bush, create new industries and raise Australia to new heights of prosperity. Who knows, it might even cure baldness.
Satire aside, the claims this pair are making on behalf of subsidised ethanol – meaning certain companies and farmers – are pure bunkum. The reason the market place has rejected ethanol is because it is not only more expensive than petrol it is also grossly inferior in terms of its energy input-output ratio. (The ratio of the amount of energy needed to produce it to its energy output). The US Department of Energy found that the net energy loss from producing the corn and then fermenting it was 3.1 million BTUs per ton of corn.
(The only reason Brazil gets a net energy gain from its ethanol is because it is fermented from a jungle-like cane plant that has a low-energy input.)
Some years ago Professor P. J. Reilly calculated that one bushel of corn produced 2.6 gallons of ethanol at an energy cost of 375,000 BTUs. However, the 2.6 gallons only yielded 218,000 BTUs of which only 43,600 actually do any useful work when substituted for petrol. This amounts to an energy loss of about 89 per cent.
In other words, ethanol contains less energy than the oil and other energy inputs needed to produce it. Meaning that from an energy accounting angle the processing of ethanol from grain is a dead loss. (And Mark Vaile has got the gall to call this outrageous pork barrel scheme an energy saver).
To bring about a positive energy balance energy inputs would obviously have to be significantly reduced. Perhaps Mark Vaile will tell Australian taxpayers how he proposes to do it. Legislation, maybe?
It is because of its gross inefficiencies that ethanol production requires subsidies. Now let us be absolutely clear what this means. The market tends to allocate factors of production to their most valued use. Using prices as signals firms try to combine factors in a way that minimise costs and maximise productivity.
The use of subsidies distorts this process by misdirecting capital into production processes that now expand output beyond an economically justifiable level. In particularly bad cases it finances ‘investments’ whose existence are not economically justified by market conditions because there is insufficient demand for their products.
This subsidy process bids capital goods away from their more valued uses thus keeping productivity and income lower than they would otherwise be. (In some countries, this process has actually devastated living standards).
This means that some firms will be forced into adopting more costly factor combinations while other firms will have to curtail planned output. Some might have to close down while others might not come into existence. All of this because ethanol subsidies would have denied them access to capital.
When subsidies are reduced or withdrawn these government created malinvestments either collapse or contract. Pressure is then put on governments to restore if not increase the income draining subsidies. This has already happened with Manildra and BoGas, ethanol-producing companies, who are demanding more subsidies.
In short, subsidies waste scarce resources, lower welfare, distort investment decision-making and corrupt the political process. Needless to say, subsidies also mean higher taxes, something Mark Vaile neglected to mention.
I’m sure Vaile and Joyce will find plenty of support among the economic illiterates that man the The Herald Sun. In late 1997 this rag reported the American Coalition for Ethanol as claiming that “each $US1 of up-stream and on-farm economic activity generates $3.20 in downstream economic stimulus due to ethanol processing...”
This is the kind of phoney-baloney economic reasoning that Premier Kennett used to justify subsidising Formula One racing. That subsidies generate the economic activity that the ethanol lobby is extolling is why economists oppose them.
Economists are forever trying to explain that this expenditure has been misdirected from more productive uses where the value of the output would have been greater. If it were otherwise, the economic value of ethanol production would more than cover its costs and the ethanol lobby would not have to demand subsidies to survive. But I fear this kind of reasoning is beyond the understanding of the likes of Mark Vaile and Joyce.
Vaile use Brazil to justify subsidising ethanol production. He is not the first. Writing for the Herald Sun (28 December 1997) Graeme Neill conveyed the impression that subsidising Brazilian and US ethanol production had created an economic success story.
The facts, however, told another tale. In the 1980s it was estimated that once all the costs of sugar-based ethanol production and subsidies were properly accounted for the product came out at three times the price of crude oil. Brazil now claims that ethanol production is no longer subsidised. This implies that Brazilian ethanol is now competitive with oil.
This ignores several facts. Firstly, Brazil has poured billions of dollars into subsidising an ersatz product. That those billions could have been used to raise the productive capacity of the country and hence its purchasing power is completely ignored by its statist admirers. Secondly, assuming that there are no longer any subsidies does this mean that production is not economic? No it does not. Apart from other factors, one factor stands out: it is impossible for Brazilian ethanol costs to fall if the price of oil continued to rise.
Cane-growing land is a fixed commodity, meaning that a continuing rise in the demand for ethanol would lead to increasing scarcity, not less. Moreover, as land is not specific ethanol could only be produced at the expense of other products which in turn would raise their prices.
For example, in 1990 OTA (Congressional Office of Technology Assessment) pointed out that if large-scale ethanol production was undertaken grain prices would have to rise. This means that if the US announcement in the 1970s to produce 10 billion gallons of ethanol, mainly from corn, by 1990 had been implemented it would have consumed about 25 per cent of the nation’s grain production in 1990
It also calculated that if ethanol production exceeded 2-4 billion gallons a year the subsidy would rise to between $US4 to $US5 per gallon. The OTA also pointed out that at that level of production more oil and gas could be used up in the production of ethanol than would be saved by its use. Nothing is for nothing.
The Economist (7 January 1989) claimed that even if genetically engineered bacteria could raise the conversion efficiency it would need 500 million acres of arable land, 105 per cent of the arable land in the US, to meet 10 per cent of the country's fuel needs. (How much would it take today?). Yet the likes of Vaile argue as if arable land is not a scarce factor of production.
The situation certainly hasn’t changed since 1989. The Bangkok-based Hutchinson, head of research for investment bank Mullis Capital, stated: “It’s easy to sell [ethanol subsidies] to voters. It helps support agricultural prices and promotes self-sufficiency goals of reducing imports”.
However, the last thing ethanol production does is promote self-sufficiency. Even though Thailand imports about 82 per cent of gas and oil it was forced, despite high oil prices, to close two of its three ethanol plants. The reason? A rise in the price of molasses raised production above the 30 per cent the maximum ethanol sale price. Furthermore, rising tapioca prices put additional pressure on ethanol production.
This is the Brazilian dilemma to which I referred earlier. Ethanol production has to compete against the production of other crops. As ethanol production rose so would the prices of those crops that are being displaced. However, at a certain point the rising value of those crops will put a check on ethanol production. If the prices of alternative crops continued to rise then ethanol production would have to be reduced.
No wonder Nattapon Nattasomboon from Thailand’s industry ministry’s ethanol committee said: “It is not economically viable to produce ethanol, especially without subsidies from the government”. (Reuters, 28 February 2005).
None of this fazes the relentless rent-seekers that run the Grains Council of Australia. This outfit had the cheek to claim that the economic activity stimulated by tax exemptions and subsidies “will equal or exceed the taxation forgone”.
In other words, these tax rip-offs will eventually pay for themselves. That this so-called line of economic reasoning could be applied to any investment proposal was completely ignored by these self-less beacons of economic development.
It is abundantly clear that even if the energy ratio was favourable ethanol would still be uneconomic so long as its costs of production per barrel exceeded the costs of producing a barrel of oil — and that includes oil from the world’s massive shale deposits.
The likes of Vaile and Joyce simply do not understand that in a free market people would not knowingly waste resources by pouring them into a project the value of whose product is less than the value of the resources it consumes. A free market would allocate capital goods to where they produced the greatest value thus raising output and living standards.
Moreover, a corrupt-free government would not line the pockets of supporters and rent-seeking businessmen with taxpayers’ money, some of which ends up as Party donations; it would not abuse its power by favouring some producers over others; it would not tolerate its citizens being exploited nor would it exploit them for political gain.
I think this pair need lessons in civic responsibility as well as economics.
BrookesNews.Com
Monday 11 July 2005