Bush Ethanol Plan Cut Down

President Bush’s call for increased use of ethanol would increase fuel costs and do little to cut greenhouse gas emissions, analysts believe.

In his 2007 State of the Union address, President Bush proposed cutting gasoline use 20% by 2017, mostly by replacing the fuel with ethanol and by boosting overall fuel economy.

“President Bush’s plan is so shot through with loopholes, exceptions and escape clauses that it’s impossible to say what would happen to gasoline consumption if Congress approved the plan,” says Jerry Taylor, an analyst at the Cato Institute in Washington, D.C. “That’s probably a good thing because the President’s plan would almost certainly send fuel prices through the roof.”

Taylor says ethanol costs about $2.53 a gallon to produce, including subsidies. Without governmental support, the price would be at least $1 higher. Gasoline costs about half that in wholesale markets.

Kiichiro Sato / AP An E85 fuel pump is shown at the Ohio Department of Agriculture in Columbus, Ohio. The fuel consists of 85 percent ethanol and 15 percent petroleum. (AP Photo/Kiichiro Sato)

Blending ethanol with gasoline permits refiners to produce greater quantities of lower octane fuel at reduced cost. Use of ethanol as an additive increases octane, reduces tailpipe pollution and increases the volume of available fuel.

But overall, increased use of ethanol would boost greenhouse gas emissions because of the additional fossil fuel needed to produce it, Taylor says, citing a report by the Massachusetts Institute of Technology.

“Expanding corn production would require greater energy inputs,” Taylor says. “New cropland would have to be harnessed and it would almost certainly be less productive than the land now in use. That means more fertilizer, irrigation – more energy and, on average, more greenhouse gas emissions.”

Bush’s proposal counts on increased research and production of ethanol made from cellulose such as wood chips, switch grass and other non-corn feedstock. That’s where the future lies because current corn-based ethanol production can’t meet the increased demand called for by Bush’s proposal.

The basic question: Will users pay through subsidies and mandates or will private investment flow into the sector? If cellulose ethanol has merit, venture capitalists will bring it to market. Heavy subsidies suggest a lack of merit.

Another analyst dismissed much of Bush’s speech as routine political twaddle.

“I think most of any president’s State of the Union address – Bush, Clinton, Reagan, Carter, Ford, whoever – tends to be the stuff of pipe dreams,” says Tom Kloza, an analyst at the Oil Price Information Service. “But there’s bipartisan support for renewable fuels. If there’s ever an ethanol glut, producers won’t be demonized for cutting back but refiners taking the same action would evoke thoughts of John D. Rockefeller and (fictional TV character) J.R. Ewing.”

Kloza expects gasoline prices to increase 30 to 40 cents and crude oil to rise to the mid-60s in the next 45 to 90 days.

Saudi Arabia didn’t cut production when the price of a barell of crude oil fell below $50 a barrel because worldwide demand remains strong and significant new supplies of non-OPEC oil won’t be available for about two years, he says.

Ethanol is heavily subsidized and the industry exists as we know it today because state and federal governments mandate its use.

“We view the industry as commodity-based and dependent on high oil prices, or alternatively, on government policy in low oil price environments,” Elif Acar, an analyst at Standard & Poor’s, said in a research report. “Margins are subject to commodity price volatility and have been very thin or negative in the past.”

Seth Perlman / AP Strong demand for the  nation's corn for use in ethanol production may drive up prices.  (AP Photo/Seth Perlman)

Typically, corn and natural gas together make up 70% to 80% of typical dry-mill production costs and the cost of the commodities move independently of each other, according to experts in the field.

Corn Now trades at about $3.76 a bushel. Analysts say if the price climbed to $4.80 and ethanol prices fell to about $1.60 a gallon,  production of the fuel would become unprofitable. Ethanol now sells at about $2.15 a gallon, so you can imagine how much of a production boost it would require to dramatially slash prices.

“…The industry’s long-term viability depends on the availability of this subsidy, especially in a low oil price environment,” the S&P analyst says.

The price of a barrel of oil on the New York Mercantile Exchange peaked last July at $78.40, dipped below $50 this mmonth and recently traded at $54.70, a drop of 30.2% from the high.

Investor interest in ethanol stocks has cooled. VeraSun energy is down about 43.5% from its 52-week high of $30.75. Aventine Renewable Energy Holdings is off 57.8% from a 52-week high at $42.50. Pacific Ethanol recently fetched $16.76, a decline of 62.3% from a 52-week high of $44.50.

The Cato Institute’s Taylor says the farm lobby and ethanol producers have plugged the fuel as the answer to just about every economic, environmental and foreign policy problem now confronting the nation. Politicians like to boost voter sentiment, even if it means spending buckets of tax dollars to do so.

“That’s all you need to know to understand the president’s speech Tuesday night,” Taylor says.

© 2009 CNBC, Inc. All Rights Reserved