Some weeks I struggle a little to decide on a topic. It isn’t for lack of topics for they are like natural gas reserves – at one time I wondered whether I’d be able to find a topic every week. But like natural gas reserves, as I “worry” about running out of topics, the topic list is vastly outstripping demand. This week it was easy.
I watched the state of the union address last week, or I should say I started watching the state of the union. It doesn’t matter who is president, from Reagan through Obama, I can only take about 20 minutes before I am forced to turn it off. I either get nauseous from the rosy talk or disgusted with vague speak of wrong-headed policy. Luckily, or maybe not so, President Obama talked about “clean energy” in the first twenty minutes – a topic I’m most interested in.
As he spoke about “investing in” clean energy, something like 80% “clean” by 2035, I kept asking my TV, “what is he talking about?” over and over. WHAT IS HE TALKING ABOUT? As I’ve written many times in this blog, the federal government should get out of picking winners and losers. Let’s examine an example of the federal government’s brilliance in promoting clean energy.
Energy Policy Act (EPACT) 2005 issued under 100% Republican power, mandated that 7.5 billion gallons of biofuel – which is essentially 100% corn-based ethanol – be produced annually by 2012, next year. Last year, the out-of-control EPA declared we should increase the ethanol content in gasoline from 10% to 15%.
Note what has happened since EPACT 2005. Due to a combination of easy money, Fannie and Freddie government-backed loans, wild-eyed psychotic institutional investors, hedge fund managers, home flippers, and crap like interest-only mortgages, we experienced a bubble and then a colossal collapse of the housing market but also commodities at the same time.
The government has a solid track record of screwing up markets and then when the poo hits the fan, there they are, lecturing the private sector and pointing fingers at everyone but themselves, the chief culprits. The housing collapse fits this model.
The commodity balloon including corn prices that grew in lock step with housing in 2007-2008 put a crushing load on dozens of new ethanol plants that sprouted on the heals of EPACT 2005. Many bankruptcies ensued.
As a result of the struggling ethanol industry, the government once again runs to the rescue. But STOP THE MUSIC! Think for just a minute. Let’s establish that ethanol producers are manufacturers. I think everyone agrees with this. Manufacturers take commodities, or raw materials like plate steel, bar, ore, grain, sugar, plastic resin and turn them into fasteners, heavy equipment, dipsticks, cereal, Pop Tarts, and ice cream buckets. They make scarce goods out of less scarce goods, a concept I learned in basic economics in college, or maybe in the third grade when I made cookies from scratch.
A whopping 40% of our 12 billion bushel annual corn crop goes to ethanol production. While The Wall Street Journal waxes about food inflation, which is all too real, what they don’t discuss is this issue of manufacturing the less scarce goods into more scarce and thus more valuable products.
For the love of Pete, wake up you dunces! The value of the gasoline the 2.5 gallons of ethanol displaces is worth barely more than the bushel of corn that produced it! HELLO! So what’s the response, let’s use even more of the more valuable feedstock for the same old demand of the end product. This is lunacy; monumentally, gallactically stupid!
According to the ethanol industry itself, a bushel of corn produces 2.8 gallons of ethanol, and I’m sure this is the latest, absolute greatest conversion to make ethanol look good. Current commodity cash prices include $2.40 per gallon of gasoline and $6.25 per bushel of corn. Do a little math. The ethanol leaving in tankers is worth barely more than the corn coming in, raw! This doesn’t include amortization of the plant itself, labor, or the massive amount of energy required to manufacture ethanol.
The price of corn is elastic. That is, it’s price changes a lot with demand, especially when the supply of the feedstock is tiny , teeny weeny, itty bitty, compared to the finished product it is displacing. I.e., if all 12 billion bushels of corn were manufactured into ethanol it would displace four percent (4%) of our petroleum demand! This is like feeding hogs fois gras so we can reduce our dependence on foreign lard.
Here is what is going to happen as a result of federal government brilliance pushing this renewable “clean” source of energy – I would say write it down and save it, but I’m doing that for you – the continued easy money, potentially devastating inflation (see Playing with Fire), and massive upward pressure on corn prices is going to ravage the ethanol industry. It doesn’t take a genius to see this is going to happen, but apparently it takes somebody smarter than a U.S. Senator.
Meanwhile, most people don’t realize it, but these completely government-induced artificial demands on commodities and resultant high prices are driving farmland prices to the stratosphere. An acre of decent farmland in Iowa fetches $8,000 and in some places considerably higher. Say hello to the same wild-eyed crazy speculation we had in the housing market two or three years ago. Only this is a lot wilder, and the hangover? It’s too serious to joke about.
The government’s intrusion into renewable fuels is going to bankrupt the ethanol industry. Once that happens, the house of cards crashes along with grain prices. Land prices will crash, and like the housing market, there will be a massive farm-country crisis that will make the mid-1980s crisis look like the failure of an eight-year old’s corner lemonade stand. Land prices will plummet below the principal on outstanding loans, much more so than homes. I estimate that land prices will crash by about two thirds or maybe only by half if we’re lucky, to somewhere near $3,000 per acre. When will this happen? I would say for sure in the next 10 years, probably in the next 5 years.
In a bitter case of irony, government “assistance” for states like Iowa is going to devastate the state. Thank you Chuck Grassley and Tom Harkin, and here goes any shred of credibility I would give Newt Gingrich (I actually wrote this whole thing before this last salvo went to press).
And on the way to this pandemonium, livestock growers are going to go broke on exorbitantly priced feed. Some already have per the above WSJ opinion piece. We’re all paying for soaring food prices but food prices don’t matter to the Ben Bernanke. It’s not part of “core inflation”, as though nobody eats!
After the bomb hits, all kinds of suppliers of farm equipment, goods and services are going to get whacked and there will be a swath of bankruptcies again, making 1984 (the year) seem like Little House on the Prairie. One “solution”, god forbid, is to throw more money at ethanol subsidies. What’s it going to take? – $2/gallon of federal subsidy? Is this the kind of “investment” we’re talking about?
So think about it. Do you really want the brilliant federal government driving us toward another cliff in renewable energy? I can’t think of a more devastating outcome than will happen with ethanol, but then I also couldn’t think of a crazy scenario of how saving energy results in greater consumption in “Upside Down Consequence of EE” but then within a week in “The Delectable Light Bulb” a bizarre real example dropped in my lap. The next government renewable energy drive may not be devastating, but I guarantee it will be a failure by any reasonable measure. Has the federal government driven the breakthroughs in lighting and other technologies? Not that I’m aware of. The private sector has. What happened to the Bush’s great government hydrogen solution for transportation? – and fuel cells cars? How about the synthetic fuel godsend from the Carter days? That was a winner, to be sure.
Renewable energy IS NOT like the development of space exploration leading to satellites for national defense then phones, TV, and GPS – or nuclear power. In these cases, the features and requirements of the end product were well defined. It was just a matter of physics and engineering to make it happen. All known renewable energy today has significant physical barriers to success – like there are only so many acres of tillable soil on the continent. The yet unknown successful, cost-effective, and plentiful source of renewable energy may be percolating in a lab somewhere or may only be a wild idea in someone’s mind or not even that yet. I don’t know what it will be, but we aren’t going to ride solar and wind energy to the renewable sunset.
Feds – just defend us from enemies, foreign and domestic, and provide equal opportunity for all. We will take care of the rest. And, funny how things like satellites, GPS, internet, lasers, compact discs, DVDs, sonar, and stuff like that are spin offs of what the government is supposed to be doing – protecting us from enemies!
In reply to “Amber Waves of Ethanol” from The Wall Street Journal above, the CEO of the Renewable Fuels Association, (lobby) states there is no food-ethanol trade off. Forty percent of the nation’s corn crop going through ethanol plants is no tradeoff? Nevermind. Put down your emotions and think about what he says. The supply of crops (production) hasn’t changed and “remember, farmers in the U.S. see less than 20 cents on every dollar spent on food.” What does either of these have to do with pouring 40% of the corn crop down the ethanol hole or changing supply or farmer’s share of the take? In fact, it actually bolsters the fact that supply isn’t changing while demand is rising and will continue to do so. You have to be smarter than that, man.
Lastly, I want to make it clear I am not ranting against the ethanol industry. As I’ve said before, everyone has to play the game by the rules government puts on us. However, once this bust happens, everyone involved should have to live with the consequences without bailout. People need to take responsibility for their own decisions. I chose not to pursue government ARRA handouts because I considered the red tape, competition for the money, types of clients that would use it, and that it’s a one-time deal, would make for a miserable ROI for us. If others want to land the money, and then hire us, I may consider it.
All is not lost for farmers and ethanol-plant owners. Sell! Farmers can sell their obscenely overpriced land and lease it back with long term contracts. When prices crash, take it off the hands of the sucker that bought it from you – at that point it will probably be the bank, but the bank will also be broke – maybe you can take it from bankruptcy court.