Investigation: Inside the ethanol subsidies controversy

Hardly a week goes by in the US without another round of jousting in the debate over whether government subsidies for ethanol are the harbinger of a brave new low carbon world or simply to blame for the still-record food prices facing consumers.

Both sides in the debate are aggressively agitating at the moment; no doubt intent on trying to influence the incoming Obama Administration with the merits of their respective points of view.

In a nutshell, the pro-subsidies camp argues ethanol is being used as a smokescreen by food producers to keep prices up and their profits high; and it needs the subsidies to create a major job-producing industry.

The naysayers want the subsidies phased out not only because they say they are driving up food prices, but also because ethanol research is now showing that corn-based biofuels could be bad for the environment as well.

Through several different programmes ethanol is subsidised in the US to the tune of $5bn and, surprisingly to many observers, this is not a new phenomenon - hand-outs for the industry have been around for 30 years.

It was however the Bush Administration's Energy Policy Act of 2005 that really kick-started the ethanol industry as we know it today. That act launched the Renewable Fuels Mandate, forcing state governments to blend billions of gallons of renewable fuel with gasoline by 2012 and giving ethanol producers a market for their product.

The mandate incentivised farmers to grow corn for ethanol, which no doubt was a factor in the run-up to record corn prices, which led to a knock-on effect on wider food prices as the cost of corn-based animal feed also rose.

According to economic forecaster IHS Global Insight, the bottom line for consumers was four per cent food price inflation in 2007 and another 5.3 per cent this year. Yet in a new report distributed earlier this month Global Insight stressed that biofuel subsidies were just one of several factors that led the food price inflation.

In the report John Kruse, managing director of Global Insight's Agriculture Service described as "fiction" the premise that biofuels was the only reason for the inflation.

He said the causes included higher energy costs, which in turn led to higher transportation costs, higher processing costs and high fertilizer prices.

Poor weather also disrupted global wheat production in 2006 and 2007 and there was income growth in Asia, particularly China, which led to long-term tightening of supply and demand. Biofuel was a factor, but just one of several.

Despite the release of this independent analysis the drumbeat from the blame-ethanol lobby keeps on. Food prices, with one or two exceptions such as milk and produce, have remained stubbornly high despite the fact that the price of a bushel of corn has halved since the summer – although it is still historically high – and the cost of fuel has more than halved.

In fact, while the price of everything else fell in the US in October, grocery prices in the government's Consumer Price Index actually rose by 0.1 per cent. Moreover, government economists are still predicting food prices will increase by as much as 4.5 per cent next year although Global Insight says the worst is over and prices will rise only about one per cent.

Meanwhile, the Grocery Manufacturers Association, the packaged food industry’s lobbying organisation, continues to blame ethanol for high prices. Just a couple of weeks ago, as part of the Food before Fuel coalition, the GMA called for the new Administration and Congress to repeal the subsidies.

However, profit and loss statistics from the GMA's member companies tell an interesting story about who is really being harmed by rising crop and transport prices. One thing is clear, it certainly isn't the food producers.

While corporate profits are nose-diving in almost every sector, they are rising healthily at the likes of Kraft, Kellogg and Heinz. In an apples-to-apples comparison at Kraft, the company's sales rose nearly 10 per cent in its latest financial quarter and profits rose 14 per cent. Over at Kellogg, sales grew nine per cent and profits 12 per cent. At Heinz, sales rose four per cent and profits 22 per cent last quarter.

While the food producers are doing nicely the same cannot be said for grocery chains, which face the brunt of consumer anger on a daily basis. Most of the big chains showed negligible percentage increases in profit and one, Publix, centered in the south east of the US, saw its profits fall nearly 19 per cent in the most recent quarter.

Perhaps not surprisingly, the abnormally healthy financials from the food producers has attracted the attention of politicians. Chuck Grassley, a Republican senator from the farm belt state of Iowa, is leading the attacks: " Now, my question is, will lower input costs be passed on consumers with lower food prices?"

Democratic congressman Collin Petersen, of Minnesota who is the chairman of the House Agriculture Committee, also called on GMA members to reduce prices and apologise to farmers for its anti-ethanol smear campaign.

As BusinessGreen.com reported recently, the ethanol industry has toughened its stance against its detractors by forming a new lobby group, Growth Energy, to make sure Washington and the American public understand their case. With ethanol companies struggling at present – with the fuel being more expensive than gasoline – it is important to the industry has a message that resonates.

Growth Energy points out that the US Department of Energy estimates that for every one billion gallons of ethanol produced, 10,000 to 20,000 additional, non-outsource-able, jobs will be created.

Another recently released study also proves the economic value of ethanol. That research in Texas showed ethanol raised feed prices costing Texas livestock producers $1.8bn, but to offset that it saved the state's motorists $4bn.

It is statistics like those that has Stewart Ramsey, senior economist within Global Insight’s Agriculture Service, believing the subsidies are safe. At a time when the employment environment is dire, the Obama Administration is not going to cut funding to a new industry that can prove it is creating jobs, he says.

There are signs that the GMA and Food Before Fuel lobby are changing tack a little in attacking ethanol. There also seems to be a slight de-emphasising of the price-rise issue to instead concentrate on ethanol's supposedly detrimental affect on the environment.

The World Wildlife Fund is a member of Food Before Fuel and it says its has witnessed "the negative impacts of the biofuel policy not only on the environment, but on vulnerable populations throughout the world".

But ethanol firms like Green Energy and other producers counter that corn-based ethanol is simply a precursor to so-called second generation cellulosic ethanol, which they are investing heavily in developing and can be generated from non-food based crops.

In short, it appears certain that the to-and-fro on the merits of ethanol will not end anytime soon.