Ethanol: Another Chapter in Scamnation

Ethanol: Another Chapter in Scamnation
September 15, 2013

Dear readers, this Sunday afternoon I urge you to take a ten minutes to read Gretchen Morgenson and Robert Gebeloff’s front-page piece in today’s New York Times, “Wall St. Exploits Ethanol Credits, and Prices Spike” (http://www.nytimes.com/2013/09/15/business/wall-st-exploits-ethanol-credits-and-prices-spike.html).

Morgenson and Gebeloff expose the latest incarnation of the ethanol ripoff and the status of this government-created mess.

Please permit a personal polemic. I’ve pounded tables for years about ethanol as a massive scam. Our national policy diverts 40% of the U.S. corn crop (14% of the global corn crop) in order to produce a fuel that requires almost as much energy to produce as it supplies. Our ethanol mandate has starved millions of people; I’ve watched it with my own eyes in many countries in my travels. A 2011 study by the National Academy of Sciences estimates that, since 2007, the expanding U.S. biofuels subsidy has fueled 20%-40% of the increase the world has seen in the prices for agricultural commodities. In a country like Guatemala, that means that tortilla prices double and egg prices triple. (Source: http://www.nytimes.com/2013/01/06/science/earth/in-fields-and-markets-guatemalans-feel-squeeze-of-biofuel-demand.html)

Ethanol damages engines, too — ask any user; I’ve seen it myself throughout the US, and Popular Mechanics concurs: http://www.popularmechanics.com/cars/alternative-fuel/biofuels/e15-gasoline-damage-engine.

Corn ethanol has poisoned our planet while it has lined certain private and politically connected pockets with billions. It has succeeded in raising our costs, for minimal net energy gains.

Morgenson and Gebeloff focus on just one aspect of the ethanol boondoggle, but it’s a crucial one:

“the rapidly growing role of Wall St. banks in gaming the ethanol credits market. Ethanol credits (or RINs, as they’re called) were created by the Environmental Protection Agency and Congress as a way to assure the inclusion of ethanol in gasoline as an energy-saving measure. But gasoline producers who couldn’t or didn’t want to include ethanol could buy credits from those who did. Unfortunately, the market for the credits was almost completely unregulated … and Wall St. abhors a profit vacuum. So in stepped the speculators, amassing millions of credits and making a killing on the wide spread between the bid and ask prices of the credits. Predictably, this drove the price through the roof: the credits, which cost 7 cents each in January, peaked at $1.43 in July and now are trading for 60 cents.”

The bottom line? Consumers will pay at the pump, say the authors. Congratulations to Gretchen and her colleague for exposing this next chapter in a continuing shameful national ethanol scam.

We shouldn’t be under any illusions about the geopolitical effects of our national ethanol policy, either. The following excellent summary and comment came to me this morning from a prominent industry insider. He offers much food for thought:

“Ethanol was a bad policy, primarily to buy and reward grain-state votes. It spurred grain planting to meet the mandate, but not fast enough, so prices called out for more. The poor were hurt overseas and Arab Spring ensued.

The US didn’t back down. Brazil and Argentina planted like crazy, boosting their economies and saving Argentina one more year from default. Then came the drought. Prices spiked higher – but not as high as if acres had not been added for ethanol. RINs took some pressure off and allowed ethanol corn back into the feed market. High grain prices benefitted farmers worldwide – whether they planted corn, wheat, rice, or oil palm. Record crops were planted this year.

Global urban dwellers at the low end suffered again. Who knows what role Egypt and Arab Spring played in Syria? Food inflation plus Arab Spring scared China’s new leaders. The purge of oil oligarchs there has begun, along with a major push for alternative energy (solar, wind, nuclear, gas – anything).

Without ethanol, would gasoline have been priced higher? Would we have natural gas-driven trucks a la Boone Pickens? Would fracking be even bigger around the world? The spike in prices this year was a reaction to the shortage in corn caused by the drought last year. Rather than pay high prices for corn, blenders bought stockpiled RINs. The real story of the market was the explosion from $0.02 per RIN, when nobody wanted them, to $0.07 in August 2012 when the short corn crop became clear. This surge attracted the Wall Street players. They benefited when corn prices spiked again in Jan-Feb on the perception that South America crops would not clear the market before US crops came in in August-September.

Now corn prices have moderated. The possibility that RINs rule will be changed is a critical risk in this market now as the downside from $0.60 is much bigger than the upside…. RINs prices spiked in February, but the RFS standard is now a hot potato in Congress. If the article helps spark a change in RFS mandates, it will have served its purpose.”

Many thanks to my friend for his comments. And to the New York Times for giving the issue prominent disclosure.

Please remember that this all starts in the corn-farmed, politically charged Iowa caucuses. Which means, it is our sick and rotten political system that produces these behaviors. That will likely continue until we repeatedly and mercilessly pound the politicians who have sold our nation down a river of ethanol.

Thank you for 10 minutes on a bully pulpit. Feel free to forward if you concur.

David R. Kotok, Chairman and Chief Investment Officer