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The Ethanol Myth

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Biofuel a triumph of politics over logic.

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No apes for biofuel!

Growing demand for ethanol has driven up the cost of corn in the United States and led to clearing rainforests in Indonesia, Malaysia and Thailand to plant oil palm, a highly productive oil seed used to make biofuel. Demand is so strong that some now fret about destruction of the natural habitat for orangutans.

It takes more energy to produce a gallon of ethanol than the ethanol provides, making biofuel the triumph of politics over logic. Congress mandates the use of the alternative fuel, creating a guaranteed market, but rising costs have hammered ethanol stocks. Nevertheless, President Bush wants to increase the use of ethanol so don't bet on the primates in Asian rainforests.

Oil surged to a record $139.89 per barrel Monday before falling back to $133.35 the next day. This should be good news for ethanol because the biofuel allows oil companies to add octane more cheaply than additional refining. But the market has turned thumbs down on ethanol producers VeraSun (VSE), Aventine (AVR) and Pacific Ethanol (PEIX) as the price of corn continues to rise. Archer Daniels Midland (ADM), a major ethanol producer, is a diversified company and its stock recently hit a 52-week high.

The basic question: Why did anyone think ethanol made sense?

The sales pitch for biofuel is simple and intriguing: Ethanol produced from corn -- good old grain alcohol -- allows oil refiners to produce greater quantities of lower octane fuel, cutting costs at the refinery. Use of ethanol as a fuel additive boosts octane, reduces tailpipe pollution and increases the volume of available fuel. About 30% of the gasoline sold in the U.S. contains 10% ethanol. Use of E85, a blend containing 85% ethanol, may increase as carmakers build more vehicles capable of using the fuel. Ford Motor Company (F) and General Motors (GM) now offer flex-fuel vehicles.

In 1979, the last year of President Carter's administration, Congress approved ethanol subsidies in an effort to offset an embargo by the Organization of Petroleum Exporting Countries. (Does anyone remember gas lines, the "energy crisis" and "malaise" - or care to?)

Federal subsidies for ethanol totaled about $6.8 billion in 2006 and will increase to about $8.7 billion a year if current policy holds - and there's no reason to think it will change. The Clean Air Act of 1990 boosted demand for ethanol by mandating its use as a gasoline additive to replace MTBE, an octane booster that turned out to be a pollutant. In last year's State of the Union address, President Bush proposed reducing gasoline use by 20% in ten years, mostly by replacing gasoline with ethanol and by increasing overall fuel economy for the nation's vehicles.

Uncle Sam's subsidies for corn and ethanol production are a tribute to the political muscle of Midwestern lawmakers and Iowa's first-in-the-nation presidential caucus. Candidates routinely bow to the wisdom of ethanol and so far only Senator John McCain of Arizona, the presumptive Republican nominee, has questioned its economics. In 2006, subsidies averaged about $1.21 for each gallon of ethanol produced, or about 48.5 percent of its wholesale price. By contrast, federal oil subsidies total about 0.3 cents per gallon of gasoline.

Demand for corn has driven up food prices - corn futures recently fetched $6.23 a bushel on the Chicago Board of Trade, a record high. The World Bank reports "almost all of the increase in global maize production from 2004 to 2007 (the period when grain prices rose sharply) went for biofuels production in the U.S."

Ethanol proponents seem to have overlooked a basic point: Diverting corn production to ethanol doesn't mean people (or cattle) eat less. Corn available to consumers has decreased, driving up the cost at home and leading to food riots in several countries, including Cameroon, Egypt, Mozambique and Senegal.

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