Distorting the Energy Market

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The government is hurting our ability to develop new sources of energy; and both the Republicans and Democrats are to blame.

In the most general terms, Republicans support continued tax breaks and subsidies for the oil and gas industry, and Democrats support grants, subsidies, and tax breaks for such new forms of energy as wind and solar. Neither party has a good energy policy. Both are blocking the path of innovation.

To create a fossil fuel alternative we must find an energy source that is cheaper, easier, and better than fossil fuel. But when government is picking which alternatives are worth pursuing, in addition to funding traditional energy sources, our view of what energy sources may work out becomes clouded. As long as government provides subsidies and tax loopholes to oil and gas

companies, they will hold an advantage in the market. Not only does government intervention in this manner make fossil fuels a highly lucrative industry, thus attracting many bright businesspeople, engineers, and scientists, but it makes the introduction of alternatives more difficult, since potential new competitors find working in an unbalanced market nearly impossible. Even if there were an energy alternative that consumers would want, the alternative would not be able to seize enough market share to turn a profit, because the coalition of government and big oil cannot be challenged by a newcomer.

With few exceptions, people agree we need to move away from burning fossil fuels if we want to meet future energy needs with as little disturbance to existing ecosystems as possible or beyond what we might consider desirable. And because oil and gas receive government benefits, the conventional thinking goes, so too should alternative energy exploration, in order to “level the playing field.” But what the best alternative might be is still unclear. One reason why it is unclear is that government involvement clouds the picture.

Think of ethanol. For years, because of Iowa's importance in the presidential nomination process, ethanol was highly subsidized by the government. Now we discover that it was not a workable, standalone alternative to fossil fuels. Consider all the resources that were misallocated because of this pursuit. Private resources, such as time and expertise, were focused on making ethanol work — in order to procure government money. If there had been no government money in ethanol research, engineers and scientists in the energy industry would have had a greater incentive to look elsewhere for a good alternative. But when the government creates a market there is no need to look elsewhere. The only problem is that the government lacks anything like a good record as a venture capitalist.

If it is true that necessity is the mother of invention, then the government is stripping us of that necessity. What is necessary for every company to operate is money, and if it doesn’t have a strong need for money, because government is supplying all it needs and then some, its incentive for invention is stripped away. If we want to find the best energy source, both long-term and short-term, the government needs to stop trying to control which sources come to market, or stay in the market.The government needs to divest itself of all financial interests in the energy industry.




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Two Big Surprises

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Well, now, you can knock me over with a feather! Two stories just out are amazing in their a priori improbability. They tell us a lot about the growing awareness of our looming national financial crisis.

The first is the news that the U.S. Senate has voted to end federal subsidies for ethanol, which this year hit a high of $6 billion from taxpayer dollars.

This is surprising for a number of reasons. The ethanol lobby (i.e., the group of rentseekers who derive much of their income from this screwy subsidy) is powerful, consisting of many players in key political states. Moreover, it has been around for more than 30 years — an unhappy product of the Carter presidency. Also, it has been a darling of the environmentalist movement, which has consistently opposed fossil fuel and nuclear power, favoring instead so-called “renewable” sources of power (biofuels, wind power, and solar power).

Even more surprising is that the vote was bipartisan and wasn’t even close: 73 for, and only 27 against, with Dianne Feinstein (D-CA) joining Tom Coburn (R-OK) in sponsoring the bill. In the end, 33 Republicans and 40 Democrats joined to kill the subsidy program.

I suspect that a number of facts helped the Senate reach this epiphany. One is that despite over 30 years (and untold billions of taxpayer dollars) invested in research and development, the energy output that you get for the required input still keeps the fuel from being economically attractive — a point that even Mr. Green himself, Al Gore, mentioned when he came out against corn-based ethanol earlier this year. In part, the problem is that we are making ethanol out of corn, which is far less efficient than making it out of sugarcane — and this is why, besides giving the domestic producers of the stuff a hefty tax credit of 45 cents per gallon of ethanol blended with gasoline, the feds have had to impose a whopping 54 cents per gallon tax on ethanol imported from abroad (mainly Brazil).

Another senatorial eye-opener may have been the recent, massive discoveries in domestic sources for oil and natural gas that can be produced by new technology such as fracking. These discoveries make the case for subsidizing domestic ethanol even more dubious.

Besides, politicians are finally beginning to see the obvious, deleterious impact that diverting 40% of our corn crop to make ethanol (which, again, we could buy more cheaply from Brazil) has on food prices both here and abroad. The rapid inflation of food prices has caused riots abroad and is beginning to cause real discomfort here.

Finally, there is the sense that this subsidy program has just gone on too long. As Senator McCain put it, “Enough is enough. The industry has been collecting corporate welfare for far, far too long.” Exactly so. There is demand for ethanol, but the industry needs to supply it in the free market.

The ethanol industry has been angling to replace tariffs and subsidies with federal spending for special pumps and tanks to hold higher concentrations of ethanol. But the House just voted against that by a margin of 283-128.

So it may be that the governmental subsidies for ethanol will end soon.

Now, the second surprising story is that the AARP, the liberal advocacy group that purports to represent the elderly, and was so crucial in helping President Obama ram through Obamacare, has changed its position on reducing benefits for Social Security. John Rother, the AARP’s policy head, has said that the AARP now views change in Social Security’s benefits structure as inevitable, and wants to have an influence on the process. This is a big change from AARP’s earlier stance, which was that all we needed to do was increase payroll taxes to cover the deficits. As Rother put it, “The ship was sailing. I wanted to be at the wheel when that happens.” Of course, the question is, why would we want this toad and his leftist organization — who did all they could to block reform and increase the depth of the problem — to be “at the wheel” of reform?

It is all so richly ironic. The AARP was viciously instrumental in killing President Bush’s attempt to reform Social Security. It claimed that Bush was going to shortchange the elderly. Now the AARP itself will face the same charges.

Indeed, the AARP immediately aroused the antipathy of a coalition of leftist groups calling itself (in pure Alinsky style) “Strengthen Social Security.” It has already accused AARP of becoming elitists disconnected from their base.

The AARP is approaching this cautiously. It lost about 300,000 members by helping push through Obamacare. To cover its tail, it wants to make sure that the Social Security revision process is bipartisan. Its own polls match public polls that show the elderly deeply oppose changes to the program. One recent poll shows that 84% of all Americans 65 and older oppose any and all cuts in benefits.

But the AARP and members of Congress are finally coming to see the iceberg of fiscal insolvency toward which the economy is headed. Visions of Greece, currently in the throes of riots by dependents of the state and facing the prospect of defaulting on its debts, are concentrating minds wonderfully.

In fact, it is all rather like watching a Greek tragedy. The blind AARP finally has to face its fatal flaw — the mess it helped create and maintain.




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Greenbacks and Green Energy

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Larry Kudlow kicked a hornets’ nest when he suggested last month that the riots that were then breaking out in Algeria, Egypt, Jordan, Libya, Morocco, and Yemen were caused not just by indigenous anger at tyrannical regimes but by skyrocketing food prices. Kudlow noted that Egypt in particular is the world’s largest importer of wheat, and rising wheat prices had pushed the Egyptian annual inflation rate to over 10%.

Kudlow suggested that the Fed’s easy-money pump priming may be in part to blame. As he noted, commodities are typically priced in our currency, and the Fed has been producing it as fast as rabbits on meth. The CRB food index is up 36% in one year, and inflation is blossoming around the world — in Latin America, Asia (China and India especially), and now even in the EU.

Kudlow was (as usual) quite prescient. Recent stories confirm the increasing squeeze of food inflation. First is the report that the dollar’s rapid descent is hurting many people in undeveloped countries, such as the Philippines. A large percentage of Filipinos work abroad for American employers, or for employers in countries (such as Hong Kong and Saudi Arabia) whose currencies are closely tied to the dollar. As the American dollar loses value, the funds that Filipinos who work abroad send home to help their families also lose value. Considering that remittances from abroad account for about 10% of the country’s economic output, this is causing immense hardship.

The once-lowly Philippine peso has appreciated against the dollar by over 15% in the last three years. So the dollar’s fall is hurting a lot of people. One woman quoted, who uses her husband’s remittances to feed and educate their three children, has seen the number of pesos she gets from him go down by nearly 25% over the last few years.

The problem is the same for China, India, and Mexico, all countries with large numbers of workers paid in dollars or dollar-linked currencies.

Besides the Fed’s endless pump-priming, another cause of food inflation has been the continuing boondoggle called the ethanol program. For years, the federal government has been shoveling tens of billions of dollars at corn growers to get them to produce corn for making ethanol for fuel.

Now, this program has long been criticized as a way of replacing petroleum. It is hugely costly, especially when you consider how much energy it takes, in fertilizers, planting, harvesting, and shipping the corn. Why, even Al Gore — the über-Green — is now questioning the wisdom of the corn-based ethanol program.

Not as much comment has been made on the role our massive ethanol program plays in jacking up food prices. Since now roughly 40% of America’s corn (which means 15% of all corn produced worldwide) is being used for ethanol, corn prices have skyrocketed, increasing food prices in countries (such as Mexico) where corn is a major staple for people or a major source of cattle feed.

Moreover, the billions of bucks shoveled out by the federal government have induced many farmers to switch from growing wheat to growing corn, thus helping to drive wheat prices up even further.

Just as Gore now doubts the wisdom of using corn-based ethanol as a substitute for petroleum, no less a luminary than Bill Clinton is wondering whether the ethanol program isn’t causing food riots and political instability all over the world. He expressed these heterodox thoughts at the Department of Agriculture’s annual Agricultural Outlook Forum. While he said he still believes in corn-based ethanol, he urged farmers to consider the effects of their choices on developing countries.

He was being ludicrously timid. The corn-based ethanol program should have its subsidies ended immediately. Then we would see what the real price — set by supply and demand, not by Congress — should be. My bet is that the industry would shrivel up rapidly, freeing grain for human consumption.

As the cliché has it, what goes around comes around. A recent story reports that the global food inflation is now hitting American stores. The U.S. Department of Agriculture estimates that US food prices will jump 3% to 4% this year — hardly news to anyone who has shopped for food lately.

In fact, consumers would have felt the sting of inflation earlier and deeper, except that supermarkets have not been passing on the full hit, for fear of hurting sales. But as prices for food commodities keep rising, sooner or later the full cost of those increases will have to be paid by the American consumer.

At that point, perhaps we will see food riots. Or at least see Obama join Egypt’s Mubarak as a toppled leader.




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Go, and Sin No More

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Frantically focused special interest groups have a habit of defeating their own goals, hurting their own self-interest by an excessive pursuit of it. Labor unions are a classic instance: they have often been so greedily intent on exacting every concession from the companies they are bargaining with that they put the companies out of business, and their own members out of work.

Environmentalist groups are another classic case. They have routinely pushed programs that allegedly benefit the environment, but in reality do not. For example, they helped stop nuclear power 30 years ago, an act that exacerbated the very problem — global warming — that so concerns them now. A number of prominent Greens now realize their error.

A recent instance of this phenomenon is none other than the Green giant himself, Al Gore. He just came out against the federal government’s subsidy of ethanol. As he remarked to a green energy conference in Athens, “It is not a good policy to have these massive subsidies for first generation ethanol. First generation ethanol I think was a mistake. The energy conversion ratios are at best very small.”

More surprising still was his admission that his original support had been based on his presidential ambitions, specifically, his desire for the support of corn farmers in Iowa and Tennessee. But one wonders what took Gore so long to wake up. Subsidized corn-derived ethanol has been a dubious program from the day it was first conceived.

The American ethanol program began in 2004 when Congress established a subsidy of 51 cents per gallon for gasoline containing 10% ethanol. (In 2008, the subsidy was lowered to 45 cents per gallon.) It did this in spite of the obvious drawbacks of making ethanol from corn. Ethanol is the alcohol derived from fermenting sugar, and corn is only 40% sugar to begin with.

Very rapidly, corn that was being used to feed animals and people was diverted to the ethanol boondoggle, until the U.S. ethanol industry used, as it does today, over 40% of all the corn grown in the United States, and fully 15% of the corn produced worldwide. One unintended consequence was rapidly discovered —  shortages in cattle feed and human food. This was folly incarnate: taking perfectly good food and trying to use it to derive fuel. As a consequence, food prices increased, especially in countries (such as Mexico) where corn, or meat derived from animals fed on corn, is a staple of the average person’s diet. By 2008 food prices stood at record levels.

The ethanol subsidy program was questioned from the start. In 2005, a major study by Pimental and Patzek (the first a professor of ecology at Cornell, the second a professor of environmental engineering at Berkeley) argued that ethanol actually requires 29% more fossil fuel energy to produce than the energy it delivers.

The reason ethanol advocates didn’t realize this is that they didn’t count the unseen cost of the energy needed to produce the fuel, such as the energy used to make the fertilizer required to grow the crops, the energy used to power the farm equipment required to plant, irrigate, and harvest the crops, and the energy used to transport and grind the crops and distill the alcohol from the mash.

While many pro-ethanol spokespeople have attacked the work of Pimental and Patzek, it still seems clear — now even to Gore — that the input-yield ratio from ethanol is disappointing at best.

Besides the inefficiency factor, there are other drawbacks to ethanol. It is hard to keep water from mixing with it, which makes shipment hard. And it can be destructive to the rubber components of automobile engines.

Worse yet, a major study published this year by the Congressional Budget Office — hardly a right-wing source — revealed that the use of ethanol to reduce greenhouse gas emissions runs about $754 per metric ton of CO2. That’s about 38 times the average price, on the European Climate Exchange, that a European company would pay to be allowed to emit a ton of emissions over its allotment.

The ethanol subsidy program expires at the end of the year. Perhaps the Republicans, bolstered by their support in the recent election, will work to end this pointless program for good. Ending it would save $5 billion a year, and show some common sense about environmental and energy policy.

And maybe they could call Al Gore to testify.




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