Last Call for Ethanol?

It's no mystery that the great ethanol surge appears to be coming to an end in the U.S. Purportedly, ethanol is now a glut on the market, and investors in new production facilities are getting cold feet.

As the author of the definitive study on fuel ethanol I suppose I should register an opinion on this matter and perform a bit of analysis. So here goes.

First I would like to say that I have always been a bit skeptical regarding the notion that ethanol was going to be the successor transportation fuel to petroleum. Just like I was skeptical about similar representations with respect to hydrogen. I just couldn't see it in either case, at least not with current technology.

Still, there was and is a lot more reality to ethanol than to hydrogen. Hydrogen was a big public policy initiative with almost no market forces behind it. Ethanol, on the other hand, was at least within shouting distance of gasoline in the area of production costs, and, furthermore, it leant itself to an incrementalist approach in the market.

And in fact it still does. Ethanol works well as a gasoline additive for the purposes of oxygenation and octane boosting. It's a lot better than MBTE which it is in the process of replacing. So why is the ethanol boom going bust?

It's all a matter of uncoordinated growth, or to be more precise, production outstripping distribution facilities and feedstock availability.

All of the entrepreneurs and their venture backers who got into ethanol concerned themselves exclusively with making the stuff, and, in most cases, they used traditional corn feedstocks which they purchased from farmers. Everybody was focused on the middle of the chain, leaving other folks to worry about the feedstock itself and the distribution and marketing of the final product.

So the guys on either end of the supply chain got squeezed when production began to ramp up at an almost exponential rate. Farmers were willing to grow a little more corn, but they couldn't adjust to near doubling of demand and they already had their food processing accounts to serve. They couldn't just write those off. On the other end, the independent filling stations had to pop for roughly sixty-thousand dollars to put in a single E-85 pump. Most stations outside of the farm belt just weren't willing to do it so that left you basically with just the additive market.

Now the additive market holds the potential of tens of millions of gallons a year, and it may well reach that point, but that wasn't going to happen quickly absent the means of moving ethanol from the distillery to the blending facility. Railway is the cheapest way to do this today but the tanker cars are already booked solid and the railroads won't order more unless they're sure that demand will continue to increase. And they're not sure. Dedicated pipelines are the real answer, but no one's building them or even proposing to build them.

During the eighteen eighties the fledgling American petroleum industry encountered similar problems with production outstripping the ability of the refiners to move oil by pipeline or by rail, but there most of the refining capacity was controlled directly or indirectly by Standard Oil which happened to have been run by one of the best corporate strategists who ever lived. Any obstructions in any part of the supply chain were immediately addressed, and the industry as a whole was never seriously impeded.

The ethanol industry lacks such cohesive structure and firm, centralized control, and it also supplies a product that is less in demand than kerosene was in the late nineteenth century. And that means that its very real problems are not likely to meet with effective solutions very soon.