Ethanol Policy

It seems that every time you pick up the paper or switch on the TV, someone is talking about a new way to make his car run on biodiesel or ethanol:

“I converted my car to run on old McDonald’s french fry oil, and the mileage is pretty darn good.”

Well, there we have it…energy crisis solved…right? Wrong. You see, for every good idea and every well-thought-out plan that may work on a small scale, there are always problems on a widespread level. Ethanol from corn is a perfect example. We will examine why ethanol has failed in a moment. And why even bother with alternative fuels? Do we really need them?

Let’s think about some alternative fuels and energy sources. Think of nuclear, solar, hydrogen, geothermal, coal and biodiesel. While we’re at it, let’s think about ideas like recycling, conservation, smaller cars, efficient homes and even walking. Yes, walking. These ideas are no longer just for polite cocktail party talk. These things will now be necessities if the world — and, most certainly, the U.S. — is going to continue to function in the face of dwindling easy-to-get-to sources of oil.

One thing is for sure. The vast petroleum needs of a growing planet are not slowing down. In fact, quite the opposite.

We suddenly have a whole new ballgame, as millions and millions of new drivers hit the road in India and China. The economic boom in those places has spurred a new middle class. These are not the regimented masses of just a few decades ago. The new middle-class citizens of the developing world are not content with meager rations, bare-bones quarters and Mao or Nehru jackets. Instead, they are demanding more luxury items and a far superior standard of living. And you know what? They have the money to pay for these things.

So we have a problem. There are a lot of people competing for the world resource pie. But the pie is not growing very fast. In many ways, the size of the pie is static, and in some respects, it’s actually shrinking. Thus, we get the golden rule of supply and demand, which is that those who have the gold make the rules.

The idea of ethanol from corn or other feedstock is not new. Byron King and I have talked about this in our Outstanding Investments letter many times before. Farmers have used ethanol from corn for years on a local basis, and it has served them well.

I visit many farms every year. One small town in Minnesota is a perfect example of how corn-based ethanol’s evolution went from a simple small-scale solution to a nationwide disaster.

In the small southern Minnesota town of Waseca lives a good friend of mine, Geb. Geb is a lifelong farmer and resident. Geb made his career in farming, and his hands tell the tale of many years of hard work and toil. Geb now enjoys retirement and investing, and his son Scott handles the day-to-day operations of the farm.

I visited Geb and Scott’s farm about two years ago. As we walked over his farm, Scott was nice enough to show me the incredible advancements in farming technology. Global Positioning Systems (GPS) in the tractors and combines enable the driver to know exactly which parts of the fields he has already sprayed with fertilizer, in order to save money. And this level of technology is just a start. There are many other things that make this not your father’s farm. Different seeds, different irrigation methods, different weather forecasting. I was impressed.

Later that day, the discussion of ethanol turned into more of a history lesson and led me to realize that corn-based ethanol on a nationwide scale was going to be a disaster. (Remember, this was about two years ago.)

Wouldn’t it be great to grow enough of something in your yard and then have a machine turn it into fuel you could put in your car? What could be better than taking a small portion of your corn crop and converting it into ethanol at either your farm or the locally owned farmers’ co-op down the road? You could then use the ethanol to run your farm vehicles. And if you didn’t need all of it, you could sell a little to the local gas station or your neighbor. It makes an incredible amount of sense on that small-scale level, and it worked like that in the Corn Belt for many years. Fast-forward to 2008 and we find a much different story.

The idea was simple at first. We would use ethanol for fuel, just as they do “back on the farm.” But when the time came to scale it up, everything became super complex. Oil prices surged year over year, and the idea emerged that alternative fuels — like ethanol — would start to replace oil, just as they had done in Brazil years earlier. It was a nice idea. However, without any real planning or study, it was doomed to fail. And now we know that it has failed.

Yours for resource profits,
Kevin Kerr
may 6, 2008

The Daily Reckoning