Anti-Market Bias

And from one of my daily must read blogs no less. The pain…the pain (actually I suspect this is more of an aberration than the norm for the Commissar).

The Commissar has a post on ethanol and its possibility in helping with the current gasoline/oil situation. I don’t know a lot about ethanol other than most people seem to think that ethanol is an unlikely replacement for gasoline. But what got me was the final comment on free markets.

Free Market?

I’m a big fan of Milton Freidman, but freeing ourselves of dependence on Middle Eastern oil should be easily justified on national security grounds. At a bare minimum, any free-market purists would agree that we should remove the tariffs on foreign sugar-based ethanol, imposed to help our domestic corn-based ethanol industry. The Feds should promote:

  1. ethanol-compatible vehicles, like my Explorer
  2. more E85 fueling stations
  3. construction of ethanol distilleries, here and abroad

domestic and foreign sugarcane production to feed ethanol distilleries
It’s coming, comrades, it’s coming. E85. But the Lefties already hate it. Do we need any more evidence that it’s a good idea?

Here is my problem with this line of thought. What is the national security issue really?

The way I see it there are two possible ways to look at this.

First is that a portion of the money we spend on Middle Eastern oil eventually finds its way into the hands of those who would attack this country (I’m primarily thinking terrorism here). If this is the main concern, then reducing our expenditures on oil (from anywhere) is the goal. To achieve this goal we need to find a substitute for oil. Anything else will do literally nothing. The reason is will do nothing is because it is like re-arranging chairs on the Titanic. Since oil is a globally traded commodity, buying from another source will do nothing to the price.

As an aside to this, drilling in ANWR would likely have little effect in the long run and no effect in the short run. ANWR oil production is estimated, in the high case, to be around 1.5 million barrels per day. Current global production is around 85 million barrels per day, and it is growing. So by the time that ANWR is at maximum production it will likely be only a tiny fraction of daily production. To be sure it would have a downward effect on prices, but it isn’t likely to take us back to the $1.01/gallon that we were seeing several years ago.

The second take is that the volatility of oil and gasoline prices is a threat to our national security. Frankly, I don’t see this one. Why isn’t food a national security issue? Something happens to our food supply and we are in big trouble. But, aside from that objection the idea that we can save money by finding an alternative is for the most part a fiction. If it was economical to switch to this alternative right now…we’d switch right now. That is generally how markets tend to work. In my posts on the price of gasoline and oil there are plenty of commenters that are quite upset about the cost of gasoline. Given an alternative that is just as cheap if not cheaper my thinking is that they’d take it. The reality is that all alternatives are generally more expensive right now. Hence, switching from oil/gasoline to something else is going to cost us just as much if not more than what we are currently spending on oil/gasoline.

This doesn’t mean that there are never going to be any substitutes. Basically, I’m arguing that at the current prices for oil and gasoline the alternatives are not economically viable. Yet. If prices stay high like this there are incentives to look for alternatives. What are those incentives? Well here are 8.4 billion in incentives. That’s right, those profits of the oil companies act as incentives to find something better. Be it a more efficient and lower cost hybrid or even perhaps ethanol or something else.

As for the Feds encouraging things, why? If it is currently profitable to do something, then why encourage it? Aren’t the profits enough? If it is profitable and the government is preventing it from being done, then the solution is to get the government out of the way.

My thinking is that we don’t need the government to do anything. In fact, I’d argue that the government is, if anything, part of the problem. The current volatility in gasoline prices is in part due to the boutique blends, the lack of competition in the refinery industry, and other mandates from, you guessed it, the government. The market has found substitutes for many products in the past as they became expensive. Of course, hampering the market means you’ll have less innovation (e.g. the former Soviet Union and the Eastern Bloc countries). In both cases, the market can provide a solution. Having government get in the way, will if anything, likely make things worse.

FILED UNDER: Economics and Business, National Security, Terrorism, , ,
Steve Verdon
About Steve Verdon
Steve has a B.A. in Economics from the University of California, Los Angeles and attended graduate school at The George Washington University, leaving school shortly before staring work on his dissertation when his first child was born. He works in the energy industry and prior to that worked at the Bureau of Labor Statistics in the Division of Price Index and Number Research. He joined the staff at OTB in November 2004.

Comments

  1. Steven Plunk says:

    Steve V.,

    Thanks alot for the post. If I had nickel, nickle, nickal, for every mistake I ever tieped into a comments section I wood be rich.

    You’re dead right on the market vs. government approach. We need the government completely out of the business as much as possible.

    It is government intervention on ANWR that is keeping free market oil exploration from going on. While it’s only a few million barrels it’s enough that somebody wants to drill for it so why stop ’em.

    The ethanol thing is hooey. If it becomes profitable (hence the most efficient) we would not need subsidies or protective tariffs.

  2. Alan says:

    Steve,

    The gov’t is already in the market in a huge way, subsidizing the cost of oil. Providing security (military support) is one way, but there are many others.

    BTW, let me share something with you regarding ethanol. It is already immensely profitable. When scientists, engineers and economists study ethanol as an energy supply, they take into account that a gallon of ethanol contains roughly half the energy as a gallon of ethanol. In other words, you need two gallons of ethanol to replace one gallon of gasoline.

    Consumers aren’t quite so smart though. They will go to the pump and pay essentially the same price for gasohol (10% ethanol) as they pay for gasoline, not realizing that they are getting 5% lower gas mileage with the gasohol.

    Companies that made long term contracts for ethanol are paying about $1.20 per gallon. That same ethanol is now being sold to the consumer for about $2.70 per gallon.

    In my book, that equals profitable. Expect to see a lot more ethanol production in the coming years.

    IMHO, we should save ANWR until it will really make a difference — about 15-20 years from now.

  3. Alan says:

    Sorry for the typo above– it should read “…a gallon of ethanol contains roughly half the energy as a gallon of gasoline.”

  4. Dave Schuler says:

    If this is the main concern, then reducing our expenditures on oil (from anywhere) is the goal.

    Uh, no. The goal is reducing everybody’s dependence on oil. Help every country in the world (that has the water resources) develop the technology to make cellulosic ethanol replace pure gasoline.

  5. Steve Verdon says:

    Dave,

    If an alternative to oil is found that is economical then it doesn’t really matter if it is used here in the U.S. or world wide.

  6. “Here is my problem with this line of thought. What is the national security issue really?”

    I’ve answered in depth here, but left a comment because I still can’t trackback to OTB.

  7. RJN says:

    I found this. It should open some eyes as to the value of ethanol.

    “David Pimental, a leading Cornell University agricultural expert, has calculated that powering the average U.S. automobile for one year on ethanol (blended with gasoline) derived from corn would require 11 acres of farmland, the same space needed to grow a year’s supply of food for seven people. Adding up the energy costs of corn production and its conversion into ethanol, 131,000 BTUs are needed to make one gallon of ethanol. One gallon of ethanol has an energy value of only 77,000 BTUS. Thus, 70 percent more energy is required to produce ethanol than the energy that actually is in it. Every time you make one gallon of ethanol, there is a net energy loss of 54,000 BTUs.’

  8. RJN says:

    What might be smart is to burn corn for space heat and, thus, replace fuel oil.

    Example: Calculate cost per million Btu for 15% moisture shelled corn that costs $2.00 per bushel and is burned in a stove that has an efficiency of 65%.

    Cost per million Btu = [$2.00/bu ÷ (392,000 Btu/bu x 0.65 efficiency)] x 1,000,000

    = $7.85 per million Btu

    Here are energy content, burner efficiencies, and costs per million Btu at average efficiency and the indicated price for several fuels:

    Fuel oil, 140,000 Btu/gal, 70 to 90% efficiency (80% avg.), $1.50/gal:

    $13.39 per million Btu

    Propane or liquefied petroleum gas (LPG), 92,000 Btu/gal, 70 to 90% efficiency (80%avg.), $1.00/gal:

    $13.59 per million Btu

    Natural gas, 100,000 Btu/ hundred cubic foot (ccf), 70 to 90% efficiency (80% avg.), $0.80/ccf:

    $10.00 per million Btu

  9. Herb says:

    If the Government would get out of the way, the place to start is to outlaw contributions given to politic ans by the oil companies.

    Stop all aid and gifts to such countries as Saudi Arabia, UAE, Qatar, and all the others.

    Next Get those wacko environmentalist out of the way and let go hug their trees somewhere else.

    There are no doubt several more good moves that could be made, but the problem is that Government will never got out of the way because the people feel that is the only avenue to air their grievances with. The oil companies will not listen to the people so, where does the average schmo go for help.

  10. Alan says:

    RJN, your figures are wrong. With currently used technology, you have to invest about 100 BTU to get 130 BTU out. In other words, there is a 30% net energy gain. Plants being built today achieve approx. 35% energy gain, and it is estimated that over the next 10 years, that will be pushed up to 45-50%.

    But all that doesn’t matter. What really matters is how much the consumer is willing to pay for ethanol vs. how much it costs to produce. The answer is that is costs ~$1.20 per gallon to produce, and sells for ~$2.70.

  11. Steve Verdon says:

    Russell,

    I strongly disagree with your analysis. The idea that Bin Laden is a tool for the Saudi government strikes me as perhaps one of the most out-there things you have written (don’t get me wrong, I frequently agree with you).

    Still, your point about re-investing may have some merit. The UAE isn’t a hotbed of terrorists and that maybe because the Emir there re-invests the oil revenues.

    As for places like Saudi Arabia, I think you have completely glossed over the dilemma facing the rulling party: that early on they got into bed with Islamic extremists. That extremism takes form in Wahabbism which is similar to the type of islam we saw in Afghanistan.

    The national security issue related to oil strikes me as a pretty weak one, overall.

  12. Steve Verdon says:

    RJN,

    I’m not opposed to ethanol, I’m just opposed to propping it up with government subsidies. If it takes subsidies too make something economically viable, then it isn’t economically viable.

    We can’t get off our addiction to oil by taxing ourselves to pay for an even more expensive alternative. Now if ethanol doesn’t fit into this catagory then great.

  13. RJN says:

    Alan:

    The corn alone contains 392,000 BTU per bushel. The yield from one bushel of corn is 2.7 gals of ethanol. So, without counting the energy required to process the corn, it takes 145,000 BTU for one gal of ethanol.

    Alan, are you claiming that ethanol has more than 70,000 BTU of energy per gal? No can do.

  14. RJN says:

    That should read 77,000 in my question to Alan.

    Ethanol requires a large subsidy to make it cost effective for a consumer. It is bull, and has always been bull. It will always be bull. Ethanol is a sure loser as an energy source.

  15. Alan says:

    Hi RJN, it takes about 75-80,000 BTU to produce a bushel of corn and you get out about 5-10% more than that in ethanol energy. But that’s not all you get out–you also get co-products like corn oil and corn gluten. One way to do a total net energy analysis is to factor in the amount of energy saved by not having to grow additional corn just for oil and gluten. This yields the most conservative estimate. For an example, see http://www.transportation.anl.gov/pdfs/AF/265.pdf.
    Also note that to some extent, the energy you put in can come from coal, thus allowing you to in effect convert coal energy into a transportation fuel. Since coal is an abundant domestic energy source, this is an additional positive factor for ethanol production.

    But in the end, it comes down to dollars and cents, and the single most important dollar factor at the moment is that consumers are currently willing to pay double what they should for ethanol relative to its energy content, i.e., they are willing to pay roughly the same amount per gallon of ethanol as a gallon of gasoline, even though ethanol has roughly half the energy content and gets half the gas mileage.

  16. Alan says:

    P.S. Citing Pimental is cherry picking–he is one of the few researchers that shows a negative energy balance, and the primary reasons are that he overestimates that amount of fertilizer required to produce corn, and overestimates the energy consumption of the ethanol production plant.

  17. RJN says:

    Motorists are not “willing” to pay double for ethanol energy. They are forced to by stupid laws requiring an ethanol mix.

    Steve is right,of course, in his observations that government should stop propping up intrinsicly underperforming sources of energy.

  18. Alan says:

    > Motorists are not �willing� to pay double for ethanol energy.

    RJN, you have no idea what you are talking about, do you?

    Try going to a state that does not mandate gasohol, then go to a service station that is selling gasohol for ~7 cents less per gallon than most other service stations charge for gasoline, then look at how busy they are. Bottom line, consumers are currently willing to pay basically the same price for gasohol as gasoline.

  19. RJN says:

    Alan:

    Now you have confused us all. First you make the claim that motorists are willing to pay double for ethanol. Then you say that motorists will buy gas with ethanol if it is discounted. It seems to me that the motorist is going for the discount and not the opportunity to pay double.

    Back in the ’80s ethanol screwed up non-metalic fuel handling components. I learned my lesson, and have avoided it since. Especially since I learned it is a fake – energy wise – substitute for gasoline.

    BTW: My initial point was that using corn as a heating fuel makes much more sense than using it as a costly substitute for gasoline.

  20. Alan says:

    > My initial point was that using corn as a heating fuel makes much more sense than using it as a costly substitute for gasoline.

    Your suggestion of burning corn is a non-solution to a non-problem. If we want to burn something to produce heat, we burn coal or natural gas, which we have in relative abundance in the North America. What we are looking for is an alternative transportation fuel, i.e., an alternative to gasoline that makes our cars propel themselves forward. Burning corn does not solve that problem.

  21. RJN says:

    Alan, have you ever tried to heat your house with coal? Nasty. Natural gas, on the other hand, is a useful transportation fuel. Using corn, instead of fuel oil, for heat releases fuel oil for use as diesel fuel.

    Shale, and tar sands have more potential as feed stocks for motor fuels than ethanol.