Wednesday, November 01, 2006

Ethanol or Hybrids? — The Real Story, Part I

If anyone doubts that Americans are addicted to oil, he or she must be living on another planet. President Bush was absolutely correct in calling attention to this dependence on what has been called “black gold” but could be termed today as “black platinum.” But recognizing that a problem exists is much easier than establishing a solution. After all, that solution has eluded every president for over 30 years. The fundamental problem can be attributed to an economic theory first developed in 1838 but not widely accepted until published again in 1890. We know it as the “theory of supply and demand,” a concept that now seems deceptively simple—the price of a good is determined by both the supply and demand for it. For example, if the demand for oil exceeds the supply, the price will escalate until equilibrium exists. Well, hello America! Does it take 138 years for Americans to understand that model?

Furthermore, is it so difficult to recognize that the United States, with only 5 percent of the world’s population consumes 25 percent of the world’s oil production? But consider this, because the outlook is even worse: by the year 2025, U.S. demand for oil is estimated to increase by 50 percent, and the demand for oil by China will exceed that figure. If the Peak Oil theorists are right, unless we develop some realistic solutions quickly, the world could be facing an energy crisis of gigantic proportions.

Scary Predictions From an Oil Expert

In an interview in the October 16 th issue of Barron’s, (note that Barron’s is very selective relating to the caliber of their interviewees) Charley Maxwell, an oil veteran of 20 years, predicted that “More than 50% of the non OPEC production will therefore have peaked [by 2008].” He then says, “There are all kinds of issues as to when the whole world peaks. I use a range from 2015 to 2020, which depends on when the rest of the world wakes up to the need to conserve, which could delay the peak.” Conserve? Conserve? Does that word exist in the vocabulary of possible solutions put forth by this administration? Well, no-o-o-o-o! The administration’s view is in sync with “Big Oil” — find new sources of energy and increase production. In other words, concentrate on increasing supply and more or less ignore the demand factor.

Mr. Maxwell also comments on the fact that “The oil companies as a group, [especially Exxon Mobil] seem to believe the future production potential of the world is very large, very wide open, and yet production numbers don’t indicate this is so.” He cites the “recent big discovery in the Gulf of Mexico,” but the fact that Exxon is not taking on any leases for deep-water drilling after 2008” is a clear indication that Exxon must think, “the deep water leases aren’t going to be important because the oil found will be more expensive than the common garden-variety Texas oil from 6000 feet down, and that [since] you will have lots of oil coming from sources like that you don’t need these high cost leases down the road.”

If you want a further idea as to the critical nature of this problem, Mr. Maxwell also predicts that if solutions are not quickly implemented, the price of a barrel of oil will stand at $85 by 2010, $180 by 2015, and $300 by 2020.

Ethanol as Panacea—But Whose?

On October 13 th of this year, Thomas Friedman’s column in The New York Times described a survey taken of likely voters from both parties that indicated 42% of the participants chose “energy independence” as their number one security concern. Surprisingly, this far outnumbered the number two choice “combating terrorism, which garnered 24% of the vote.” Perhaps the public has finally grasped the dimensions of the problem. Friedman has long been a staunch advocate of energy independence, as well as a strong critic of this administration’s weak and misdirected energy policies. Unpredictably, the same issue of The New York Times contained an article detailing a speech given by President Bush at a conference to promote bio-fuels where he suggested that the push to wean America from oil addiction would be a priority of the last two years of his administration. It is unclear whether Bush knew of Friedman’s survey information, or whether Freidman knew the subject of Bush’s speech. Whether this was just a serendipitous coincidence is impossible to establish.

Of course, this is not the first time a president declared oil independence as a priority. Thirty-three years ago, President Nixon initiated “Project Independence.” In 1977, Jimmy Carter, in an oft quoted line promised, “Beginning this moment, the Nation will never again use more foreign oil than we did in 1977—never!” Yeah, sure! Neither of these initiatives, nor any other over the ensuing years has been effective in achieving the goal. We are using more imported oil than ever before.

Nevertheless, since President Bush (rightfully) stated the obvious, that Americans are addicted to oil, there has been a sudden rush to judgment regarding the best way for the country to ultimately achieve the oil independence that (as mentioned above) has thwarted every president for more than thirty years. In his infinite wisdom, the President has announced that the not so secret weapons that will accomplish the goal of oil independence are ethanol and hydrogen fuel cells. While the latter is by far the most desirable of all possible solutions, and automakers are working toward that goal, it is questionable whether most readers of this article will live long enough to benefit from that process. As far as ethanol is concerned, that is another story. While it is a story where the ending is unknown, (and although this is not exactly the beginning), what follows is as good a place to start as any.

ADM—Part of the Problem, Not the Solution

Just as WMD is an acronym, ADM is also a symbol, but for something much more benign than Weapon of Mass Destruction. Nevertheless, ADM is a stock market symbol, representing a company whose ethical misdeeds became the internal WMD that could have backfired by destroying the company. In the early 1990’s, that company, Archer Daniels Midland, the agricultural behemoth, became the personification of corporate greed and deceit.

In 1995, just prior to the whistle-blower led exposure that precipitated a much-publicized scandal (two books were written about it), the Cato institute, a non-profit public policy foundation, well known for its ultra-conservative values, published a policy analysis titled “A Case Study in Corporate Welfare.” The first paragraph read, “The Archer Daniels Midland Corporation (ADM) has been the most prominent recipient of corporate welfare in recent U.S. history. ADM and its chairman Dwayne Andreas have lavishly fertilized both political parties with millions of dollars in handouts and in return have reaped billion dollar windfalls from taxpayers and consumers. Thanks to federal protection of the domestic sugar industry, ethanol subsidies, subsidized grain exports, and various other programs, ADM has cost the American economy billions of dollars since 1980 and has indirectly cost Americans tens of billions of dollars in higher prices and higher taxes over that same period. At least 43 percent of ADM’s annual profits are from products heavily subsidized or protected by the American government. Moreover, every $1 dollar of profit earned by ADM’s corn sweetener operation costs consumers $10, and every $1 of profits earned by its ethanol operation costs taxpayers $30.”

Shortly after this analysis was published, what seemed like disaster struck ADM. This was well depicted in the International Herald Tribune as follows: “In mid-1990 the business pages had the peculiar odor of a cheap spy novel. There were secret rendezvous in hotel rooms, allegations of prostitutes hired to do corporate espionage, an FBI dragnet, and a double crossing mole.” [Sounds like a great movie plot to me.] “But this was not just pulp fiction. It was the story of Archer Daniels Midland Co. a $20 billion [the current figure is $32.6 billion] international powerhouse in agricultural-commodities processing.” And here is the key information: “From 1991 to 1995, the company was involved in several international price-fixing cartels. Mark Whitacer, an ADM executive blew the whistle. In 1996, three of the company’s top executives, [including Chairman Andreas’s son] were sentenced to jail terms ranging from two to two and a half years.” (Ironically, Whitacre, who worked as an informant for the FBI, was himself a thief since he ended up serving nine years for embezzling $9 million from ADM.)

As a result of its indiscretions, ADM was fined a breathtaking $100 million, and subsequently paid an additional $400 million to settle a civil class action lawsuit accusing the company of fixing prices in the huge market for corn sweetener. As determined by the Cato Institute, much of ADM’s ability to garner huge subsidies for its products were the results of large contributions and inside connections to both political parties. From a cost/benefit standpoint, these payments and relationships were a staggering success. (Remember that song from the show Cabaret, “Money Makes the World Go Round?)

And don’t think that the scandal, fines, and huge monetary settlements changed the way business is conducted, and continues to be conducted. As recently as one month ago, the editorial page editor for Barron’s wrote an editorial deriding the concept of ethanol as “the” solution to our oil addiction. He stated, “Like Brazil, the U.S. has provided some foolish incentives to use ethanol made from corn, and President Bush wants more. Since taking office, his administration has spent more than $10 billion on alternative fuel research and development, and in his most recent State of the Union address he pointed to the promise of ethanol fuels. He set a goal of replacing 70% of imported oil from the Middle East by 2025—coincidentally his stated target year for sending an expedition to Mars.” (That last bit was supposed to be sarcastic).

The article continues, “The political motivation is partly to provide another form of aid to corn farmers. Most states raise some corn, and so most senators support corn farmers. And, of course, the road to the White House starts in the Tall Corn state of Iowa. Furthermore, the well connected and politically generous firm, Archer Daniels Midland is the nation’s largest producer of fuel ethanol [to the tune of 25% of the total ethanol production.]” (My emphasis)

It appears that nothing much has changed. Apparently substantial election campaign funds still flow from ADM to candidates, very substantial subsidies still flow into ADM, and equally substantial federal funds flow into research and development for alternate energy forms including ethanol. While the first two activities are suspect, the latter, incentives for research and development cannot be faulted—although the case for supporting corn ethanol has seen increasingly vociferous criticism.

In early October, at a bio-fuels conference where President Bush spoke, (the CEO of ADM also attended) he said that corn-produced ethanol was good for farmers and good for the country’s economy. Good for the farmers? Maybe, but the real profits as well as the government subsidies are going to the big agricultural companies like ADM and Cargill, as well as the other producers of corn ethanol. Good for ADM?—absolutely. Unfortunately, the president’s speech writers neglected to reveal that ADM’s political connections has helped them become the largest beneficiary of more than $2 billion in annual government subsidies received by the ethanol industry. That results from a 51-cent-a-gallon tax credit provided to refiners and blenders—not to farmers. ADM is estimated to earn $1.3 billion this year from ethanol alone, and its stock price and profits have doubled in the last year.

On June 25 th of this year, The New York Times ran a long article on ethanol in which it stated, “For all the interest in ethanol, however, it is doubtful whether it can serve as the energy savior President Bush has identified. He has called for bio-fuels — which account for just 3 percent of total gas usage — to replace roughly 1.6 million barrels a day of oil imported from the Persian Gulf.”

The doubt expressed by The Times, the pros and cons of ethanol, and what could be the real savior will be discussed in the next issues.

Disclosure: The author admits he does not own stock in ADM or any other company involved in the production of ethanol — which in retrospect was a major oversight.


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