The Energy Independence and Security Act (EISA) of 2007 saved the ethanol industry. The industry was heading for excessive capacity under the Energy Act of 2005. EISA raised ethanol consumption requirement. Ethanol plant utilization under EISA is projected to remain at 90% or higher through crop marketing year 2011-12. Utilization of 50% (close every other plant and the remaining plants could meet demand) was projected for 2011-12 under the older act.

The responsibility for the mandated level of ethanol use is placed upon consumption side of the industry (refiners, importer and some others) by Environmental Protection Agency (EPA) not the production side. EPA will penalize those that do not meet their EPA established targets. The penalty is believed to be $32,500 per day of noncompliance plus any economic benefit of noncompliance. EPA is able to adjust the level of consumption in the event of severe ethanol supply constraints (assumed to mean a 1988 type drought). If ethanol production and the mechanism to enforce consumption are correctly presented here, corn consumed by the ethanol industry is going to be fairy predictable through 2011-12 marketing year. (In a corn price rationing environment, the ethanol industry is going to be the last one to reduce demand unless EPA intervenes.) Ethanol production capacity, after the 2011-12 marketing year, has the potential to out pacing mandated demand. At that point predicting corn use is more difficult. (Demand will probably not be much above mandated level unless tax credits continue, an engine is developed that does not have a mileage drag at high levels of ethanol and/or a significant portion of ethanol distribution to the public moves away from the petroleum industry.)

The ethanol industry will have a very profitable period (through 2011-2012 grain marketing year) under these assumptions as long as the industry does not go into “Wild” expansion mode. Given the above, it looks like ethanol price should decouple from gasoline price and trade more closely to the price of corn. (Ethanol producers will be price setters during this period of time as long as their production can be delivered to their customers.) The refiners, imports and other will add on their margin and pass the cost to the public. Their margins will come from bio-fuel tax credit and/or higher price at the pump. It might be more socially appropriate to fund these margins from the continuation of the bio-fuel tax credit then regressively (poorer individual’s would potential pay a higher percentage of their income in supporting bio-fuel (food and fuel) then high income individuals) funding it through high pump prices (although higher pump price might reduce fuel demand). Until plant capacity substantially exceeds mandated demand the price of corn will not be affected by the use or nonuse of the bio-fuel tax credit. (The use of bio-fuel credit increase demand for ethanol and thus corn. When the plants are producing at maximum capacity that increased demand cannot be met by domestic production so more corn is not consumed. Tariffs keep the credits from funding foreign ethanol production. Tariffs, at a minimum, probably should remain in place as long as bio-fuel tax credits are continued.) The bio-fuel tariff is assumed to remain in place in these projections. Dropping the tariff is expected to decrease domestic corn demand (and as a result corn price), decrease plant utilization and increase the correlation between ethanol and gasoline price.

There is an old saying that goes something like; “It is known to work in real life. . . We need to see if it works in theory.” This is a theory. Time will tell if it is anything like real life.