Shucking the Hype: St. Louis Fed Analyzes Ethanol

ST. LOUIS — While increasing our use of ethanol for fuel may make a small dent in the demand for oil, the potential benefits must outweigh the potential costs if ethanol is going to be viable in the long-term.

This is one of main points emphasized by research analyst Joshua A. Byrge and economist Kevin L. Kliesen in the July issue of The Regional Economist, the quarterly journal of business and economic issues published by the Federal Reserve Bank of St. Louis. The publication is also available online at: www.stlouisfed.org/publications/re/default.cfm.

The environmentally friendly nature of ethanol, when compared to crude oil, has been one of the major selling points used to increase its use. Government officials and some analysts believe that burning ethanol in place of gasoline has the potential to address global climate change by decreasing greenhouse-gas emissions. Yet, one study claims that when the environmental effects of land clearing for ethanol source crops are taken into account, ethanol actually produces more carbon emissions than standard gasoline.

A second benefit used to popularize ethanol is its ability to decrease the U.S. dependence on foreign oil. Even if all the corn grown in the United States were used to produce ethanol, however, it would replace only 12 percent of the gasoline used for transportation. And this is not expected to increase significantly anytime soon.

"Even if the 2022 goals of the 2007 Energy Independence and Security Act are realized, the 36 billion gallons of ethanol will equate energetically to roughly 21 billion gallons of gasoline," said Byrge and Kliesen. "This would replace only 15 percent of transportation fuel used in 2005."

And while producers are beginning to explore switchgrass, or cellulosic ethanol, as a way to increase our use of biofuels, there is serious concern about the virtually nonexistent infrastructure to support it.

Other questionable claims concern the possibility that the rise in demand for corn, the primary ingredient in ethanol, has led to increased food prices worldwide. While the authors assert that ethanol production may not be driving the recent run-up, it does lead them to highlight the potential need to reassess the United States tariff on ethanol for fuel production. At current oil prices, ethanol production should be highly profitable even without the ethanol tariff, and a reduction in the tariff could ease the effect of ethanol's production on food prices.

"Since alternative fuels are more expensive to produce than gasoline or diesel, the long-term benefit from ethanol production depends on its viability when compared to conventional fuels," concluded Byrge and Kliesen. "If we see a repeat of the 1980s' decline in oil prices, we would likely see a considerable departure of economic resources from ethanol production."

With branches in Little Rock, Louisville and Memphis, the Federal Reserve Bank of St. Louis serves the Eighth Federal Reserve District, which includes all of Arkansas, eastern Missouri, southern Indiana, southern Illinois, western Kentucky, western Tennessee and northern Mississippi. The St. Louis Fed is one of 12 regional Reserve banks that, along with the Board of Governors in Washington, D.C., comprise the Federal Reserve System. As the nation's central bank, the Federal Reserve System formulates U.S. monetary policy, regulates state-chartered member banks and bank holding companies, and provides payment services to financial institutions and the U.S. government.

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