This week a study on peak oil by a German military think tank was leaked on the Internet. The document shows that the German government is closely studying the issue of peak oil, and is aware of the potential for serious consequences as oil production declines. The study is reminiscent of the Hirsch Report, commissioned by the U.S. Department of Energy, that warned of the risks posed by peak oil.

Europe's continued reliance on Russian oil and gas supplies may not be secure in the long term, according to the study.

The document warns of the potential for regional shortages, market failures, and a shift in political power toward those capable of exporting oil. This report describes potential outcomes that require planning and preparation. The scenarios outlined in the paper are exactly the kinds of drivers that lead me to advocate for greater regional energy self-sufficiency. The report clearly lays out just how vulnerable Europe will be because of its continuing dependence upon Russia for both oil and gas, and notes that Russia will be in a very strong political bargaining position as a result.

The report can be accessed from the popular German paper Der Spiegel in this story: Bundeswehr-Studie warnt vor dramatischer Ölkrise. The report is so far only available in German, and while Ich spreche ein wenig Deutsch (I speak a little German), I am not fluent enough to capture the essence of the report. (Der Spiegel has summarized the report in English now: Military Study Warns of a Potentially Drastic Oil Crisis).

However, I have a friend who is both fluent in German (his native tongue) and passionate about peak oil outreach. Given a week, I could probably translate the report. My friend (who didn’t want to be identified) did it overnight. Below is his translation of the major points in the report.

Peak Oil

Implications Of Resource Scarcity On (National) Security

Center for German Army Transformation, Group for “Future Studies”

July 2010

1.        Introduction

The focus of the document is on the topic of finite resources, using Peak Oil as an example. The report is part of a series of publications focused on long term (30 years) with the intent to enable the Ministry of Defense to take action early.

In the past, resources have always triggered conflicts, mostly of regional nature. For the future, the authors expect this to become a global problem, as scarcity (mainly of crude oil) will affect everybody.

The authors confirm multiple views on Peak Oil timing and concede that there will be Peak Oil eventually. The study isn’t about positioning the problem on a timeline, but instead about the consequences of a peak. They expect major consequences with a delay of 15-30 years after the peak has hit.

The report refers to the uncertainty of reserve statements mainly in OPEC countries based on the quota allocation method within OPEC but also refers to the possibility of better extraction technologies.

They suggest that it has become urgent to understand those consequences of an eventual peak now in order to have enough time to adapt.

2.        The Importance of Oil

2.1       Oil as a driver of globalization

95% of all industrial outputs is dependent on oil, in fuels, as a chemical base for polymer production etc. Oil has become a key driver of modern lifestyle and globalization.

Substantial oil price increases poses a systemic risk, not just for obvious things like transportation, but equally for other subsystems.

Thus, internationally, but equally nationally, there is a vital interest in securing access to oil, which is currently possible on world spot markets, with OPEC being cooperative due to a mutual dependency between key actors (and a massive presence of the U.S military in the gulf region).

Yet on the other hand, regional conflicts can always at least partially be attributed to resources, such as in the Caucasus region, the Middle East or in Nigeria, or they fuel conflicts due to the wealth they create (such as in Africa).

The report sees – within a timeframe until the year 2040 – a changed international security layout based on new risks (including transport risks for fuels) and new roles of actors in a possible conflict around the distribution of increasingly scarce resources.

2.2       German energy security

The term is defined narrowly as “reliable energy supply”, and then extended to include environmental objectives, technology transformation of societies, planning for energy demand and the long-term planning of a national strategy, tied in with international organizations

This expansion of the view is seen as required based on the globalization of energy markets. However, the report then narrows down the scope again to the possible risk from a supply shock, focusing on the key suppliers of oil: Russia, Norway and the U.K. It is noted that both European partners are already past their peak and that Germany is increasingly dependent on Russia, which currently is reliable but not necessarily so in the long term. Given the expected decline in German energy consumption, the Russian share will likely be 40% by 2025, with the Middle East, Africa and sources around the Caspian Sea making up for the increasing gap from declining European production.

3.        Possible Scenarios After Global Peak Oil

This chapter looks at gradual changes (3.1.) and the risk of disruptive changes (3.2) past a certain tipping point.

3.1       General interdependencies driven by Peak Oil

3.1.1      Oil as a deciding factor in international relationships
With increasing scarcity, producers are increasingly in an advantageous position, both from high revenues and access to cheaper oil when compared to spot market prices. This partly reverts the trend to free oil markets which took place after the ’70s shocks, and gives those countries more control over the supply chain, with a risk of monopolies and nationalizations, and of “political pricing.”

Further, oil producers use increasing amounts of their production internally at lower prices, which increases domestic consumption and inefficiencies, accelerating the problem. [The authors miss out on the fact that high oil prices also bring more wealth to the country which AGAIN increases resource consumption].

The report then looks at increasing “strategic” moves by key actors including the Chinese CNPC (China National Petroleum Corporation), which tries to grab the sources that are still available (particularly in Asia and Africa), but often at relatively unattractive conditions.

The focus of risks is expected in the “strategic ellipse” region (a term used for the region East of Europe reaching from Saudi Arabia in the South to Russia and former Soviet Union countries in the North), because a majority of oil reserves are located in this area.

Overall, the authors expect a reduction of “free market” mechanisms in oil trade, and a rise in more protectionism, exchange deals, and political alliances between suppliers and customers, which could lead to significant geopolitical shifts. Equally, the authors expect this interdependency to shape foreign affairs of oil importers, making them more tolerant towards rogue behavior of suppliers out of sheer need.

Overall, higher volatility and loss of trust are seen as possible outcomes in a world where oil supplies are limited, increasing the need for “oil related diplomacy” and thus increasing risks for moral hazard among all actors, which in turn decreases overall global supply security.

The report then refers to already existing actions of the German government to tie close economic relationships with energy suppliers, and to the tendency of consuming countries to reduce oil dependency, trying to steer clear of risks of future supply shocks.

The Middle East is identified as a very dangerous region with high external involvement from many players and thus a very unstable overall situation.

Overall, the report expects a reduction of the importance of “Western values” related to democracy, and human rights in the context of politically motivated alliances, which increasingly are driven by emerging economies such as China – likely leading to double standards. Emerging economies are equally expected to receive higher recognition in international organizations, particularly those with strength in resources (such as Russia).

3.1.2      New security risks based on additional/alternative energy resources
New conflicts are potentially arising from oil exploration in international or disputed ocean waters, where multiple issues arise, particularly around the arctic circle, with further geopolitical risks for conflict.

Also, the shift to natural gas is reviewed as an extension of the “oil age”, because it might be able to replace crude oil as a bridging source until new solutions are found. The risks for problems from transporting gas (pipelines) and the related issues (as seen between Russia and its neighbors during the past years) are highlighted.

Equally, nuclear power as a potential source is highlighted – emphasizing the risk for safety and the proliferation of nuclear technology. This would also require an increasing shift towards electricity.

Equally, the competition between biofuel and food production is highlighted, showing the limits of biofuel outputs to compensate for reductions in oil availability, and also showing risks for water supply and soil degradation from excessive use.

Overall, the authors see a trend to increase the energy autonomy of entire regions from external supplies, both in the ability to generate alternative fuels (from biofuels and coal), but particularly in electricity generation.

3.1.3      A shift in roles between private and public actors
Based on the increasing importance of oil, governments are becoming more relevant in securing the benefits of oil, both on the supply and on the demand side. This puts a higher emphasis on political negotiations and deals, and increases the risks for nationalizations of resources and key exploration activities.

Exploration licenses are seen as a key area where bidding wars (including non-financial commitments) might emerge. Equally, increasing pressure to renegotiate or revoke already existing licenses might emerge. Ultimately, each country will try to secure sufficient oil to keep its standard of living.

On the other hand, private enterprises are seen on the rise in protecting infrastructure and ensuring production and transportation security in less developed regions, particularly if weaker countries become unable to keep their own services up.

The dependency on oil-related infrastructure (pipelines, refineries, harbors, key pathways on oceans) will increase, and thus the risk. Damaging infrastructure through hostile acts (sabotage, war) might become an attractive target for groups or countries with a tendency to use violence. The same is expected for electricity and natural gas-related infrastructure – they all might require higher protection.

Generally, the focus of risks is expected in the region which the authors consider the “strategic ellipse” (a term used for the region East of Europe reaching from Saudi Arabia in the South to Russia and former Soviet Union countries in the North), because a majority of oil reserves are located in this area.

3.1.4      Economical and political crises as a consequence of the transition to “post-fossil” societies
A number of risks of higher oil prices are seen for modern economies, particularly in transportation. Security risks are seen in resulting systemic crises.

A first direct consequence of higher oil prices and lower availability of fossil fuels is a possible reduction in transportation capacity, equally in individual transportation and in freight forwarding. This might lead to another “mobility crisis” for societies that heavily depend on cars and trucks.

Higher cost in commercial transportation markets might severely affect current supply chains, and no alternatives are in sight (electric trucks don’t exist yet). Particularly food might become a critical issue for countries that are a) highly dependent on imports and b) are susceptible to price-increases of food products, particularly affecting Africa, parts of Asia and Latin America, and the Middle East.

High oil prices would further affect almost all aspects of society, as it will also influence the cost of chemicals and all products derived from them, which might substantially alter the nature of value chains and make certain things uneconomical – ultimately leading to higher unemployment during a transformational phase away from an oil based economy. This might particularly affect the German car industry.

Limits in availability might also strengthen regulatory efforts, encourage the allocation of energy (oil) by rationing schemes and possible other actions limiting free markets.

Additionally, the changes and likely reduction in standard of living might render societies less stable and make them more attracted to extremist political positions and even trigger changes in government systems, as trust into key actors in politics will diminish. This might be a particular risk for the relatively young democratic countries in Eastern Europe.

3.1.5      More selective intervention – key actors overwhelmed
Overall, more expensive transportation and increasing problems “at home” might reduce the ability of larger countries to intervene internationally (politically and/or with military action), and also lower the readiness to provide help to poorer countries. The focus will be more on a country’s egotistic (energy) interest and not so much on an ideal of transferring Western values. The gap will likely not be filled by NGOs, as they will be affected by similar limits.

Overall, international institutions will be weakened, as they will have less resources to provide help and support, and it becomes equally possible that help will be attached to direct (energy) needs of the donors.

3.2      Systemic risks after reaching a “tipping point”

In addition to the gradual risks, there might be risks of non-linear events, where a reduction of economic output based on Peak Oil might affect market-driven economies in a way that they stop functioning altogether, leaving the range of a relatively steady downward trajectory.

Such a scenario could pan out by an initially slow decline of trade and economic activity, combined with higher stress on government budgets from lower tax income, higher social cost and growing investment into alternative technologies.

Investment will decline and debt service will be challenged, leading to a crash in financial markets, accompanied by a loss of trust into currencies and a break-up of value and supply chains – because trade is no longer possible. This would in turn lead to the collapse of economies, mass unemployment, government defaults and infrastructure breakdowns, ultimately followed by famines and total system collapse.

4.        Challenges for Germany

4.1      Risk of new dependencies for Germany

Oil as a new factor of global power would create significant dependencies for Germany, and in order to avoid supply issues, strong ties with suppliers are a must, but equally a diversification of supply relationships, taking into account that a supplier might intentionally reduce capacity to accomplish political objectives.

Among the key supplier countries is Russia (supplying 35% of German oil imports), where reliability risks are prevalent, given past experience. Natural gas, as a possible temporary substitute, bears the same risk (37% come from Russia). Thus, a diversification becomes essential.

4.2      Focus of politics on supply relationships

Germany needs strong and reliable ties to Russia and other Caspian Sea countries. This might create some challenges in international relations, particularly with smaller Eastern European countries [like Poland]. Thus, intensifying relationships to the Middle East might be equally relevant. However, all those relationships have an inherent risk of being instruments in conflicts, which puts a certain limit on treating all foreign partners the same.

4.3      More pragmatic foreign policy

The need to mitigate supply risks might require some compromises on foreign affairs topics (such as human rights). Equally, more active diplomatic efforts will be required with a focus of energy security in mind. This is more difficult given Germany’s reluctance to engage in political power play due to its history, but needs to be tackled in order to deal with the challenges ahead. The authors don’t want to encourage military solutions, but suggest a strong preventive development of political and diplomatic initiatives to tackle the problem.

4.4      Importance and freedom of industrial nations reduced

All industrial nations that depend on energy imports will become more dependent on new partners, both in emerging economies and supplier countries. This requires a new focus in foreign affairs, sometimes giving up standards in negotiations with countries that have different cultures and political systems.

4.5      Help in stabilizing supplier countries at risk

Some supplier countries (and surrounding regions) might be destabilized by the force of higher resource prices. This is an area where Germany needs to help by providing support for nation building and conflict resolution on the national and international level. This is in conflict with the lower economic power likely to result from Peak Oil, which might make interventions less likely and requires new approaches of “stabilization with lower effort.”

4.6      Growing conflict potential concerning the Arctic Circle

Germany might have to take positions in case of an upcoming conflict regarding resources in the Arctic Circle, where multiple countries (including Russia) have open claims for accessing oil and gas fields. This requires further research.

4.7      Nuclear technology proliferation

The risk for nuclear technology proliferation and thus more countries with the potential for nuclear weapons (and the risk for terrorists having access to nuclear material) is growing due to the proliferation of nuclear technology for energy generation. Equally, risks for terrorist attacks and accidents on German soil are rising. Both scenarios require more surveillance, intelligence and preventive action.

4.8      Higher conflict potential regarding critical infrastructure

Energy delivery infrastructure for all sources including electricity will have a higher importance in an oil constrained world, thus, securing its reliability, security and availability becomes mission-critical. International cooperation is needed to secure large international supply paths (pipelines, sea routes).

4.9      Larger “energy regions” change international alliances

The expectation of stronger connections between suppliers and consumers across continents creates different settings for current international alliances and security risks. DESERTEC (a large power production system in Northern Africa based on CSP) would require different settings even for military strategies.

4.10   Peak Oil for armed forces

Armed forces would also be significantly affected by fossil fuel limits, as they are very dependent on oil products. Significant investments in alternative energy procurement technologies (biofuels, coal-to-liquids – Fischer-Tropsch) and applications (electric and hybrid vehicles) would be required, with long transition times. Further, local energy-independence of stationary troop infrastructure (like military bases) using more renewable sources would be beneficial. Long term objective would be to fully convert Germany’s armed forces to only use renewable energy sources by 2100.

4.11   Crude Oil as a systemic risk

For scenarios which end with a complete destabilization of societies, Germany is at a significant risk given its strong participation in a globalized economy. Being still able to act requires a number of basic infrastructures to keep functioning, both for the country and its armed forces. Work is required to look into redundancy, high-resilience of infrastructure and local self-organization approaches.

5.        Summary

The report sees significant risks arising from an unavoidable peak in oil production, which go beyond gradual shifts in energy systems and economies. This will likely lead to economic change and new geopolitical risks that affect much more than just what we can anticipate. The overall ability to describe exact outcomes is very limited, as many scenarios are possible, and further research is required.

Overall, more emphasis needs to be put on understanding and shaping international relationships in respect to energy security, anticipating and integrating the ongoing shift to different players in a resource-constrained world.

In any case, Germany has to identify and implement alternatives to the current transportation technologies that require oil, and put a similar emphasis on avoiding other dependencies, for example concerning rare earths.

For armed forces, Peak Oil creates significant risks, both from a mobility standpoint as well as from dependencies on other societal services. Understanding those risks requires further analysis and likely a very different approach in the future.

In general, more preparation is required for society and army to make sure that problems are recognized and solutions are actively implemented.

The Saudi Arabia of Ethanol

Iowa is to corn ethanol what Saudi Arabia is to oil. At present Iowa has the capacity to produce 3.5 billion gallons of ethanol per year, which is 26% of the nation’s total (Source). This is of course due to the large amount of corn production in Iowa, enabled by ample rainfall and rich topsoil.

But Iowa differs from Saudi Arabia with respect to energy production in one very important detail: Saudi Arabia satisfies their own energy needs with the oil they produce, and exports the excess. Iowa on the other hand exports the vast majority of the ethanol they produce while importing gasoline as motor fuel.

Gasoline consumption in Iowa is presently around 1.6 billion gallons per year (Source). This is the energy equivalent of 2.4 billion gallons per year of ethanol. Yet amazingly, Iowa does not have an E10 blend mandate that is so common in many other states. Of the 3.5 billion gallons of ethanol Iowa produces each year, only 100 million gallons is consumed in the state (less than 3%!). Perhaps even more amazing is that Iowa — seemingly the best candidate in the U.S. for biofuel self-sufficiency — ranks in the Top 10 consumers of gasoline per capita in the U.S. (Source).

Iowa is a state that by all accounts should be able to satisfy their own liquid fuel needs with ethanol, and still have some left for export. They are perhaps unique in the U.S. in that respect. Instead, petroleum continues to supply over 90% of the motor fuel in Iowa, and virtually all of the fuel used in the farm equipment for growing all of that corn. Something is wrong with this picture.

Why Isn’t Iowa Self-Sufficient?

That is a perplexing question. If ethanol is a real alternative to gasoline, why hasn’t it taken over the marketplace in Iowa? Ethanol should have a greater advantage over gasoline in Iowa than probably in any other state. And in fact, the price spread between gasoline and E85 is consistently higher in Iowa than in other states (Source). The reported price spread in Iowa as of July 2010 was 30.1%, which should be large enough to drive consumers to E85 over gasoline. So what is the problem?

There are three possible problems that I can identify: 1). Perhaps there isn’t enough E85 infrastructure in place. 2). There aren’t enough E85 vehicles on the road; 3). The price is still too high relative to gasoline.

Regarding infrastructure, as of January 2010, there were an estimated 136 service stations in Iowa selling E85 (out of 977 total service stations) and a total of 2,233 Stations selling E85 in the United States (Source). Iowa also has an incentive program in place to install new E85 infrastructure (see below), but with 136 stations across the state (and growing), availability doesn’t seem to be a major limiting factor.

The availability of E85 vehicles may be a more serious impediment. As of 2009, there are reportedly around 8 million vehicles on U.S. roads that are E85 capable (Source). Given a total vehicle population of around 250 million, that means that only around 3% of the cars on the road are E85-capable. (I could not find statistics specific to Iowa). This would seem to be a limiting factor at present for E85 penetration; E85 can’t capture 10% of the market if only 3% of the cars can burn it.

Yet even with some E85 vehicles on the road, sales of E85 in Iowa have been falling and sales of ethanol in general lag the rest of the U.S.:

Final 2009 Iowa Ethanol Sales Figures Show Step Back for State

JOHNSTON, IA – The Iowa Renewable Fuels Association (IRFA) today announced that Iowans chose E10, a 10 percent ethanol and 90 percent gasoline blend, only 73 percent of the time during 2009 according to Iowa Department of Revenue (IDR) figures. According to the Des Moines Register, Iowa ranks 32nd in ethanol sales despite being the leading ethanol producer.

“Iowa’s ethanol sales did not reach the 2009 goal of the Iowa Renewable Fuels Standard,” said Monte Shaw, IRFA Executive Director. “These are figures based on mandatory reporting of taxable gallons to the State of Iowa and the IRS – not an incomplete, voluntary report. Obviously, IRFA members are disappointed in the results. The state has also released E85 sales for the first nine months of 2009. During those three quarters, E85 sales were down 15% compared to 2008.”

The number of E85 vehicles has been slowly rising, so if E85 sales are falling then there is also apparently a cost factor that is coming into play. For much of 2008, the price differential between E85 and gasoline was 15-20% (historical pricing available at E85prices.com). For the first half of 2009, that price differential had fallen to only 10%. Clearly, if E85 is ever to become the dominant fuel in Iowa, the price differential will have to properly reflect the fuel economy difference of E85 versus gasoline. E85 contains about 25% less energy than gasoline on a volumetric basis. Owners that experience a 25% reduction in fuel economy will expect to pay 25% less for their fuel. In fact, they may expect to pay 30% less due to having to refuel more often.

But, a real game-changer could be ethanol-optimized engines such as that touted by Detroit-based automotive engineering firm Ricardo. While their engine is projected to cost more, they project that they will deliver fuel economy from E85 that is comparable to what can be achieved with gasoline. (I reported on this concept in some detail in All BTUs Are Not Created Equally). In that case, consumers may be willing to buy E85 at a lower differential. The caveats here are that the engine is still in the lab, and the higher engine cost will determine the E85 differential that consumers will expect.

Recommendations

Before making recommendations, it is important to clearly set out the objective. As I have said numerous times, corn ethanol may not be a sustainable solution that is broadly applicable across the U.S. However, I do believe that it could be a very good solution in specific regions. Ethanol made from irrigated corn and shipped to California is in an entirely different sustainability category than ethanol produced and used locally in Iowa. In fact, despite my reputation as an enemy of ethanol from people who are careless with their interpretations, I have used Iowa for years as an example of what sustainable corn ethanol could look like. I have long believed that Iowa is in a good position to lead the way forward.

So from my perspective, the objective would be to increase the sustainability of ethanol — starting in Iowa — by increasing local consumption. This would decrease U.S. dependence on foreign oil more than if we have to transport oil from the coasts inland to Iowa while transporting ethanol from Iowa to the coasts.

Pump infrastructure in Iowa does not appear to be the limiting factor. Plus, Iowa already has good incentives in place that support rolling out additional E85 pumps (See Current E85 Incentives below). Iowa also already has a tax credit in place that is specifically directed at E85 sales (which is on top of the national ethanol tax credit). Ultimately, additional incentives may be required, as evidenced by falling E85 sales in the past year. Incentives could be in the form of direct E85 tax credits or fuel tax reductions or waivers. But the real issue seems to be lack of E85 vehicles.

According to automakers, the vehicles are on the way:

US automakers on track for more ethanol vehicles

U.S. automakers also expect to meet a goal of making half their vehicle production flex-fuel by 2012, up from around 30 percent now. But they warn that they could pull back if there aren’t enough gas stations with ethanol pumps.

On the other hand comes news that people may not be interested in buying them:

Flex fuel vehicles may be on the way out

When it comes to buying cars, Americans are still using the price of the vehicle as the primary deciding factor. A well-priced, fuel-efficient vehicle is the car of choice for Americans and this is bad news for the flex fuel vehicle industry. In a survey conducted by Harris Interactive, only 5 percent of respondents said they would be extremely likely to purchase a flex fuel vehicle, even if it only added $250 to the base price of the vehicle.

So it would appear that consumers may need some convincing before they are ready to take the plunge on an E85 vehicle. There are several ways to incentivize sales of E85 vehicles. The worst is probably just to mandate that vehicles sold in the state of Iowa are E85-compatible. (I think this is the worst because mandates often have unintended consequences; hence I prefer incentives over mandates). Probably the most manageable would be rebates or expanded tax credits — at the state or federal level — for the purchase of an E85 vehicle. Instead of a Cash for Clunkers program (which I was not a fan of), we would have been better served to have a cash for E85 vehicles program.

Such a program should probably be driven from within Iowa. After all, they arguably stand to benefit from using the ethanol they produce and moving toward true energy independence. Transportation costs cited in the recent DOE study on the proposed ethanol pipeline (that I discussed here) suggested that railing ethanol costs $0.19/gallon (shipping via pipeline was cited at $0.28/gal). Imagine that only half of the ethanol produced in Iowa is used in Iowa; there is a potential shipping savings of over $330 million per year. (However, under the present system these costs are passed through to consumers out of state, so it might be hard for Iowa to justify a program on the basis of savings for Iowans).

Beyond personal transportation, corn growers should be pushing for tractors that can run off of ethanol. They can be built. In 2006 the Saskatchewan Research Council unveiled a tractor modified to operate on 100 per cent hydrated ethanol. More on that development here:

From late December 2006 to late January 2007, the 120 horsepower ethanol-fuelled tractor clocked 60 hours of running time and got fuel mileage of 24 litres per hour. It takes about 15 bushels of wheat to create one tank of hydrated ethanol for the tractor, says Rueve, explaining that the fuel consists of 94 per cent alcohol and 6 per cent water.

As farm input costs increase, both the tractor and the truck are examples of developments that may make farm operations more sustainable in the future. Meanwhile, biofuels in general offer one option for those who are looking for ways to revitalize the rural economy.

So often we hear about how ethanol is providing homegrown fuel for automobiles, and yet the tractors that produce the homegrown corn run off of petroleum. I think it would be in the best interest of Iowa and of the country as a whole (given Iowa’s importance as a food producer) to break the petroleum dependence of Iowa’s farms by building tractors that can run off of ethanol (or biodiesel).

Conclusions

Iowa could be self-sufficient with their ethanol production if certain policies are supported. Some policies are already in place that are meant to address E85 availability and cost. However, the availability of E85 vehicles and the willingness of consumers to buy them is probably the key limiting factor. Ultimately, building up an E85 market in Iowa and eventually in the rest of the Midwest could solve a number of issues for the ethanol industry. If the Midwest adopted E85 as its flagship fuel, there would be no blend wall to be concerned about, nor would an expensive ethanol pipeline be needed to export ethanol out of the region. The potential market across the Midwest is triple the nation’s current ethanol production, giving ethanol producers an ample opportunity to grow without forcing national mandates that put E15 into cars that aren’t designed for it.

Current E85 Incentives

Iowa has tax credits in place specific to E85 sales:

E85 Retailer Tax Credit

A tax credit is available to retail stations dispensing E85 for use in motor vehicles in the amount of $0.20 per gallon for calendar year 2010, and $0.10 per gallon in calendar year 2011. After 2011, the tax credit decreases by $0.01 each year and expires after December 31, 2020. Taxpayers claiming the E85 tax credit may also claim the tax credit available for retail ethanol blends for the same gallon of fuel and tax year. (Reference Iowa Code 422.11O)

And toward blending infrastructure:

Biofuels Infrastructure Grants

The Renewable Fuel Infrastructure Program provides financial assistance to E85 and biodiesel retailers. Cost-share grants are available for up to 70% of the total cost of the project, or $50,000, whichever is less, to upgrade or install new E85 or biodiesel infrastructure. Applicants may also qualify for supplemental incentives for up to 75% of the cost of making the improvement, or $30,000, whichever is less, to upgrade or replace an E85 fueling dispenser that has not been approved by an independent testing laboratory. The supplemental incentive is available only to applicants who made the improvement no later than 60 days after the date of the publication in the Iowa administrative bulletin of the state fire marshal’s order providing that a commercially available fueling dispenser is listed as compatible for use with E85 by an independent testing laboratory.

Biodiesel distributors may apply for a cost-share grant for infrastructure upgrades and installations at biodiesel terminal facilities. Facilities blending or dispensing blends ranging from B2 to B98 are eligible for up to 50% of the total project, or $50,000, whichever is less. Facilities blending or dispensing B99 or B100 are eligible for up to 50% of the total project, or $100,000, whichever is less. The Renewable Fuels Infrastructure Board was established under the guidance of the Iowa Department of Economic Development; this 11-member board has authority to determine the eligibility of applicants. (Reference Iowa Code 15G.202-15G.204)

I am no economist, but bear with me while I try to explain why I think we are in for a very long and difficult economic period. My thesis for The Long Recession goes something like this: Historically, when oil prices rose quickly and remained high the economy struggled. High oil prices lead to recessions and depressions, because they suck so much money out of the economy. A person whose energy bills go up by $100 or $200 per month has that much less to spend on other things. It is essentially like a tax applied to everyone that uses energy — with a large chunk of the money exiting the U.S. and contributing to our trade deficit.

Historically after a period of high oil prices, people start to modify behaviors, and at the same time producers rush in to take advantage of higher prices. This generally leads to a decline in oil prices and the economy recovers. But I believe this time is different. And if not this cycle, very soon. Because while we are already seeing consumers modify behaviors (U.S. oil demand is creeping back up, but still below the levels of 2 years ago), we aren’t seeing a lot of new oil coming online “to the rescue.” The reason for that is that there just isn’t a lot of new oil to be produced; i.e., the Peak Oil factor. So despite the fact that prices did crash following fast the run-up in 2008, prices quickly recovered back into recession-inducing territory.

That leads me again and again to the question: How do you recover from a recession when oil prices are high and show no sign of abating? We could recover from recession if demand drops a bit more and takes oil prices down. But, what happens when we start to come out of the recession? We use more oil, and if there are supply constraints this will send prices right back into recession country.

Today comes more bad economic news, and like much of the bad economic news makes zero mention of the role of high oil prices:

Downward revision of GDP growth a strong signal of stalled recovery

Second-quarter economic growth was revised to an anemic 1.6%, a decline that was slightly less than many economists had predicted. But the report was a sobering cap to a week of bad economic news that has raised fears the nation could plunge into another recession. Bernanke says the Fed is ready to step in to provide additional stimulus.

What I continue to forecast is a very difficult economic period in which we start to power down or continue to suffer the economic consequences. I don’t believe future economic cycles are going to look like those of the past 100 years because of oil supply constraints. I believe we are looking at an extended period of (at best) no-growth or very little growth. At some point, there are alternatives that will begin to fill a respectable gap, but I think that oil price point is back up over $100/bbl.

No doubt the housing crises was a major contributor to our current economic predicament, but even if we miraculously recover from that the oil price risk still hangs repressively over us. So while I appreciate that It’s the economy, stupid and the economic indicators get all the news, I believe the reason we are in for prolonged economic bad news is “It’s the oil, stupid.”

Tom Rooney is President and CEO of SPG Solar, in Novato, California, one of the larger solar integrators in the country.

I am working on yet another project, due at the end of this week. Therefore, I haven’t had a chance to work much on my next essay, which will be about the potential for E85 to push Iowa much closer to energy self-sufficiency. Meanwhile, I have been sent a guest editorial on solar power by Tom Rooney, and this seems like a timely occasion to put it out for readers to chew on.

Tom is the president and CEO of SPG Solar, in Novato, California, one of the larger solar integrators in the country. His commentaries have been in the New York Times, Los Angeles Times, Miami Herald and “hundreds of papers in between.” He has also appeared on C-SPAN and Fox Business News.

Tom chose a provocative title for this essay. I say provocative because I personally consider both liberals and conservatives bad on energy in specific ways, and good in others. I think conservatives tend to overweight the role that domestic drilling can play in pushing the U.S. toward energy independence, and liberals overweight the impact that renewables can play in displacing oil.

While each has its part to play, I think each side broadly tends not to recognize just how deeply dependent we are on petroleum, and in particular imported petroleum. I think both sides would like to tell the Middle East to get lost while we either drill our way to independence if the government would get out of the way (pro-Big Oil), or make a painless switch to renewable energy if Big Oil would just get out of the way (anti-Big Oil). I have criticized both points of view, which is why conservatives have criticized me for being liberal, and liberals have criticized me for being conservative.

I don’t think my energy views are conservative or liberal, but rather I think they are reality-based. If I say that I think coal will become a much more important component of the liquid fuel mix in the future, that isn’t a hope or a wish. It is what I think will realistically happen — we will build coal-to-liquids plants to deal with declining petroleum supplies. Those on the right might hope to see it happen (pro-business, especially pro-U.S. business), but the left would adamantly oppose it on environmental grounds (unless one happens to be the governor of Montana which has lots of coal reserves). Me? I just think it’s likely to happen as petroleum depletes, so I think we have to be ready to deal with it.

With that intro (to specifically clarify that I don’t think that conservatives are all bad or all good on energy), here is the guest essay on solar energy by Tom Rooney.

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Why Conservatives Are Bad on Energy: It’s All About the Costs

By: Tom Rooney

For the R-Squared Energy Blog

Conservatives, let’s talk about energy. And why so many conservatives are so wrong — so liberal, even — on wind and solar energy.

Let’s start with a recent editorial from the home of ‘free markets and free people,” the Wall Street Journal. Photovoltaic solar energy, quoth the mavens, is a “speculative and immature technology that costs far more than ordinary power.”

So few words, so many misconceptions. It pains me to say that because, like many business leaders, I grew up on the Wall Street Journal and still depend on it.

But I cannot figure out why people who call themselves “conservatives” would say solar or wind power is “speculative.” Conservatives know that word is usually reserved to criticize free-market activity that is not approved by well, you know who.

Today, around the world, more than a million people work in the wind and solar business. Many more receive their power from solar.

Solar is not a cause, it is a business with real benefits for its customers.

Just ask anyone who installed their solar systems five years ago. Today, many of their systems are paid off and they are getting free energy. Better still, ask the owners of one of the oldest and most respected companies in America who recently announced plans to build one of the largest solar facilities in the country.

That would be Dow Jones, owners of the Wall Street Journal.

Now we come to “immature.” Again, the meaning is fuzzy. But in Germany, a country 1/3 our size in area and population, they have more solar than the United States. This year, Germans will build enough solar to equal the output of three nuclear power plants.

What they call immaturity our clients call profit-making leadership.

But let’s get to the real boogie man: The one that “costs far more than ordinary power.”

I’ve been working in energy infrastructure for 25 years and I have no idea what the WSJ means by the words “ordinary power.” But, after spending some time with Milton Friedman whom I met on many occasions while studying for an MBA at the University of Chicago, I did learn about costs.

And here is what every freshman at the University of Chicago knows: There is a difference between cost and price.

Solar relies on price supports from the government. Fair enough — though its price is falling even faster than fossil fuels are rising.

But if Friedman were going to compare the costs of competing forms of energy, he also would have wanted to know the cost of “ordinary energy.” Figured on the same basis. This is something the self-proclaimed conservative opponents of solar refuse to do.

But huge companies including Wall Mart, IBM, Target and Los Gatos Tomatoes figured it out. And last year so did the National Academy of Sciences. It produced a report on the Hidden Costs of Energy that documented how coal was making people sick to the tune of $63 billion a year.

And that oil and natural gas had so many tax breaks and subsidies that were so interwoven for so long, it was hard to say exactly how many tens of billions these energy producers received courtesy of the U.S. Taxpayer.

Just a few weeks ago, the International Energy Agency said worldwide, fossil fuels receive $550 billion in subsidies a year — 12 times what alternatives such as wind and solar get.

Neither report factored in Global Warming or the cost of sending our best and bravest into harm’s way to protect our energy supply lines.

Whatever that costs, you know it starts with a T.

All this without hockey stick graphs, purloined emails or junk science.

When you compare the real costs of solar with the fully loaded real costs of coal and oil and natural gas and nuclear power, apples to apples, solar is cheaper.

That’s not conservative. Or liberal. That comes from an ideology older and more reliable than both of those put together: Arithmetic.

Global economic recession drove energy consumption lower in 2009 — the first such decline since 1982. Take a look at the world’s energy consumption as a factor of renewable and non-renewable energy resources, courtesy of our friends at the Travel Insurance Blog.

Click image for full-sized version

Source: Travel Insurance Blog

There was a recent article in MIT Technology review called What’s Holding Biofuels Back? There is a relatively simple answer to the question that I will delve into below, but the short answer to “What’s holding biofuels back?” is that we placed unreasonable expectations on them to begin with, and they have simply failed to meet those unreasonable expectations. People would think it was unreasonable if Congress mandated a cure for the common cold within 5 years, but they don’t think twice when Congress mandates the creation of a cellulosic ethanol industry within 5 years. Yet either scenario requires technical breakthroughs that are not assured.

The article notes that the cellulosic ethanol mandate for 2010 in the U.S. was cut by 93.5%, and now the 2011 mandate has been slashed (as I have predicted for several years would be the case):

This year’s mandate was supposed to be 100 million gallons of cellulosic biofuels, but that was reduced to 6.5 million. Last month, the EPA announced that it would lower the requirement in 2011, from 250 million to somewhere between five million and 17.1 million gallons.

The reason?

The EPA is doing this because not enough cellulosic biofuel is being produced to meet the targets. So far, no commercial plants have been built–just some small pilot and demonstration-scale plants.

So they have identified the effect, and then go searching for causes. They quote a number of cellulosic ethanol players who blame the lack of progress on not enough funding or mandates. While it is true that if you throw massive amounts of money at the problem, you could certainly get some cellulosic ethanol facilities off the ground. But before throwing money at a problem, there needs to be a clearly identified path to long-term economic viability that is based on reasonable assumptions.

Unreasonable expectations are at the heart of the mandate-rollback. It was an unreasonable expectation for Congress to believe they could mandate technology. If something is uneconomical today, there are no guarantees that it will be economical tomorrow — even if you pass laws dictating that things must happen. You may make an uneconomical solution appear to be economical if you throw large amounts of cash at it, but then it is only “viable” as long is it continues to receive those cash infusions.

It is also true that sometimes uneconomical solutions can become economical given enough research and development, but bear in mind that we have been working on cellulosic ethanol for over 100 years. The same fundamental challenges that existed 100 years ago still exist today. (You can read more about the specific challenges of biofuels in Five Challenges of Next-Generation Biofuels).

MSNBC suggested in The green-energy landscape just keeps changing that perhaps the economics are a bit more challenging than proponents had appreciated:

Five years ago, cellulosic ethanol – produced from humble grasses and wood waste — looked as if it could be a “simple solution to pain at the pump.” [RR: Readers of R-Squared were not under that impression]. But in Science’s special report, Robert F. Service says the federal government’s plan for ramping up cellulosic-ethanol production is in “deep trouble” because the economics of ethanol don’t make as much sense as folks thought they would back then [RR: Again, regular readers were informed about the real economics of cellulosic ethanol as well as some of the unreasonable assumptions that caused various players to forecast the production of cheap cellulosic ethanol]. Technically, it’s still tougher than expected to convert cellulosic feedstock into fuel than it is to use American corn or Brazilian sugar cane.

The current issue of Science referenced in that quote has a special section on the future of energy called Scaling Up Alternative Energy. The authors dissect the alternative energy situation, and they conclude the same thing that you have heard me saying for the past five years:

The U.S. government’s flagship plan to reduce the nation’s dependence on oil by scaling up cellulosic ethanol is in deep trouble, highlighting the complex technical, economic, and political forces buffeting global efforts to create viable alternatives to fossil fuels.

Part of the problem in scaling up cellulosic biofuels continues to be technical. To brew ethanol, manufacturers use yeast to ferment simple sugars such as glucose. That task is relatively cheap and easy when starting with a raw material—or “feedstock”—rich in those simple sugars, such as sugar cane in Brazil. In the U.S., brewers using corn as a feedstock face a slightly more complex process, because they first must use enzymes to break apart the starch in corn kernels into their component glucose molecules. The task becomes even more difficult when using cellulosic feedstocks such as switchgrass, corn stalks, or wood chips. The sugars in these feedstocks are locked in cellulose, hemicellulose, and lignin, biopolymers more complex than starch. Breaking those biopolymers into intermediate compounds that can be converted to ethanol remains a difficult problem. Researchers call it “recalcitrance,” and it currently limits brewers to converting just 40% of the energy content available in cellulosic feedstocks to ethanol. Fermentation, by contrast, converts about 90% of the energy in simple sugars to ethanol. That means cellulosic ethanol plants currently need far more raw material than first-generation plants do to make the same amount of ethanol.

That’s also why I maintain that cellulosic ethanol will never be produced at a lower cost than corn ethanol: It is much more challenging to unlock the sugars in biomass than in corn. People may project lower costs, but they do so on the basis of models that have not been validated in the real world. As an example, I may presume that I can acquire waste biomass and will be paid $100/ton to take it. On that basis, I may very well project $2/gal (or lower) cellulosic ethanol — because the biomass contribution in that case is negative $1 per gallon. But I believe this is one of the most fundamental Bad Assumptions made by prospective producers of cellulosic ethanol. In the long run, nobody is going to pay me a lot of money to take their biomass, even if I find someone willing to do so today. I believe it is far more likely that I will have to pay $100/ton for large quantities of biomass to make it worthwhile for farmers to grow and harvest it. If that’s the case, then the $2/gallon ethanol case if I am being paid to take the biomass suddenly becomes $4/gallon when I have to pay for it.

I noted the unreasonable expectations in a recent story in Pacific Business News:

Biofuels have supporters, but scale remains an obstacle

“Biofuels will become increasingly competitive,” said Rapier. “I’m not looking at where things are now, but where things are going.”

That said, Rapier is also realistic about the current difficulties facing the industry.

“The thing about biofuels is that people don’t appreciate how difficult it is to compete with oil,” said Rapier. “A lot of time there are unreasonable expectations.”

Over time, I do believe that biofuels will become more competitive. But those who suggest that there is an easy path, and that cellulosic biofuels will have an easy time displacing oil — are simply creating those unreasonable expectations. Biofuels have to contend with oil, which Mother Nature already processed over millions of years with heat and pressure to produce an energy-dense, transportable mixture. With biofuels humans must grow and transport the biomass (which is far less energy dense than oil), and then add heat and pressure to convert the biomass into fuels. Thus, it shouldn’t be a surprise that biofuels tend to be more expensive than oil.

However, oil is becoming more difficult to extract, and is of course a depleting resource. Over time this will continue to drive up the cost of oil and various oil substitutes, which will improve the economic prospects for those biofuels that are not heavily petroleum dependent.

In conclusion, it is fine to set goals, as the EPA did with the cellulosic ethanol mandates. But when the goals aren’t reality-based, they will eventually need to be massively scaled down as they were. Frequently scaling back expectations will ultimately erode public confidence in the sector. So let’s operate on a more reasonable set of expectations: Prices at the pump will rise, and as they do so certain biofuel technologies will become more competitive. If Congress doesn’t attempt to anoint specific technology winners before they perform, then we won’t be collectively disappointed if they fail to deliver.

Europe's largest wind farm, with 140 turbines, operated at less than a quarter of its capacity in 2009.

Researcher says that government subsidies are to blame.

More than half of Britain’s wind farms are operating at less than 25 percent capacity because they’re installed in areas without a continuous breeze, according to an academic study reported by the Daily Mail.

The study was based on official data provided by energy regulator Ofgem.

The worst locations cited in the study were a 9-turbine wind farm at Blyth Harbour in Northumberland, northern England, which managed to reach only 4.9 percent of its capacity, and a 4-turbine operation at Chelker reservoir in North Yorkshire operating at 5.3 percent capacity.

More than $400,000 a year can be earned in subsidies from one turbine operating at 30%.

Europe’s largest wind farm, located near Glasgow, ran at less than 25 percent capacity, according to research of the data from 2009.

The analysis was carried out by Michael Jefferson, a professor of international business and sustainability at the London Metropolitan Business School.

Jefferson placed the blame squarely on government subsidies, which he says encourage firms to site their operations badly because of their rush to take advantage of financial incentives. British consumers currently pay an extra £1 billion ($1.56 billion) per year on their fuel bills in order to subsidize the government’s push toward it’s renewable energy goals.

“There is a political motivation to drive non-fossil fuel energy, which I very much respect, but we need more focus,” Jefferson said. He suggests that stimulus funds should be reserved only for the windiest of projects in order to ensure that taxpayers are getting the most bang for their buck.

Operations that fall below 25 per cent should be deemed ineligible for renewable subsidies. “That would focus the mind to put them in a sensible place,” he said.

Britain has 2,906 wind turbines spread over 264 sites with a further 7,000 turbines planned for the next 12 years.

Jefferson has written extensively on energy policy, including contributions to various UN bodies. He was the Deputy Secretary-General of the World Energy Council for 10 years, where his work with the Intergovernmental Panel on Climate Change led to a certificate for his contributions to their award of a Nobel prize.

I began to hear rumors about a week ago that Range Fuels had started to produce some methanol from their plant in Soperton, Georgia. This week they announced that they have indeed begun to make some product:

Range Fuels Finally Gets its Cellulosic Plant Running

Georgia — After a two year delay, Range Fuels is producing methanol fuel from its commercial-scale cellulosic ethanol facility in Georgia. The company initially said the plant in Georgia would be producing up to 20 million gallons of fuel in 2008. Then it got pushed back to 2009. It is now finally operating in the second quarter of 2010.

The delay is not out of the ordinary for cellulosic ethanol producers. Because of the technical and financial problems companies have been facing, the Environmental Protection Agency scaled back its 2010 mandate for cellulosic fuels from 100 million gallons to 6.5 million gallons.

Let me first extend my congratulations to Range, and let’s hope that the start-up proceeds smoothly. Generally when trying to start up something for which there are not a lot of existing facilities, the learning curve can be bumpy because you have to figure it out as you go along. So do not be surprised to see that they are up and down a lot as they work out the kinks (not that those sorts of things make the news).

Oddly enough, a few people have e-mailed me with this news to claim that this vindicates Range from the criticisms I set forth in Broken Promises from Range Fuels. I don’t want to use this post to rain on their parade, but given these misconceptions let’s have a look at what I have said.

First, nobody ever doubted that Range could take biomass, gasify it, and produce methanol. That technology has literally existed in some form since 1923. And nobody doubts that they can make some ethanol in the same way. Again, very old technology, just not cost-effective. Range has their own particular version of the technology, but nevertheless there is nothing fundamentally new in their approach.

So that’s the first point that should be clear. My criticism was not that they can’t produce some alcohols, therefore production of alcohol doesn’t invalidate the criticism. My criticisms were based on historical claims that Range made and failed to deliver upon. These aren’t issues where the jury is still out; they are history. Range claimed they would build a 100 million gallon per year ethanol plant for $150 million and start producing in 2008. First production of methanol in mid-2010 after taking in more than double the money they claimed they would need for an ethanol plant does not invalidate my criticisms in any way.

People knowledgeable in this field knew when they started hyping this back in 2006 that they could not possibly deliver “cellulosic ethanol” via this process at the cost and on the schedule they were claiming. So when costs started to escalate, schedules started to slip, and they ended up switching to methanol, they were certainly open to criticism given how vocal they had been about hyping themselves.

Imagine if Walmart started to hype $100 Dell laptops — this week only. I go to Walmart to get one, and find that they don’t actually have any for sale. If I criticize them for the false advertising, my criticism isn’t invalidated if you go there a month later and buy a $300 VCR. Yes, Walmart would have delivered something – but that wasn’t what they said they would deliver.

As I have said before, people are accountable for what they write and say. That includes me. So my criticisms of Range are certainly fair game for discussion. Just make sure you understand what those criticisms are before you write to tell me the criticisms were wrong. Keep in mind that the criticisms revolve around costs and time delays that are historical. And contrary to what some people seem to think, I do not wish to see Range fail. If I criticize President Obama, that doesn’t mean that I hope he fails as a president.

Regarding their production of methanol instead of ethanol, a story at earth2tech missed the mark by suggesting this was the nature of my criticism. To the contrary, I favor gasification approaches to methanol (or ethanol, mixed alcohols, diesel, jet fuel, etc.) I like those processes because they don’t rely on a lot of fossil fuel inputs and can result in a higher efficiency to fuels than other approaches.

However, at present the gasification of biomass to methanol has to contend with the much cheaper method of gasification of natural gas to methanol. The latter presently sells for about $1/gallon, and Range’s methanol will struggle to compete with that. So their business plan will be to sell their methanol to the biodiesel industry, which reacts it with a vegetable oil or animal fat to produce biodiesel. Range will rely on a $1/gallon tax credit when they sell their methanol (again, only worth $1/gallon at market prices), and then the biodiesel industry will turn around and collect another $1/gallon tax credit when they sell the biodiesel (presuming this credit is extended as expected).

The path forward for Range is pretty clear. They have to get through this start-up phase and demonstrate that they can run their process consistently. We won’t know that until they have a year or so of operation behind them; any corrosion and reliability issues will take a while before they are obvious. Range will reportedly try to move production to ethanol next year, and that will present its own challenges. Given that they recently requested more DOE funding (which they did not receive), it is clear that the capital requirements for their process are high. So ultimately they must also show that they can run the process cost-effectively.

First production of methanol is a noteworthy achievement, but there is a long road ahead. Just ask Changing World Technologies, who also once started up a plant and began to produce some fuel. But instead of being remembered as an innovative biofuel company, CWT went bankrupt and is the poster child for the “over-promise and under-deliver” strategy. Let’s all hope for a better outcome for Range Fuels.

As election season heats up, Obama took on Republicans who he says would rather “stand on the sidelines” than do what’s necessary to create jobs.

President Barack Obama tours the ZBB Manufacturing Facility in Menomonee Falls, Wis., and is shown the battery making process by ZBB President and CEO Eric Apfelback, left, and ZBB employee Lonnie Mages, August 16, 2010. (White House Photo/Chuck Kennedy)

While visiting a Wisconsin battery plant that he touted as the future of renewable energy in America, US President Barack Obama predicted that his administration’s clean energy policies will create 800,000 jobs in the next two years.

The President also harshly criticized political opponents who blocked some of his administration’s policies in Congress.

“There are folks in Washington right now who think we should abandon our efforts to support clean energy,” Obama told the crowd at ZBB Energy Corporation’s manufacturing facility. “They’ve made the political calculation that it’s better to stand on the sidelines than work as a team to help American businesses and American workers.”

Obama toured ZBB Energy Corporation’s manufacturing facility, which received $1.3 million in Recovery Act State Energy Program loans in order to fund a $4.5 million factory renovation to triple their capacity to manufacture flow batteries and power systems.

President Barack Obama speaks to workers following a tour at ZBB Energy Corporation in Menomonee Falls, Wis. ZBB is a leader in the design and manufacture of advanced energy-storage products. August 16, 2010. (White House Photo/Chuck Kennedy)

“We expect our commitment to clean energy to lead to more than 800,000 jobs by 2012,” Obama declared. “And that’s not just creating work in the short term, that’s going to help lay the foundation for lasting economic growth.”

The advanced zinc bromide flow batteries and intelligent control platforms manufactured by ZBB, are crucial components to building a smart energy grid and expanding the commercialization of electric vehicles. They allow users to cut costs by shifting energy use to off-peak hours and bank intermittent sources of energy like the sun and wind for future use.

Obama highlighted the major advances America has made in battery technology in just a few short years. “I just want everybody to understand –just a few years ago, American businesses could only make 2 percent of the world’s advanced batteries for hybrid and electric vehicles — 2 percent.  In just a few years, we’ll have up to 40 percent of the world’s capacity.”

In my recent post Thoughts on an Ethanol Pipeline, I described what I feel would be a more rational approach to ethanol policy than some of the policies that have been pursued over the years. This gist is that the Midwest currently produces about 95% of the ethanol in the U.S. (12.5 billion gallons), but they export 70% of that ethanol out of the Midwest. At the same time, they import gasoline that is the energy equivalent of 37 billion gallons per year of ethanol.

It would seem to be a more sensible energy policy to utilize ethanol production closer to the source of production — especially given that the motor fuel demand in the Midwest is far greater than the volume of ethanol produced there. Many readers agreed, and following that essay, they provided a number of excellent comments. I drew on those comments in my latest essay for Forbes: The Midwest Should Use Its Own Ethanol.

Here I want to continue to develop policy recommendations around this theme. Reader Paul Nash came up with a specific plan, which I share below (here is the link to the original comments).

The Rationale for a Policy Change

• The industry wants a pipeline to support a greater market on the east coast.
• This market will likely only grow by either raising the blend mandate, or exporting ethanol
• From a national energy use point of view, it is much better to have the ethanol being used near to where it is produced (Midwest).
• Presently, this is only happening to the extent required by the blend mandate – there is relatively little E85 usage.
• Other than raising the blend mandate, the only real way to grow ethanol use is by E85.
• Many/most flex fuel drivers (today) do not run on E85 because it is either hard to find and/or there is little financial benefit to doing so.
• Some new flex fuel vehicles are optimized for E85, and their drivers will get a financial benefit, but they will only be a small portion of the market.

Specific Recommendations

1. Scrap the VEETC (since there is a mandate already and the VEETC is scheduled to expire at the end of 2010).
2. Maintain a producer’s credit for cellulosic ethanol, until 2015.
3. Double the VEETC credit for E85 sales (as well as for 85% blends of methanol and mixed alcohols).
4. Pay this credit to the retailer, not the fuel blender (if it is a different party).
5. Place an export tax on ethanol equal to all the producer credits (including corn grower’s credit).
6. Do not give any government subsidy for the pipeline – let the industry decide if they want to spend that money, or develop the market in their own backyard.
7. Relax law allowing drivers (not retailers) to blend any amount of ethanol they like into their fuel.  i.e. mix E85 with regular gasoline in any proportion they want.

Projected Consequences

So, with a $0.90 tax credit on E85, drivers will have a real, immediate, and obvious monetary incentive to use it. Retailers, faced with making good margin on E85, will have good incentive to install pumps. The ethanol industry might even choose to partner with them to help pay for said pumps. The ethanol producers might even set up their own E85 stations at the distillery gate, just like wineries sell at the cellar door.

Fueling stations selling E85 and nothing else, supplied directly by the distilleries, will begin to appear, and would be VERY easy and cheap to set up, and would, of course, be within easy trucking range of said distilleries.

Drivers are legal to use higher mixes, but are not being forced to, and no one is selling higher mixes. The responsibility is purely with the drivers who decide to use higher mixes, or not, so the retailers/oil companies and ethanol industry are not liable for any engine problems (unless, of course, if the ethanol industry claims there won’t be problems).

Now, doubling the credit on E85 to $0.90 is a huge subsidy to the E85 users, but there are not that many of them (presently) so the total amount spent on this subsidy will be far smaller than the $6 billion/yr presently.

This plan leaves the oil refiners out of the ethanol subsidy business, but that is OK as they are mandated to blend x amount of ethanol, this is not destroying their business in any way – it is merely promoting an alternative fuel that they (to date) have refused to promote.

If the retailers and drivers “follow the money”, we would see a rapid increase in E85 usage, and I’ll bet it gets used more in corn country first, which is as it should be.

Conclusions

I agree with most of what Paul suggests, and believe it would create huge new opportunities for the domestic ethanol industry without the need for an E15 mandate. These policies would also move the industry closer to the generally accepted purpose of U.S. biofuel policy, which is to use biofuels to reduce demand for petroleum. The farther biofuels are moved from the point of production, the less petroleum they are able to offset due to the energy cost of moving the biofuels.

However, I don’t believe the subsidy would need to be as high as $0.90 per gallon. I certainly think such a high subsidy would result in explosive growth for the E85 industry, but then we would once again have to contend with a $6 billion ethanol subsidy in just a few years. I think the same goal could be accomplished with a subsidy of around $0.50/gallon.

According to E85.com, over the past year E85 has been anywhere from 10% cheaper to 22% cheaper than gasoline. Given an observed E85 energy penalty of 25-30%, it is likely that E85 would need to be consistently 30% cheaper than gasoline to build a substantial market. (Another possibility is the continued development of engines that can reduce the E85 energy penalty by using higher compression ratios; if you only lose 10% fuel efficiency on E85 then you will happily buy E85 at only a 15% discount to gasoline).

The narrowest spread between E85 and gasoline over the past year occurred in December 2009 when gasoline was $2.56 per gallon and E85 was $2.30 per gallon. To increase that narrowest price spread back to 30% would require an additional E85 subsidy of $0.51 per gallon. At the widest spread over the past year in May 2010, this level of subsidy could have had E85 undercutting gasoline by more than 40%. At that price spread, E85 demand would grow rapidly.

Given the meager level of E85 sales in the U.S. today, this level of subsidy would be far lower than present ethanol subsidies, while providing strong incentives to build out E85 infrastructure and E85 vehicles. Further, it would actually strengthen the energy security of the Midwestern states well beyond the status quo.