Several years ago, when former Treasury Secretary Lawrence Summers walked past me, I asked him, “What is the most important economic idea to teach my students?” Without stopping, he said, “the power of the market.”
Now, asked why Congress’s ethanol mandate has not worked, I can also say, “the power of the market.”
In 2007, when a barrel crude oil was approaching $140.00, Congress passed the Energy Independence and Security Act. Hoping to mandate the use of homegrown biofuels, they established quotas and subsidies. One goal was to increase ethanol use from 2008-2022. On the supply side, they mandated the amount of ethanol to be increasingly produced and then blended into gasoline. With a 46 cent per gallon subsidy, they made ethanol production cheaper until 2011.
Responding, the number of U.S. ethanol plants multiplied from 81 to 214. A 3.9 billion gallon capacity in 2005 became 15.7 billion gallons today. The result (below) has been an ethanol glut:
We could say that the power of the market was reason the Congressional ethanol mandate flopped.
Our Bottom Line: Market Incentives
Oil markets, corn markets and foreign ethanol markets have collided with Congress’s ethanol plans. Unimaginable in 2007, the shale boom increased domestic oil production and helped to send the price of a barrel of crude cascading to a $26 low. Meanwhile, constrained by the crash of markets during the December 2007-June 2009 recession, our gasoline consumption went down. Even now, we are buying less gasoline (141 billion gallons) than during 2007 (142 billion gallons). In addition, always affecting the cost of production, markets that determine the price of corn impact domestic ethanol.
So, with domestic markets creating problems that Congress did not expect, we have producers trying to increase exports:
I guess at home and abroad we can see the power of the market.