Navigant Research Blog

Drought Won’t Dry Up U.S. Biofuels

Mackinnon Lawrence — September 4, 2012

The worst drought in half a century across the U.S. Midwest is having a devastating impact on agricultural production.  Conditions have deteriorated such that the USDA is forecasting the 2012-2013 harvest to be the lowest in 17 years, with corn prices up by more than 60% over the past two months.

Rising corn costs, a key ingredient in animal feed in the U.S., are expected to drive up the cost of meat, dairy, and eggs.  As a result, the corn starch ethanol industry – a favorite punching bag for just about everyone who doesn’t make a living off of it – finds itself in the crosshairs, with opposition building amongst a diverse group of domestic and international stakeholders.

Admittedly, all this seems to paint a grim picture for biofuels.  In our forthcoming Biorefinery report, Pike Research has slashed its U.S. corn starch ethanol production forecasts for 2012 and 2013.  At the same time, we maintained a strong growth projection for the industry in the U.S. and abroad over the next decade.  The drought matters, but its long-lasting effects will be small.

Corn Starch Ethanol Growth Plateaus

Long before the drought, momentum behind corn starch ethanol had deteriorated in the United States.  Currently accounting for more than 46% of global biofuels production, the industry expanded rapidly over the last decade, due in part to an annual subsidy worth $6 billion.  That subsidy was scrapped at the close of 2011, as industry proponents shifted their focus to expanding end-market access.

What’s more, under the EPA’s revised Renewable Fuel Standard (RFS2), the volume of ethanol derived from corn starch that can be blended into existing gasoline supplies is capped at 15 billion gallons starting in 2015.  This policy has already sent a clear market signal that corn starch ethanol’s future will be significantly restrained, thus diverting industry investment to advanced alternatives over the last few years.

As a result, the corn starch ethanol boom of the 2000s has given way to a next wave of advanced conversion technologies.  In our forthcoming Biorefinery report, we project that 50+ new advanced biorefineries – using non-food feedstocks – will be built annually in the U.S. by 2022.

Regulatory Backlash to Nowhere

Fearing a global food crisis caused by the U.S. drought, the United Nations called for an immediate cessation of government-mandated U.S. ethanol production, a directive that is likely to be repeated many times throughout the next decade.  On the domestic front, decreasing corn supplies have stoked debate about whether the RFS2 corn starch ethanol mandate should be scaled back.

Backlash in the U.S. and abroad is unlikely to materialize into regulatory action, though.  International organizations like the U.N. have no legal authority to compel the United States to adopt or abandon specific policies; meanwhile, the ethanol industry annually contributes more than $45 billion to U.S. GDP and helps ensure some semblance of global equilibrium between liquid fuel supply and demand.  Despite its shortcomings, corn starch ethanol is a mature industry with steel in the ground and an established track record of revenue generation.  Although RFS2 may be up against the ropes, Big Corn is a heavyweight in the Washington political arena, and ethanol is a primary beneficiary.

Consolidation Improves Industry Health

Ultimately, as my colleague, Alex Lauderbaugh, commented earlier on this blog, industry consolidation bodes well for advanced biofuels.  Companies like Gevo and Butamax, which are currently embroiled in a contentious patent dispute, are among those next generation biofuel companies particularly advantaged by the troubles of the first-generation ethanol industry.  These companies aim to retrofit existing biorefineries to produce isobutanol, a molecule that qualifies as an advanced biofuel under RFS2.

While the current drought will put a dent in U.S. ethanol production for 2012 and 2013, the biofuels industry will emerge leaner and better-positioned to expand both conventional and advanced production capacity over the next decade.  Although our recent forecasts show U.S. biorefinery infrastructure attracting nearly $60 billion over the next decade, only a fraction of this total is expected to be the result of new corn starch ethanol capacity.

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