An Energy Bill for Central Planners
Amidst record prices for oil, US lawmakers have struck a solution that will prove unfortunate. Larding the bio-fuel industry with egregious subsidies, they have passed an energy bill mandating a colossal diversion of domestic food supplies from the dinner table to the gas tank.
Masquerading as a path to energy independence – the bill barely dents American reliance on foreign oil and will fan a wave of food inflation that could dwarf that experienced in the 1970’s. Oddly enough, this massive project bears eerie resemblance to one embraced by China during the late 1950’s, when Communist leader Mao Zedong ordered farmers to build pig iron furnaces in the middle of agricultural areas in the name of self sufficiency and modernization. Hailed as The Great Leap Forward, the diversion of farmland to industrial projects resulted in widespread famine.
One would assume that most lawmakers are at least vaguely familiar with the history of American energy policy, not to mention past failed attempts to achieve the false god of energy independence. If so, their unwillingness to concede that these measures have produced the opposite of energy security (while propelling energy prices to record levels) at the very least raises questions.
Still, it is doubtful that these lawmakers, who rail against rising fuel or education costs, understand why food bills have barely nudged for the last 25 years. How, for example, did the price of corn remain at about $2.70 per bushel while the price of college tuition soared from $3,000 to $30,000? Unfortunately, the knowledge gap here has allowed them to be duped by the powerful farm lobbies that for years to come will reap a bonanza due to a combination of global food price inflation and farm subsidies. When we factor in the latest energy bill's potential impact on food prices, we can perhaps foretell further consumer unrest.
Funnily enough, the relative stability of food prices over the last three decades is a legacy of Cold War politics. Europe, poor and food deficient after WWII, and laboring under the illusion that commodities aren't fungible, created the Common Agricultural Policy (CAP) in the 1960’s in order to provide a buffer against Soviet encroachment. The CAP turned Europe into a major grain exporter by the late 1970’s. And after Mao’s failed industrial experiment in China, significant agricultural reform, including foreign investment and technology transfers following US President Nixon’s 1972 visit caused China’s grain production to quintuple in 5 decades, transforming it also into an exporter.
Elsewhere – in response to the CAP and US acreage set-aside programs, Argentina and Brazil multiplied their own arable land levels. The latter, combined with the aforementioned grain surpluses flowing from Europe helped to keep prices artificially low. The US similarly used export enhancement programs (cash bonus awards to exporters) to dump grain into North Africa and the Middle East to keep them out of the communist fold.
All of this changed with the end of the Cold War. Europe switched focus from food production goals to land conservation, causing its mountains of wheat to decline. Elsewhere, rapid emerging markets growth increased disposable incomes, raising the demand for foodstuffs; particularly meat and dairy products. China, reaching arable land capacity in 1995 has since seen acreage decline, and is resuming as a net importer. India, the world’s second largest wheat producer (and once an exporter), is today scrambling for foreign wheat to feed its burgeoning population. Pakistan, Russia and Ukraine have halted wheat exports and Argentina has increased its grain export tariffs.
And as the US remains open for business even within a cheap dollar environment (dollar weakness a frequently unsung factor in commodity boom of recent years), prices for wheat and soybeans reached record highs last week. Against this background of shriveling grain supplies and global monetary uncertainty, Congress has decided to embrace a misshapen form of autarky.
A review of the math of the energy bill reveals that the 2022 ethanol mandates of 36 billion gallons are equivalent to this year’s entire corn crop - a record 13 billion bushels and one that normally supplies 70% of the global export market. Even though the bill calls for half of all ethanol production to come from non-corn sources (e.g., woodchips), the technology for non-corn production is a decade away.
Grain prices are extremely sensitive even to minor shocks of supply and demand. While the post-Bretton Woods weak dollar in the early '70s factored heavily into the rising prices of all commodities, Soviet purchases of about 20 million tons of US feed grains and wheat sent prices soaring. Similarly, earlier this year, a decline in Australian wheat production caused global wheat prices to almost triple. The heavy levels of bio-fuel production mandated by the energy bill legislation will negatively impact the nation’s corn-reliant beef, hog and poultry markets; something that will force US consumers to pay up in the future when purchashing meats.
As for fuel efficiency, meeting the mandates for ethanol production with corn will provide a paltry 12% of the nation’s gasoline needs. Even the most sanguine experts claim that the conversion of corn into fuel adds only about a 34% energy boost, and some would say that the conversion process is a net negative. During planting, fertilizing, harvesting, drying and manufacturing, corn-based ethanol consumes almost as much fuel as it produces, and in the end, contains only 70% of the energy of gasoline.
Moreover, since ethanol cannot travel along gasoline pipelines, transportation of it insures even more fuel consumption. And speaking to the not-so-sanguine market view of ethanol, to protect its large US producers, Congress maintains a tariff of $.54 per gallon on the more efficient sugar-based ethanol made in Brazil.
Notably, the calories in the amount of corn needed to fill one SUV tank with ethanol, about 450 pounds, could feed one person for a year. While Americans will doubtless experience higher food prices under the bill, the least developed countries stand to suffer the most. Indeed, it is in poor countries that food costs frequently account for half of one's income. As it is, according to the UN, these countries have already seen a 25% rise in their imported food bills this year.
By adopting a large command-economy program that central planners would cheer, the US has renounced the market forces that drive the costs of the world’s most basic commodities. Sadly, this project will likely engender a chain of future interventionist policies - including rationing, price controls, and export halts - that will surpass what we experienced in the 1970’s.
Hailed by Speaker Pelosi as a triumph of American independence and bi-partisan cooperation, the energy bill is instead a remake of The Great Leap Forward – with potentially unsettling consequences ahead.
Ann Berg has served on the board of directors of CBOT, and is a frequent writer on issues relating to commodity prices.
