The New New Thing

Are subsidies wrecking the development of a clean energy source?


Every year, there is a new green technology that triggers eager predictions that the days of gasoline-powered engines are numbered. Last year, it was lithium-ion batteries. The year before that, it was hydrogen fuel cells.

This year's buzz generator—a new biofuel developed by a small Illinois company called Coskata—holds genuine promise to become a cleaner and cheaper alternative to gasoline. But the fuel's efforts to achieve commercial viability will be hurt, not helped, if its well connected investors succeed in convincing the federal government to mandate a distribution infrastructure for it.

Coskata's backers include General Motors CEO Rick Wagoner and Sun Microsystem co-founder and venture capitalist extraordinaire Vinod Khosla. They want every gas station in the country to replace half of their gas pumps with special units known as E-85 pumps. E-85 is a blend that contains 85 percent ethanol and 15 percent gasoline. Like diesel, it must be pumped through a different system than conventional gasoline.

Most ethanol in the United States is produced from corn, but Coskata says that it has found a way to generate ethanol from woodchips and other biomass at potentially half the cost of gas and a third the cost of corn-based ethanol. What's more, it has done so without any research subsidies that many other alternative fuel ventures get. This is especially impressive since such "cellulosic ethanol" has to date been more expensive than corn-derived ethanol. That's because the sugar in corn is relatively easy to extract, while that in wood chips and other raw materials for cellulosic ethanol is hard to reach because it is protected by a rigid cell wall. Breaking down this cell wall has been prohibitively expensive. Until now, that is.

Coskata's breakthrough involves a new thermal process that gasifies biomass (and, in the future, potentially even rubber tires and petroleum coke) to produce something called syngas, a mixture of carbon monoxide and hydrogen. This gas is then fed to Coskata's patented cocktail of five bacteria that turn it into ethanol. Using this method, Coskata says, it can generate more ethanol from less feed and water than corn-based techniques.

Coskata's fuel has a number of other advantages over corn-based ethanol. Since corn doesn't grow everywhere, corn-generated ethanol generated has to be transported. Given ethanol's corrosive and volatile nature, this can't be done through existing oil pipelines. So it has to be hauled in trucks, which adds to its costs (not to mention related greenhouse gas emissions). This is one of the main reasons why the energy-adjusted average price of E-85, whose main ingredient is corn-based ethanol, is currently around $3.53 per gallon-despite a 50-cent per gallon federal tax subsidy for producers. This is still 20-30 cents higher than the price of gas right now when it is at a record high.

What's more, diverting corn for fuel has the undesirable effect of raising food prices. Higher corn prices lure farmers to grow corn over other produce, bumping up prices of fruits and vegetables. Meat-eaters are effected, too, since corn is a major component of livestock feed. Because Coskata's fuel can be produced anywhere, from any sort of plant, it avoids these drawbacks.

Impressive though Coskata's technology is, its market success will ultimately depend on offering pump prices that are about 25 percent lower than gas, since ethanol contains 25 percent less energy than gas. Coskata is confident the pump price of its fuel will be somewhere between 50 cents to $1.00 lower.

But that range spans the difference between market success and failure. Assuming average annual gas prices of $3.00 per gallon, a 50-cent saving won't be enough to compensate consumers for the lower energy content of ethanol-much less offset the $20,000 to $200,000 that gas station owners would have to spend to install ethanol tanks and pumps. Savings of $1.00 might do the trick, but that will require Coskata, which plans to produce 40,000 gallons of fuel by the end of the year, to develop a highly efficient production process.

But its incentive to do so will be vastly diminished if the federal government delivers it a ready market by forcing ethanol on gas stations. This might allow Coskata to capture some market share now, but over the long run its fuel will have a harder time becoming a sustainable alternative to gas, especially if gas prices drop. It will also be less able to compete with foreign ethanol if the federal government slashes tariffs on the stuff. That's a real possiblity, despite the powerful farm lobby, given the interest in promoting greener alternatives to traditional gasoline.

Khosla—an IT revolutionary turned ethanol evangelist—is fully capable of understanding such market realities. He told CNN Money some years ago that he believes in making only small investments in startup companies because too much cash breeds over-confidence and thwarts experimentation. "The right way to build a company is to experiment in lots of small ways, so that you have plenty of room to make mistakes and change strategies," he noted. That's precisely what a guaranteed market for Coskata will prevent it from doing.

It's widely recognized that the government is inept in directing subsidies to market winners. Consider three quick examples: In the 1970s, the federal government pumped hundreds of millions of dollars to develop thermal solar technologies as an alternative to the photovoltic cell. Three decades later, there is nothing even close to being commercially viable. The government also pumped billions of dollars into developing liquid fuel from coal to cut down on our consumption of Middle Eastern oil—another total bust commercially. More recently, in 2003, George W. Bush pumped $1.3 billion into a "Freedom Car" that would run on hydrogen-powered fuel cells. Four years later, the Freedom Car is not even close to being commercially viable and the enthusiasm for those fuel cells has considerably waned.

Ethanol's backers maintain that a government mandate to convert half of all pumps to ethanol is necessary because the major oil companies won't let gas stations install E-85 pumps. But this is a bogus claim. Federal laws, including the most recent energy legislation, prohibit gas station owners and oil companies from discriminating against ethanol. The real reason why stations don't carry ethanol is that it simply does not currently offer the returns to offset the thousands of dollars needed to make them ethanol-ready—much less make up the losses from oil sales.

There's no question that government intervention through taxes, regulations, and subsidies has distorted energy markets and provided oil companies with an unfair advantage. So it is not surprising that even a self-made billionaire such as Khosla with a promising new fuel on his hands should think it's right to demand government help. (Actually, he does this quite often, including last year when he attempted unsuccessfully to convince California voters to impose new taxes on oil to fund research into alternative fuels.) However, mandating a distribution infrastructure for ethanol would take government intervention in energy markets to a whole new level. Worst of all, it will make even promising new companies such as Coskata less able to innovate in a real, ultimately self-sustaining way.

If Coskata's fuel can make it without market-distorting subsidies, it will. The best thing that Washington can do for the company—and, more important, for consumers—is to ignore GM and Khosla's demands.

Shikha Dalmia is a senior analyst at Reason Foundation, a Los Angeles-based, free market think tank.

NEXT: All My Party People Gonna Do What?*

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  1. Ahem. It’s “Riddle me this.”

  2. The federal government is quite good at spending shitloads of money to develop technology to facilitate the delivery of ordinance to enemy targets. Many of these technologies can later be exploited by free-marketers to provide useful products to the consumer marketplace.

    However, the federal government is not so good at developing non-military technologies regardless of how much money is spent.

  3. Any comments on Zubrin’s similar but somewhat less invasive idea about having the government just mandate that all new cars sold be “flex-fuel”. He claims it’ll only raise the manufacture cost by $100 and then gas stations will put in the pumps to compete.

    I found his book “Energy Victory” in which he expounds on this idea to be interesting.

  4. He claims it’ll only raise the manufacture cost by $100

    Color me skeptical. They can’t put in a new dome light for that little.

  5. Build a better mousetrap and the world will beat a path to your door.

    I guess no one actually believes this any more.

  6. Not to mention, existing vehicles cannot run on an 85% alcohol fuel mixture. Anything more than 10% will damage the engine (or it won’t run at all).

  7. Any possibility of this company getting together with the other-one from California and instead of producing ethanol, this process is changed to produce gasoline?

  8. E85 hell, let’s see what the booze from this process drinks like.

  9. Build a better mousetrap and the world will beat a path to your door.

    I guess no one actually believes this any more.

    It just depends on what you mean by better. With mousetraps, you have an easy replacement value (I’m sure there’s some economics word for that, but I don’t know what it is) With something like automobile fuel, you have to take into account a whole infrastructure that needs to be replaced if you can’t use the existing one. You can’t just ignore this cost and say, “my new gas is cheaper to manufacture!” Your fuel may be cheaper on the margins, but there’s a huge cost that is being ignored. This is where, at least to the proponents of government meddling, the government subsidies come in.

    Speaking of subsidies, you also have to figure in the cost of competing against a group that has a large amount of government already in its corner. This cost is also not trivial.

  10. Corn>ethanol impacts beef prices, but poultry and pork not so much, as the protein co-product (distillers grains) is fed to hogs and chickens. Cattle have a harder time digesting it, tho it can mixed in a small % with other feed.

  11. Marcvs,
    The best way to deal with the problem of competing against a group with government support is to remove the government support. Of course, that is easier said than done.

  12. Anyone who thinks that the oil company’s want to discriminate against ethanol is high on crack.

    If small research firms figure out a cheap way to produce ethanol from wood chips that’s truly viable, there’s no reason to believe that Exxon, Chevron, BP, Texaco etc., won’t be the new producers and distributors of such a fuel. These companies have fuel refinement and distribution down to a science. They’ll merely purchase these new startups and roll them into the existing infrastructure organically.

    Safeway in my neighborhood already offers “Biodiesel”. It’s over $4 a gallon, BTW. Irony?

  13. Matthew | March 24, 2008, 5:40pm | #
    Not to mention, existing vehicles cannot run on an 85% alcohol fuel mixture. Anything more than 10% will damage the engine (or it won’t run at all).

    Umm, bullshit. The only thing keeping modern (eg. computer controlled ignition) consumer vehicles from using E85 or even pure ethanol is the fuel hoses/gasketing not being rated for it and possibly an upgrade in the size of fuel injectors to account for the increase in fuel necessary at WOT to maintain HP specs. Most fuels contain 10% ethanol in their “summer blends” as it is.

    As evidenced Dodge, GM and Ford all support E85. In fact, Ford has been offering E85 support on vehicles since 1996 but they didn’t really start advertising them as such until recently (go find a 1998 vintage Ranger or Taurus and look for this symbol with or without the FFV script).

    There are companies, mostly Asian, that have either not changed over their gasket and fuel system formulas to withstand E85 or have not announced the change over. Of these, Toyota is the biggest player in the United States and I doubt they will be a hold out for much longer.

    I am in no way saying that E85 is the way to go, but your claim that existing vehicles cannot run on E85 is misinformed at best.

  14. Paul,

    That has always been my contention. I spent 10 years working in the energy industry and I can tell you the folks who run the mega majors (Shell, BP, ChevTex, XOM) are not stupid. If a new energy technology comes along to supplant oil or natural gas, these companies will be on it and drive it through to completion. They know the oil will run out eventually and would have been working on alternatives for years. BP and Shell in particular are at the forefront of this.

  15. Another downside is that it may supplant an even better alternative that hasn’t been developed yet.

  16. I live in Iowa and the state gov’t here has been investing in corn based ethanol for years. Every gas station is required by law to have a 10% bled of ethanol. Both parties republicans & democrats try to out bid each other at election time to invest in corn based ethanol. If ethanol doesn’t turn to be the wonder fuel they claim Iowa’s economy will be fucked. But the heavily subsidies farmers in this state have everyone convinced that ethanol is going to make Iowa rich. When you try to tell someone that ethanol is actually worse for the enviroment the regular gasoline you come close to getting lynched.

  17. When you try to tell someone that ethanol is actually worse for the enviroment the regular gasoline you come close to getting lynched.

    Lynched is a bit strong, but a citation should be asked for.

    You MIGHT be able to make an argument of “not much better than regular gasoline” with a whole lot of qualifiers.

    Corn, however, is not a good way to make ethanol.

  18. Paul wrote:
    “Anyone who thinks that the oil company’s want to discriminate against ethanol is high on crack.”

    study the history of Roosevelt era Standard Oil and a different picture emerges. But for the oil trusts, Prohibition might not have happened. Diesel fuel was so named not by Rudolph ‘Peanut oil’ Diesel, but by Standard Oil.

  19. Kwix,

    +1 to you. In fact, tomorrow I’ll be pulling the plastic fuel tank, oversized injectors, and stainless fuel lines and rail from a 1990 Dodge that was meant to run on E85.

  20. Just where is this infinite supply of wood chips supposed to come from? The national forests?

    Every time the government tries to override free market choices and mandate new technological approaches the result is less than optimal at best and disastrous at worst. Buying the Iowa farm vote, which to say turning a high quality food source into a low-quality motor fuel, has already caused runaway inflation in food prices worldwide and in the US in particular. What is still a mystery is why the public isn’t marching on Washington with a good supply of stout manila rope.

  21. a good supply of stout manila rope

    Perhaps because bona-fide manila rope is made from hemp, the cultivation of which is illegal?

  22. I think a case can definitely be made for not having a bunch of subsidies. But IMO the first step is to stop the billions in tax breaks to the oil companies. That would at at least level the playing field a bit more for green tech. On the other hand, I think investments in infrastructure can be benefical overall. For example, I can’t help but wonder if we had taken that 500b we are spending in Iraq and spent it on renewables instead what type of position we would be in.

  23. study the history of Roosevelt era Standard Oil and a different picture emerges.

    We’re not in the Roosevelt era of Standard Oil. No one talked about supplies being finite. I stand by my assertion, any one who thinks that oil companies aren’t interested in furthering their market share is high on crack.

    Any oil company which doesn’t diversify it’s production is doomed.

    Oil companies are in business to make money. If they can make money selling you biodiesel, or Ethanol, E85, or E100 they’ll try to corner that market, too. Why wouldn’t they?

  24. It seems like the source of this fuel would be mostly waste plant material such as yard waste, leaves and shit off of crops, and old trees that are normally turned in to wood chips or mulch. I wouldn’t mind if the price of mulch increases because it is being turned in to fuel instead. I hate that shit.

    I don’t understand all the emphasis on alternative fuels. I think higher fuel prices will ultimately lead to changes in the way transportation infrastructure develops and how land is used.

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