Decision Memorandum to Members of the Congressional Brazil Caucus, Advocating Modifications to the U.S. Tariffs on Ethanol Imports

ACTION REQUESTED: Public Education Purposes Only

TO: Caucus Representatives: Xavier Becerra (D-CA); Earl Blumenauer (D-OR); Kevin Brady (R-TX); Michael Capuano (D-MA); Julia Carson (D-IN); James Clyburn (D-SC); Howard Coble (R-NC); Danny Davis (D-IL); Lincoln Diaz-Balart (R-FL); Lloyd Doggett (D-TX); Vernon Ehlers (R-MI); Philip English (R-PA); William Jefferson (D-LA); Eddie Bernice Johnson (D-TX); Ray LaHood (R-IL); Tom Lantos (D-CA); and John Larson (D-CT).

FROM: Thomaz Alvares de Azevedo e Almeida, Research Associate, Council on Hemispheric Affairs

SUBJECT: COHA’s Recommendation for Modifications to U.S. Tariffs on Ethanol Imports

Problem Definition: In May 2006, the Climate Change Science Program—the U.S. government coordinating agency on global-warming, which has brought together America’s leading experts in the field—has recently acknowledged that there is “clear evidence of human influences on the climate system” (New York Times: May 24, 2006). Yet, even at this late date, the U.S. does not have an effective “green” energy security strategy. Washington thus needs a policy for detailing countermeasures regarding current fuel usage in powering domestically produced passenger cars and light trucks, that is, pickup trucks, minivans, and sport utility vehicles (CBO: 2002, VII-VIII).

Background: The U.S. is the world’s largest producer of carbon dioxide (CO2) resulting from the consumption and flaring of fossil fuels; alone it accounts for 25% of the world’s CO2 emissions (EIA: International Energy Annual 2004). One way for the U.S. to decrease its unwelcomed contribution to global warming is to encourage the use of biofuels like ethanol, which are known to produce significantly less CO2 emissions in grams per gallon than gasoline (Argonne: Transportation Technology R&D Center, 2004). Replacing fossil fuels with ethanol has become a realistic possibility with the rising price of crude oil, which is projected to fluctuate between $55-60 a barrel for the next five years (NYMEX Market Data to 2012 ). Moreover, President Bush already has acknowledged that “extending hope and opportunity depends on a stable supply of energy that keeps America’s economy running and America’s environment clean”. He has proposed to “reduce gasoline usage in the United States by 20 percent in the next 10 years” (State of the Union Speech, 2007).

The U.S. has been searching for alternative sources of fuel for the past quarter-century, and by 1980, its incipient ethanol industry had managed to produce 175 million gallons. Today, the U.S. has grown to be the world’s largest ethanol producer, with 4.86 billion gallons in 2006 (RFA Press Release, March 5, 2007). This boom in domestic production of ethanol is, however, of recent vintage. In October 2004, President Bush signed into law H.R. 4520, which amended the Internal Revenue Code of 1986 by replacing the federal ethanol excise tax credit with a Volumetric Ethanol Excise Tax Credit (VEETC) that established a tax refund of $0.51 on each gallon of ethanol blended with gas until 2010 (GPO: American Jobs Creation Act of 2004, sec 6426). Two years later, in October 2006, the President signed into law H.R. 6 that set forth a phase-in for the replacement of gas by renewable fuels, mainly ethanol, from 2006 to 2012 (Energy Policy Act of 2005, sec 1501). As a result of these legislative measures, ethanol plants are breaking their production records with each passing year: In 2006, U.S. ethanol plants produced up to 24% more than they did in 2005, which in itself was 15% greater than in 2004. From 2000 to the present, the U.S. ethanol production has increase more than 188% (Federal Trade Commission: 2006). Yet ethanol—both domestically produced and imported —still only comprises 3.4% of all fuel consumption in the U.S. (Green Car Congress: August 30, 2006).

In December 2006, after having called on Congress to lift the import tariff on ethanol in May, President Bush signed into law H.R. 6111 that extended the $0.54 per gallon import tariff plus a 2.5% ad valorem tax mandated by the Harmonized Tariff Schedule on ethanol from 2007 to 2009 (White House: May 3, 2006 and GPO: Tax Relief and Health Care Act of 2006, sec 208). The issue now at hand is whether the 110th Congress should, in the course of 2008, extend these market protections beyond January 1st 2009. This memorandum evaluates two options with regard to promoting ethanol as a complement fuel, and as a possible replacement, to gasoline: (1) Extend once again the Harmonized Tariff Schedule with respect to ethanol imports or; (2) Do not extend the Harmonized Tariff Schedule with respect to ethanol imports, lifting both the $0.54 per gallon import tariff and the 2.5% ad valorem tax.

Alternatives:

Option 1:Extend the Harmonized Tariff Schedule for Ethanol Imports
The first option is to stay the course, that is, to rely on current national subsidies of $0.51 per gallon until 2010 and on the import tariffs of $0.54 per gallon plus 2.5% ad valorem tax, possibly until 2011, as proposed by Representative Leonard L. Bosswell (D-IA) in his H.R. 5431.

Political Feasibility: The Renewable Fuels Association (RFA) is the main lobby for this option, and it has achieved moderate support from Republicans and strong support from Democrats in Congress, with the Congressional Biofuels Caucus endorsing its position. That means that 19 Democratic representatives, including the Speaker of the House Nancy Pelosi (D-CA), and 8 Democratic senators, as well as 18 Republican representatives and 1 Republican senator, favor this option. Another three Democratic senators, along with presidential candidate Barack Obama (D-IL), are publicly against lifting the import tariffs (Senate Records: May 10, 2006). Yet by maintaining a barrier to ethanol coming from abroad, this option does little to address both the President’s and the public’s desire to rapidly decrease oil-dependency. Thus, its political feasibility is rated as an “A-.”

Effectiveness: Shell International considers that “ethanol is the best alternative to partially replace oil derivates in the next decades” (Speeches & Webcasts: February 8, 2005). Yet, ethanol can be produced from different sources, carrying different properties. Corn is the main source used in the U.S., while sugarcane is used in tropical regions like Brazil. The key difference between them is that, given the same amount of input, sugarcane-based ethanol returns four times more energy than its corn-based counterpart, while its flaring produces less CO2 (World Watch Institute and Argonne). Since extending the tariff discourages the ingress of less polluting sugarcane ethanol in the U.S., while it only moderately increases the use of ethanol over gas; the effectiveness of this option is rated as a “B-.”

Economic Impact: In 2006, the U.S. ethanol industry spent $4.1 billion in corn and approximately $3.6 billion on goods and services in order to produce 4.86 billion gallons of ethanol. In addition, $410 million more was spent on transportation from the plant to the terminal where the ethanol was blended (LECG: 2007, 1-2). Clearly, then, the U.S. ethanol industry provides a significant contribution to the American economy. Nonetheless, the heavy expenditure on corn made by the ethanol industry also has registered negative impacts. The U.S.’s National Chicken Council reported that the ethanol’s demand for corn—around 14% of the country’s domestic production—raised the commodity’s price in such a way that the wholesale price of chicken increased by 6% per pound in January. Similarly, the National Cattlemen’s Association reported that the cattle industry expects to be less profitable in 2007 for the same reason (Department of Energy-EERE: March 07, 2007). Thus, the economic factors at play here produce a “B+” rating.

Pros:
• Protect the U.S. ethanol industry, encouraging it to increase its current $7.1 billion expenditure on raw materials, transportation, goods and jobs

Cons:
• Addresses neither energy security concerns nor contends with the negative impact of global warming in the most efficient way
• Sustains pressure on the price of beef and poultry due to its corn utilization

Option 2: Not Extend the Harmonized Tariff Schedule Concerning Ethanol Imports
This option represents an incremental change in course, relying on current national subsidies of $0.51 per gallon until, at least, 2010, but not to extend the import tariffs of $0.54 per gallon plus 2.5% ad valorem tax past January 1st 2009, as proposed by former Representative Jeb Bradley (R-NH) in his H.R. 5261.

Political Feasibility: The public is the main interest-group being appealed by this option. Lifting import tariffs on ethanol would increase the amount of ethanol fuel available in the U.S. market, rendering the competition between ethanol and gasoline more fierce. As a result, the price of fuel at the pump would be lower and oil-dependency would decrease, both outcomes that are expected to please the public. Nevertheless, Republican support for this option is only look-warm, and it has attracted almost no Democratic backing. Thus, its political feasibility is rated as a “B-.”

Effectiveness: Lifting the import tariff on ethanol would make its imports from abroad cheaper, which arguably will increase the volume of ethanol imports. These imports are likely to come from Brazil, since it has enjoyed, in the last few years, a small surplus on its sugarcane ethanol production (data from UNICA). The effect of having U.S. production of ethanol complemented by ethanol from abroad is that the total ethanol supply which would be present in the U.S. market could be expected to increase. As a result of this larger stock, both the price of gas would go down and the trend of blending ethanol with gas would be encouraged. Furthermore, since sugarcane ethanol is cheaper to produce once the industry is in place ($0.83 per gallon vs. $1.14, data from ICONE), competition with countries that produce ethanol would encourage the U.S. ethanol industry to produce ethanol based on sugarcane rather than on corn—a viable option for at least sugarcane producing Hawaii, Louisiana and Florida. Thus, this option strongly favors increasing the use of ethanol over pure gas, as well as of less-polluting sugarcane ethanol over corn-based ethanol, and so its effectiveness is rated as an “A.”

Economic Impact: Increases in the ethanol supply would eventually lead to a decrease in the fuel price at the pump. It would also, on competitive grounds, decrease the price of corn, in turn lessening the pressure on the price of chicken and beef. On the other hand, due to the attractive cost of Brazilian ethanol, the increase in the import of ethanol would transfer a growing share of the revenues from the U.S. ethanol industries to Brazilian companies, potentially reducing their existing expenditure on goods and services. Thus, its economic impact is rated as a “B.”

Pros:
• Encourages the production of a form of fuel that emits less CO2
• Reduces the pressure on the pump price of fuel for the general consumer

Cons:
• Transfers a portion of the domestic ethanol production to other countries, which could lead to both reduced market share and domestic profits, if overall demand does not increase accordingly

Recommendation:
In order for the administration and the Congress both to espouse policies that decrease this country’s oil-dependency in the most expeditious manner, and to immediately address public concerns over global warming, dramatic changes must be made to the U.S.’s current energy security strategy. Therefore, it is COHA’s recommendation that the leadership of the Congressional Brazil Caucus pursue, during 2008, Option 2: Not extending the Harmonized Tariff Schedule applied to ethanol imports past January 1st 2009.

In summary, lifting both the $0.54 cent import tariff and the 2.5% ad valorem tax on ethanol would effectively increase the availability of ethanol in the U.S. This greater supply may make a case for ending the ethanol’s share in the U.S. fuel market—currently below 4%—while not risking the displacement of the domestic ethanol industry. Furthermore, it would promote the use of a “green” energy source that could initially complement, but ultimately replace oil. It is COHA’s conclusion that legislation akin to the “Ethanol Import Fairness Act” (H.R. 5261) could lay the foundation on which an effective “green” energy security strategy could be built.

This analysis was prepared by COHA Research Associate Thomaz Alvares de Azevedo e Almeida