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New Energy Economics: Ethanol and Biodiesel Tax Credit Extensions – Marginal Investment Impact


On Dec. 17, 2010, Congress passed and President Obama signed legislation extending for another year the 45¢/gal. ethanol and $1/gal. biodiesel tax credits, as well as the 54¢/gal. ethanol import tariff. The biodiesel tax credit terminated almost a year ago, and the ethanol tax credit and tariff were scheduled to cease at the end of this year.

The ethanol industry praised the extensions, saying the legislation would save jobs in rural America and lead to greater oil independence. It is true that the tax credits are a direct economic benefit to the industry. However, it isn't always clear which part of the industry captures the benefit. When margins are high, blenders are able to extract and capture most of the benefit because enough biofuel exists in the marketplace. When profitability is at a breakeven point, blenders pass greater portions of the tax credits to biofuel plants to entice production.

In the case of biodiesel production, the tax credit is large and a key economic driver. When the credit ceased to exist in 2010, most biodiesel plants curtailed production. Profitability in the ethanol industry during the past year has been somewhat mixed. Iowa State University reports that total economic returns were at a breakeven point through the summer, but increased to 33¢/gal. in November.

Extending the credit certainly will benefit established biofuel plants. However, by merely extending the credits and tariffs for only one year (Dec. 31, 2011), the legislation does little to stimulate new biofuel investment. Construction of new biofuel plants is a long-term investment, so risk-averse investors are weary of funding such ventures with such policy uncertainty. The wind energy industry was stymied for several years when its tax credit provisions were on and off again.

Creating even more angst among biofuel investors are the emerging differences within the industry. One faction seeks to continue funding tax credits at the present level, while another faction prefers to replace the credits with new investments in blender pumps, dedicated pipelines, and flex-fuel vehicles that would secure biofuel demand into the future.

In another interesting twist, the legislation extended the ethanol tax credit at 45¢/gal., while the ethanol tariff remained at 54¢. Previously, they were at identical monetary values because the tariff was justified as a means of offsetting the benefit blenders get when they import ethanol from other countries (blenders get a tax credit for selling ethanol in the U.S. but have to pay a tariff for importing it). Now that a differential exists between the credit and the tariff, foreign ethanol producers have a legitimate complaint that can be advanced to the World Trade Organization.

With a new, more conservative Congress and mounting federal budget pressures, a continued active debate is expected in 2011 on the value of biofuel tax credits and tariffs.

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