Note to the ethanol industry: If you're looking for a poster city
and spokesperson for a marketing campaign, call city hall in Walhalla,
N.D., and ask for Mayor Pat Hardy.
The city of about 1,000 is home to an ethanol plant owned by agribusiness
giant Archer-Daniels-Midland. The plant was shut down for about
a year and recently came back into production. "As far as our community's
concerned, it's a real big deal," Hardy said. "It's just been wonderful."
The plant provides good-paying jobs that attract and keep younger
workers, he said, and has had a much larger ripple effect in the
small town, which is just five miles from the Canadian border. The
local car dealership sold six cars in November alone to plant employees,
Hardy said, and local farmers are getting higher prices for the
corn used to make ethanol.
"It all filters down. ... It helps schools, the housing market,
main street. Everything you can think of in a small community, [the
ethanol plant] has been a benefit to. I can't think of one negative,"
Hardy said. With the plant located on the southeastern edge of town,
regular northwesterly winds even keep the notorious smell of the
plant out of the city most days. "It sure has helped people's frame
Assisted by clean-air mandates and a handful of government subsidies
that have made it price-competitive with conventional gasoline,
ethanol appears to be well positioned for growth. Long-term demand
for ethanol will be determined, to different degrees, by future
environmental policy and the industry's ability to attract users
in areas where ethanol and other clean-burning fuels are not required.
Ethanol currently supplies just 1.3 percent of the nation's motor
fuel but has grown from just 50 million gallons in 1980 to an estimated
1.6 billion gallons in 2000. Most ethanol is sold as a gasoline-blended
product having about 10 percent of the alcohol-based fuel. Ethanol
can be made from a variety of inputs, but today about 95 percent
of ethanol is made from corn, and four-fifths of all ethanol production
comes from Illinois, Iowa, Nebraska and Minnesotathe heart
of the so-called Corn Belt.
Minnesota spits out almost 220 million gallons of ethanol annually
from 15 plants. Ethanol production is much lower in other Ninth
District states; Montana has no ethanol plants, Wisconsin has one
and North Dakota two, including the Walhalla plant.
South Dakota has three ethanol plants making about 25 million
gallons of ethanol, but significant expansion is under way there.
Two new plants under construction will add about 55 million gallons,
and three more are in development stages that are expected to add
yet another 120 million gallons, according to the American Coalition
for Ethanol (ACE), located in Sioux Falls, S.D.
"This is an area with a lot of corn, and the idea is to make enough
[ethanol] to be a net exporter," said Ron Lamberty, ACE market development
An environmental base
Ethanol has a growing fan base, especially in rural Midwestern
areas, mostly because of the new jobs and income it is injecting
into sagging farm and rural economies. But more fundamentally, the
ethanol market exists largely because of federal environmental laws
seeking clean-fuel alternatives to gasoline.
Ethanol itself has some pollution baggage, having evaporative
tendencies in warm weather that release harmful compounds, which
partially offset ethanol's lower tailpipe emissions. But the federal
government recognizes ethanol as a cleaner, more environmentally
benevolent fuel than gasoline, which brings with it the rationalization
and justification for a variety of federal and state subsidies for
Some proponents argue that ethanol subsidies are useful in accomplishing
other goals, and, in fact, ethanol does have some complementary
benefits. As Walhalla shows, new plants have brought income stability
to some struggling farmers and hope to rural communities in the
form of local investment and good-paying jobs.
But absent the federal mandate for cleaner fuels, most pro-ethanol
arguments would not fare well on the cold scale of economics. For
example, ethanol is not price competitive with gasoline without
the subsidies it currently enjoys. Minus ethanol's environmental
benefits, efforts to help struggling farmers and rural communities
would likely be targeted very differently, rather than subsidizing
ethanol plants and fuel retailers (and by extension, corn farmers)
for a fuel few will buy on price alone.
Proponents also argue that ethanol subsidies are justified because
they increase the nation's energy independence from oil. Yet ethanol
provides much less than 1 percent of the nation's energy. Far from
providing energy security, some have argued that a confluence of
ethanol factorsblending mandates, tight supply and distribution
difficultiesexacerbated last year's run-up on gas prices.
Keys to the gas tank
Much of ethanol's market base has come courtesy of two federal
clean-air laws in the last 10 years, which gave it a direct opening
into the nation's gas tank.
The first came in 1992 when "oxygenated" gasoline was required
in 39 cities to reduce carbon monoxide emissions during winter months.
(Conventional gasoline contains no oxygen. Ethanol and other "oxygenate"
additives are used to increase the oxygen content of gasoline to
make it burn cleaner.) The Twin Cities, Duluth (Minn.) and Missoula
(Mont.) were originally designated to participate. The Twin Cities
and Duluth have since met attainment standards, and the Twin Cities
now participates voluntarily.
The second clean-air boost came in 1995, when a year-round reformulated
gasoline program (with oxygenate requirements) went into effect.
Today, the program includes 24 polluted urban areas (none in the
Ninth District) covering all or parts of 174 counties, mostly in
California and the eastern seaboard from New Hampshire to Maryland.
About 85 percent of the market for oxygenated and reformulated
gasoline is controlled by methyl-tertiary-butyl-ether (MBTE, an
oil derivative). Or at least it was, until MBTE was found to pollute
groundwater. Ethanol holds the other 15 percent of the market, but
that slice equals more than half of all ethanol demand, according
to a consultant's report to the Governors' Ethanol Coalition, an
advocacy group of two dozen governors from predominantly Midwestern
Although proposals to ban MBTE nationwide have stalled, several
states have banned the additive and some pollution-control areas,
like Milwaukee and Chicago, have switched from MBTE to ethanol as
the additive of choice. If existing oxygenate requirements remain
and MBTE is phased outboth of which the oil industry is fightingethanol
demand would likely double in just a few years to more than 3 billion
gallons, the governors' consultant report said.
"The $64 million question is whether ethanol will be the primary
substitute" for MBTE, said David Morris, vice president of the Institute
for Local Self-Reliance (ILSR), an environmental organization with
offices in Minneapolis and Washington, D.C. "If it is, that's a
major export market for the Upper Midwest." Several bills have been
introduced in Congress seeking the nationwide phase-out of MBTE,
but Morris said "everything was dead" as of mid-November.
Many in the industry are not waiting for a formal government edict
on MBTE. As many as five plants in Minnesota alone are undergoing
or considering expansion that could bring upwards of 80 million
gallons of new capacity in the next year or two. "Most plants are
trying to figure out how they can expand production to meet the
needs of California and the East Coast when they drop MTBE," said
Al Groschen, senior marketing specialist and ethanol expert with
the Minnesota Department of Agriculture.
Armed with the environmental rationale, various state and federal
subsidies have helped make ethanol more affordable at the pump.
The cornerstone subsidy is a waiver of 5.4 cents of federal excise
tax for every gallon of gas with 10 percent ethanol, meaning that
a full gallon of ethanol receives a 54-cent subsidy. Initially set
in law in 1978, the tax waiver was scheduled for sunset last year
but was extended to 2007 by Congress.
The federal government also offers a 10-cent per gallon tax credit
for producers with less than 30 million gallons of capacity. An
ethanol industry source said few producers claim the credit due
to its complexity, but a group of Midwestern legislators is nonetheless
attempting to raise the capacity limit on the credit to 60 million
gallons. In November, the U.S. Department of Agriculture announced
a new program that will pay renewable fuel producerslargely
ethanol$150 million in each of the next two years for increasing
their consumption of crop commodities used in fuel production.
Ethanol proponents point out that oil has received subsidies that
dwarf ethanol by comparison. A recent report by the General Accounting
Office (GAO) calculated subsidies of $120 billion to $150 billion
(in inflation adjusted dollars) to the oil industry since the late
1960s, mostly in the form of tax credits or deductions for asset
depletion, exploration and development. Ethanol subsidies over this
time were significantly less at about $8 billion to $10 billion.
The GAO noted, however, that oil incentives "have generally been
scaled back" and are roughly 80 percent lower today than in 1968
(inflation-adjusted), while ethanol subsidies were on the increase.
GAO figures indicate that, on a per-gallon basis, the ethanol industry
currently receives proportionately more in federal subsidies than
the oil industry.
States have also supplemented federal ethanol subsidies in hopes
of encouraging the industry within state borders. Trevor Guthmiller,
ACE executive director, said the availability and cost of corn are
important siting factors for new ethanol plants. With cheap corn
widely available in the Midwest, "growth tends to go where the incentives
are," he said.
Among Ninth District states, Minnesota has given ethanol the proverbial
red carpet treatment. It offers a producer payment and various loan
programs, and local communities often pitch in additional incentives
for new plants. The state also had a tax credit-worth over $20 million
annually to ethanol plants in the mid-1990s-before being fully phased
out by 1999 in favor of higher producer payments.
Equally important for the industry was a state law passed in 1996and
still the only one of its kind in the nationthat required
year-round oxygenated gasoline for the entire state. "A very clear
reason [for passing the law] was to incent the ethanol industry,"
said Randy Doyal, chief executive officer of Al-Corn Clean Fuels
of Claremont, Minn. Eight of 15 ethanol plants in the state have
started up since 1996, and production has since tripled (see chart).
Source: Minnesota Department of Agriculture
Minnesota, South Dakota and Wisconsin all provide 20-cent per
gallon production incentives to ethanol producers, typically capping
the per-plant subsidy at $1 million to $3 million annually for five
to 10 years. North Dakota also passed a production incentive in
1999, good for 40 cents per gallon for ethanol that is both produced
and sold in the state (for which affidavits are required). But the
state budgeted just $750,000 per year for all payments.
Guthmiller said incentives have played an important role in growing
the industry. "If you got rid of [incentives], I don't think [plants]
would get built as fast as they have in the past. But I don't think
states are doing it just for goodwill. They understand the economics
and how [states] benefit" from developing the industry within state
While most of the direct subsidies go to ethanol producers, a
fair portion appears to trickle down to corn farmers. About 80 percent
of the existing and planned ethanol plants in the Ninth District
are owned as farm cooperatives, including 12 of Minnesota's 15 plants,
which have a combined membership of 8,750 corn farmers, according
to the state Ag Department.
Ethanol cooperatives have attached substantial "value-added" paymentsplant
profits paid out to farmer shareholderson top of the market
price farmers are paid for their corn. Over the last four years,
Doyal of Al-Corn said that value-added returns to co-op members
have averaged 50 cents to 60 cents per bushel. This year the value-added
payments would be closer to $1 per bushel, he said, adding that
farmer members also received a small premium for their corn as well.
"I'm 100 percent certain members are getting more for corn than
if they were delivering [and selling] it themselves," Doyal said,
acknowledging that some co-op members might disagree. "Farmers always
think they can get more."
Supply and demand lessons
The outlook for the ethanol industry is good, given the extension
of the federal tax waiver for blended gasoline for at least the
next six years, and if clean-air laws are preserved in their current
form. Additional subsidies, low corn prices and production improvements
have also made ethanol price competitive with gasoline (see chart),
which has created growth opportunities beyond where government mandates
ethanol use for environmental reasons.
Prices are the average retail price per gallon in Petroleum Administration
Defense District (PADD) 2, a group of 15 Midwestern states including
Michigan, Wisconsin, Minnesota, North Dakota and South Dakota.
"Conventional" is regular gasoline sold in areas
not under clean-air fuel requirements; the entire state of Minnesota
and Missoula, Mont., are the only "oxygenated" areas in the Ninth
District, Milwaukee and Chicago are the closest "reformulated" areas
to the Ninth District.
Source: Energy Information Office, U.S. Department
Over the last 12 years, research by the Minnesota Department of
Agriculture shows that the average annual wholesale price of ethanol
in Minnesota (after subtracting the federal excise tax waiver and
a now-defunct state tax credit) has been 8 cents cheaper per gallon
than 87-octane gasoline. At retail fuel pumps, ethanol-blended gasoline
tends to be more expensive than regular gasoline by 3 cents to 5
cents per gallon because of added costs for blending and transportation.
But when gas prices go up, as they did last year, blending lower-cost
ethanol can provide retailers better profit margins.
"What's driving ethanol right now is the price of gasoline," Doyal
said. "We saw ethanol work into markets it was not in previously,"
like Wisconsin, which "is very much a price-oriented marketplace."
Edward Hoffman, director of petroleum marketing for Holiday Cos.,
which has gas stations throughout the Ninth District, said the company
was selling ethanol-blended gasoline in some Wisconsin stores because
it provided a price advantage over conventional gasoline.
Blenders have also started using ethanol as an octane enhancera
10-percent blend of ethanol in 87-octane gasoline creates a gallon
of 89-octane, which commands a higher price. Last year, about 45
percent of ethanol demand came from its use as a fuel enhancer (higher
octane) or extender (when gas prices are high), according to the
Governors' Ethanol Coalition report.
But increasing demand led to an ethanol supply shockan aftershock
of sorts on the heels of rising gas pricesthat pushed ethanol
prices up significantly in the latter half of 2000. Hoffman of Holiday
said the increase forced the company to take ethanol blends out
where it wasn't required by law. "A penny or two is important in
Last year's supply shock wasn't the industry's first. In 1996,
low corn supplies drove up ethanol prices dramatically and led to
a 60 percent decline in annual production. According to the Minnesota
Ag Department, average ethanol wholesale prices in the state were
18 cents higher than gasoline even after factoring in direct federal
and state subsidies of 61 cents per gallon that year.
Some argue such growing pains should be expected as the industry
becomes bigger, more efficient and competitive. "Demand is out there.
But at this point, at times there is a bit of a supply problem,"
said Lamberty of ACE. "The industry is growing, and as it does you're
not going to see those [price] spikes."
Wooing the fickle consumer
With conventional gas still comparatively cheap, ethanol's biggest
challengeand its biggest potential marketwill be to
convince fill-'er-uppers outside of polluted urban areas to freely
choose ethanol at the pump. With its current price parity to gasoline,
that's already taking place to a degree.
Neither South Dakota nor Iowa has urban control areas that require
oxygenated gasoline. Nonetheless, about 60 percent to 70 percent
of the gallons sold in those states are ethanol blends, which gives
ethanol about 6 percent of fuel market in the two states, according
to ACE's Guthmiller.
But the industry faces a number of real and imagined hurdles in
increasing its market share. Given the long-term uncertainty of
subsidy programs, ethanol's price parity with gasoline could vanish
overnight, along with most of its users.
The industry also faces significant public relations issues. Foremost
is educating the fickle consumer who "doesn't give a damn." Groschen
said. "Gas is a commodity. [Consumers] don't know what's in it and
they don't care. ... They want to put it in so you can get to soccer
Many consumers are nervous about ethanol's perceived side effects
on a car's performance, despite assurances from car manufacturers
and the ethanol industry that gasoline blends containing as much
as 15 percent ethanol will not harm a vehicle's engine. Ironically,
ethanol consumption in Minnesota rose significantly in the early
1990s "after we got rid of the ethanol labeling requirement on the
gas pumps," Groschen said. At the time, it was profitable for blenders
to use ethanol as a gasoline extender, and "as long as dealers didn't
have to deal with consumers frightened by ethanol horror stories,
they were happy to reap the profits," he said.
Ethanol also faces some distribution challenges, given that retail
and wholesale fuel networks are largely controlled by the oil industry.
"I don't know how to do it [increase ethanol consumption] from a
market standpoint," said Groschen. "The gloves and balls and bats
all belong to the company [for which ethanol] is not its core business."
Guthmiller agreed. "It's like trying to sell Pepsi through a Coke
But several sources also acknowledged that the ethanol industry
has not done a good job of selling itself. Lance Gaebe, executive
director of the North Dakota Agricultural Products Utilization Commission
(APUC), said the effort to get consumers to buy ethanol on their
own "has been substandard," he said. "It may be starting, but it's
been weak to this point, in my opinion."
APUC recently gave the North Dakota Corn Growers Association a
$10,000 grant for a marketing program designed to increase consumer
use of ethanol blends in a state that currently consumes just a
half-million gallons annually. While such a grant might seem a pittance,
efforts have been successful. A small cafe about 40 miles west of
Fargo offered free slices of pecan pie for anyone filling up on
ethanol-blended gasoline, and Gaebe said it was a "resounding success."
Part of the marketing problem is a matter of issue and geographic
focus, some said. Morris of ILSR said that ethanol is "clearly sold
as an economic benefit to farmers," particularly in times of agricultural
recession like the current one. As a result, he said, "ethanol has
never been embraced as an environmental alternative. ... On the
coasts, the environmental community is very ambivalent about ethanol."
Doyal agreed. "I'm not sure how effective marketing has been.
... For the rest of the United States outside the grain belt, you
don't hear very much" about ethanol. Doyal took matters into his
own hands, creating a marketing consortium with four other ethanol
plants in Minnesota to reach outside the region.
"Ethanol is tiny. We're a little pipsqueak." Doyal said. "You
have to just keep nibbling away."
Tobias C. Madden, Minneapolis Fed regional economist, contributed
research and interviews to this article.