Corn on the Job: Why Inflation is Here to Stay

Lots of talk today about oil hitting record inflation-adjusted highs. Gold is going up too. A grain drain around the world has food prices rising, and gas could cost more than $4 by this summer.

The Federal Reserve is not happy that the rate of inflation now sits at the top of its comfort zone. Rising inflation could reduce the purchasing power of the government's rebate checks coming this summer. We’ve been covering this on Money for Breakfast.

So what to do about our rising energy costs? Will ethanol help us get off of our addiction to Mideast oil? Will ethanol help lower our energy costs?

A growing number of studies say the use of ethanol as an alternative energy source is pretty corn flake-y.

Ethanol has been around for centuries. In the earliest instance of corn on the job, (ok that was corny), Henry Ford used it to power his first Model T. The Arab oil embargo of the early '70s, with its gas lines and soaring gas prices, helped propel the use of ethanol first as an alternative to gas. The US now makes about 5bn gallons of ethanol from corn each year, about a fifth of the corn crop. Ethanol helps cars burn cleaner, as it acts as a replacement for the fuel additive MTBE.

But analysts say that ethanol made from sugar cane generates eight times more energy than is used to produce, refine and transport it, versus ethanol made from corn. Prairie grass is near that level too. Studies suggest prairie grasses are better at creating ethanol, as they grow much faster than corn and don’t take as much energy to grow. But there is no prairie grass lobby that’s as powerful as the corn lobby, which critics charge has iced out sugar imports.

And ethanol is being blamed for helping to cause corn prices to soar 60% a year, and with it, all sorts of food prices.

Ethanol in general can’t be easily shipped via regular gas pipelines because it separates in transit, plus it sucks in a lot of impurities on the way. So it has to be transported by trucks. Most cars can’t burn gas mixed with more than 10% ethanol, because it corrodes car parts; for others a 15% blend is the limit. It’s expensive to retrofit gas stations with ethanol-blended tanks, which is why out of 176,000 gas stations in the United States, only about 600 serve E85. Also E85 gets worse mileage than gas, which poses a problem because often ethanol blends are costlier.

Carmakers largely make flex vehicles that use ethanol because they get a credit, thanks to a loophole in the law, that lets them avoid corporate average fuel economy standards ("CAFE"), which helps them make more gas guzzlers, critics say.

And ethanol produces a lot of ozone, more than gasoline, a study from Stanford University notes. By some estimates, it costs $2.24 a gallon to make ethanol but just 63 cents a gallon to make gasoline. Ethanol is largely price competitive because of its government subsidy. Congress has given more than $50bn in tax breaks and subsidies since 1995 to the industry.

However, ethanol sucks up a lot of water in manufacturing, at a time when US states face record droughts. The number of ethanol factories has tripled since 2000 to about 140 today. In general, one ethanol factory pumps out 50mn gallons of biofuels each year, but they must use about, get this, 500mn gallons a minute, says a report from the Institute for Agriculture and Trade Policy. Already complaints are being brought against these factories over water usage in Iowa, Kansas, Nebraska and Minnesota, and west in the Great Plains states, the report says.

But ethanol may be here to stay, as states like the federal mandates they get for ethanol as it helps create jobs. Archer Daniels Midland (ADM) has won about $10bn of that $50bn amount.

Presidential candidates like Barack Obama says he wants to raise US production of ethanol to 60bn gallons by 2030. President George Bush signed a bill last year that asks that the amount of biofuels in production be quintupled to 36bn gallons by 2022.

But let’s look at some math here. By some estimates, to replace the 174mn gallons of gasoline the US currently uses each year, some 261mn gallons of ethanol will need to be produced. That will require about 260mn acres of corn That’s an area the size of California and Texas combined. And that’s vs the current 73mn acres currently (the US will need about 20mn acres that to support its corn diet). That’s a lot of corn, plus pesticides, fertilizers, you name it.

What to do? Interestingly enough, it seems like in a growing number of states, Americans driving less and buying less gas. Maybe that’s the better alternative?