Why Ethanol Alone Won’t Solve U.S. Energy Problems

By Cheryl Grey, on September 12th, 2008

Although it’s debatable whether transforming a percentage of the U.S. corn crop into ethanol is responsible for recent hikes in global food prices, even the most enthusiastic industry supporter must admit that, in the long run, domestically-produced ethanol is not a viable substitute for 100% of the crude oil currently being imported.

Ethanol proponents point to the “Brazilian miracle” with the inference that, if transportation fuel independence can be achieved there, it can also happen in the United States. However, the situations of the two nations are totally different and cannot be used as any basis for comparison.

The Brazilian Solution

Brazil achieved transportation fuel independence in 2006 through domestic production of ethanol and crude oil. Although that latter is often overlooked by advocates, aggressive deepwater exploration by Petrobras and some massive offshore oil discoveries in the first few years of this century have contributed at least as much as ethanol production toward achieving this goal. Among South American nations, only Venezuela has larger crude oil reserves than Brazil, which is now one of the fastest growing oil-producing nations in the world.

For light domestic use, Brazilian refiners cut gasoline with at least 20–25% ethanol made from sugarcane. The Flex-Fuel technology operating on 87% of local vehicles allows them to burn any mixture from pure gasoline to pure alcohol, thus freeing drivers to purchase the most economical fuel available at any given time. Because ethanol only offers 70% of the efficiency and therefore only 70% of the miles per gallon of gasoline, drivers have learned that, unless it’s at least 30% cheaper than petrol, ethanol is actually more expensive in operation. On long roads with few filling stations, gasoline remains the fuel of choice.

In Brazil there are around 85 cars per 1,000 people, restricting the demand for gasoline, as opposed to fuel oil for industrial purposes and electrical generation, or diesel fuel, which cannot be mixed with ethanol as gasoline can. For this reason, despite producing 327,000 barrels of ethanol per day in 2007, Brazil also consumed 2,307,000 barrels of oil per day. Despite the substitution of ethanol for 50% of Brazil’s light transportation needs, the greatest part of their economy is run on domestically produced crude oil.

The U.S. Situation

The United States, on the other hand, possesses approximately 765 cars per 1,000 people, leading to a much higher demand for gasoline. According to the U.S. Energy Information Administration, during the week ending September 5, those cars required 9,090,000 barrels of oil per day, down from 9,393,000 during the same week in 2007. However, the U.S. mainly uses coal and natural gas for electrical generation and industrial purposes, leading to a lower reliance upon fuel oil, which is why the U.S. possesses nine times as many cars as Brazil but only uses four times the amount of crude oil.

U.S. ethanol is fermented from corn, which is much less productive than sugarcane for the purpose, requiring an additional step in the process and providing one-seventh of the energy. While sugarcane does grow in the most southern and tropical of the states (Hawaii, Florida, Louisiana and Texas), it’s not a viable crop elsewhere, leaving the U.S. mostly dependent upon corn for ethanol.

The Renewable Fuels Association says that one bushel of corn makes 2.8 gallons of ethanol, while Purdue University informs us that the 2008 U.S. corn crop will average 155 bushels per acre. Based upon these production figures, there’s simply not enough cropland even in the U.S. heartland to produce enough ethanol to replace all the transportation fuel needed on a daily basis—not if we want to eat, too.

Although a nascent technology under development is capable of producing ethanol from any form of cellulosic matter from weeds to woodchips, even that won’t be sufficient to drive much more than 30% of America’s vehicles, according to a recent report jointly authored by the U.S. Departments of Agriculture and Energy.

All-Inclusive Solution

Replacing imported oil for transportation purposes in the U.S. is not a one-step process, and more than one substitute fuel will be required. Although ethanol is a piece of that puzzle, it cannot be the entire solution.

Perhaps that’s the lesson to be learned from Brazil—not necessarily to run cars on ethanol but to be flexible in the choice of fuels. Beyond Flex-Fuel vehicles arises the possibility of hydrogen, electrical and natural gas-powered cars. Perhaps our final choice should be all of the above.



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How to Get People to Buy What They Don’t Want

By Bhagwad Jal Park, on September 12th, 2008

We learned a few pricing strategies in a previous article about how to make customers self-select and get them to pay as much as they are willing to pay for your product. However, it assumes that all of your customers value your product equally. In reality, your product will be valued differently by different people.

Let’s assume you’re selling jeans and business trousers. The trousers will be of lesser value to a teenager and the jeans, say, will be of lesser value to an office-goer. Ideally, you want to be able to sell to both of these people. But if you set a high price for jeans, then the office-goer will not buy it, and if you set a high price for the trousers, then the teenager will not buy it.

As usual, our most direct strategy will never work. Namely asking the customer what they are willing to pay for it! No. We crafty game people need a more subtle approach.

So what are we looking for in such a strategy? We want to arrange things in such a way that both the office-goer and the teenager will buy both products for as much as they are willing to pay for each. To illustrate this, we need to plug in some numbers.

Jeans – Value to teenager: 100. Value to Office-goer: 50

Trousers – Value to Teenager: 50. Value to Office-goer: 100

Nintendo Cartridges

Image Credit: inju

Ideally, we want the teenager to pick up both the jeans and the trousers for 100 and 50 respectively, spending a total of 150. We want the office-goer to buy the jeans and the trousers for 50 and 100 respectively. We want both to spend 150, and we want to net 150+150 = 300.

Clearly setting a single price for the garments isn’t going to do us any good since then either the teenager or the business person will end up either not buying it, or paying a lower price than they are willing to pay for it. The strategy to follow is that of bundling.

Bundling means that we package both the garments together and sell the bundle for 150! We wrap them nicely in a plastic bag and indicate that the two are inseparable. Now both the teenager and the office-goer can buy the bundle for a price of 150, paying as much as they would normally be willing to pay for each item. Our net gain is 300, and the office-goer as well as the teenager need never know of our clever manipulation.

There are several instances where certain items are worth different values to different people, and in situations like this, bundling can be very effective. If you remember the days of Nintendo, you would see (and you still do) cartridges that have something like 10,000 games in 1 at a reasonable price. How was this possible? The idea was that some people like certain games more than others. The best way to sell them was to put all the games together and hope that there will be something in the bundle for everyone. Selling them separately meant that almost no one would buy each game individually, but by bundling them, you ensure that you sell all of them.

This approach really works well for software since it is so easy to replicate. For bundling to work, you need to be able to manufacture the goods cheaply as well as have the goods be of varying worth to different people. When used properly , it can be a very effective strategy even for physical goods, just like the jeans and trousers example above.



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CFTC Initiates Wide Probe into False Oil Inventory Reports

By G.L.C., on September 12th, 2008

Global oil markets are sensitive to weekly reports of U.S. oil inventory levels. Prices often move up when large falls are reported and down when inventories build – particularly when the data surprises the market. Each Wednesday, the U.S. Energy Information Administration (EIA) publishes its report on oil inventories. Unexpected drops can spark price spikes on the main oil futures benchmark on the New York Mercantile Exchange.

Concerned that companies may be reporting false inventory levels to benefit their own trading positions, regulators are now investigating whether companies are injecting false data into the marketplace to influence perceptions about crude oil supply and demand. A company could under-report barrels in its inventory to suggest oil is scarcer than it really is and then sell its physical oil at a higher price when the prices increase.

It is illegal to provide false data to the EIA. While the EIA does not physically check the inventory to audit the accuracy of the reported data, it looks at other data on supply and demand to determine if the reported data is correct.

The U.S. Commodity Futures Trading Commission (CFTC) is now probing to learn if companies are reporting false inventory. It is now taking depositions about big market moves by companies that occurred unexpectedly, especially during the rapid shift in the structure of the oil markets in July 2007. During that time, oil for near term delivery had been selling at a discount to oil to be delivered months and years into the future. Suddenly oil for immediate delivery became much more expensive when the inventory of oil at a key hub declined rapidly.

The CFTC has been under increasing pressure to take action. Congress is debating whether to require it to take new steps to curb abuses. It has also been criticized for lax regulation.

The present probe is a part of a long term investigation as well as an attempt by the CFTC to improve its information and understanding of the workings of the energy market it regulates. As a part of its investigation, the agency sent out information requests to large oil traders, Wall Street firms, energy companies, and physical oil merchants. The agency is seeking the names of firms’ biggest traders and the email and instant messaging correspondence about the markets dating back to early 2007. In some cases, the correspondence requested dates back to 2005. The agency has also requested details of storage holdings and other physical assets the traders may own or control.

The probe as already started drawing criticism. The information requests are being characterized as overly broad. Critics also say that the CFTC is asking the companies and firms to disclose any unfair, improper, unethical, and unlawful practices.

The government, in an effort to control the ever increasing oil prices, has taken a few concrete steps, including efforts to rein in the speculators, and these efforts are beginning to show results. The price of oil today is less than what is was a couple of months back.

The probe is a step in the right direction. It is critical to ensure the integrity of the futures market in oil given the impact oil prices can have on all consumers.



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