If ever there were a case study in the absurdity of industrial policy, the federal mandates for cellulosic ethanol should be exhibit number one.  Back in 2007, Congress established, under the existing Renewable Fuel Standard (RFS) which already mandated the use of corn ethanol, a schedule to phase in a use mandate for cellulosic ethanol in the nation’s motor fuel supply.  While conventional ethanol is made from high energy food crops such as corn starch and sugar cane, cellulosic ethanol would be made from grass, wood, and other non-food crops, or from the waste of food crops like the stems, husks, and leaves.

The goal was laudable; making fuel from non-food sources would ease the food versus fuel pressure that has led to food inflation since the original corn ethanol mandate was established back in 2005.  The concept was dubious, however.  Essentially, that concept was to take lower energy plants, and the lower energy part of food crop plants, and extract alcohol based motor fuel from them.  That’s a tall order.  Indeed, there is a reason why liquor stores are stocked with rum from sugar cane, whiskey from grains, and vodka from potatoes – those plants are all high in sugars and starch which easily can be distilled into alcohol.  That basic distilling formula also explains why there are no liquors made from grass or trees, and why wine is made from the grapes, not the vines.

Perhaps more dumbfounding, is that Congress mandated this schedule for widespread use of cellulosic ethanol before the technology was commercially viable.  In 2007, cellulosic ethanol was still a laboratory experiment.   At the time, scientists were still studying the digestive track of certain varieties of termites to understand the chemical process of breaking down cellulose.  Cellulose is a highly complex structure of sugar molecules aligned in a certain way which give plants stability and strength.  That is why it is found in trees, stems, and stalks.  In fact, paper, textiles and other fibers are processed by matting cellulosic fibers together.  In short, cellulose is by nature difficult to breakdown.

Nonetheless, in a classic case of wishful thinking, Congress mandated the use of cellulosic ethanol in the fuel supply based on the promise of technological breakthrough.  Five years later, still no breakthrough.  In retrospect, Bill Brady, CEO of Mascoma Corporation, a major player in the development of cellulosic biofuels, admitted candidly in a  Senate Energy Committee hearing this year, “quite frankly, the rate of technological advancement was a bit oversold.”

Moreover, in addition to the mandate, and long before the Solyndra scandal, cellulosic plants were receiving federally backed loans.  To pick one, Range Fuels, of Georgia, was constructed in 2007, and projected cellulosic ethanol production from wood chips of 20 million gallons in 2008, with plans to expand their capacity to 100 million gallons by 2009.  Range Fuels received $46.3 million of a $76 million grant from the Energy Department and half of an $80 million loan from the Agriculture Department before it threw in the towel.   The plant is now being liquidated to repay its USDA loan since going into default this year after it failed to produce any fuel.

Range’s lack of production is not unique; through October this year, according to the Environmental Protection Agency who tracks biofuel production and use, no cellulosic fuel had been sold into the fuel market, despite the statutory mandate under the RFS that 250 million gallons be used this year.   EPA, however, had revised the mandate down to 6.6 million gallons because of the supply situation.  Last year, similarly, EPA used its regulatory powers to reduce the RFS mandate down to 6.5 million gallons from the 100 million statutory mandate, but supply still fell short.  Thus, oil companies who sell motor fuel into the market had to pay the federal government for a credit $1.58 per gallon for the cellulosic shortfall.  To repeat, the federal government requires oil companies to buy credits in lieu of cellulosic ethanol, even when the cellulosic ethanol supply is not available for those companies to buy and mix into their gasoline.   Those costs, of course, get passed on to the motorists at the pump.

In 2012, the RFS statutory mandate for cellulosic fuel will be 500 million gallons, and EPA projects that the eight existing cellulosic companies, if they hit their projected production targets next year, could produce 15.7 million gallons of cellulosic fuel, all the while noting that none of the companies are producing at that level so far this year.   Understandably, EPA has deferred announcing how it will handle this supply crisis next year – despite a 1 November deadline to announce the regulations.  Whatever the agency does, however, will only be a temporary solution.  Cellulosic ethanol production is way behind the schedule provided by Congress under the RFS.  Over the next decade, the mandate for cellulosic fuel under the RFS grows to 16 billion gallons annually – that is more than the amount of corn ethanol now produced at approximately 14 billion gallons.

The bottom line is that the results from a grand industrial policy experiment are in.  Cellulosic ethanol has benefitted from federal research, direct subsidies, a tax credit of $1.01 per gallon, federal loan guarantees, and even a federal use mandate.  None of these has been sufficient to incentivize a commercial supply.   It is time to rethink the RFS.

Dave Juday is a commodity market analyst and principal of The Juday Group who also serves as a CFACT policy analyst.