Understanding the Ethanol Tariff Issue

You may have seen the announcement earlier in the week that Brazil has eliminated tariffs on imported ethanol:

Brazil Announces Temporary Elimination of Ethanol Tariff

WASHINGTON – On Monday, the Brazilian Chamber of Foreign Trade said it would remove the country’s 20 percent ethanol tariff until Dec. 31, 2011, Congress Daily reports. With the temporary elimination of the tariff, Brazil was hoping to pressure the United States into lowering or removing its own tariff and taxes on imported ethanol. Currently, imported ethanol is subjected to a 2.5 percent ad valorem tax and an additional 54 cents a gallon surcharge, which terminates Dec. 31, 2010.

The Brazilian Sugarcane Industry Association is urging both countries to eliminate the ethanol tariffs. “Consumers win when industries compete,” said Joel Velasco, chief North American representative for the association. “Brazilian ethanol producers are willing to compete for consumers. What about American producers?”

I have been engaged for the past few days in a dialogue with the Brazilian Sugarcane Industry Association (UNICA), and I want to share some of that in order to shed some transparency on this tariff issue, as there are some complexities involved.

In my mind, there are three key issues that one should understand regarding the tariffs. The first is that U.S. taxpayers directly support ethanol usage through the VEETC. But that tax credit does not require that the ethanol be domestically produced. Any ethanol imported from Brazil can qualify the gasoline blender with the same VEETC as ethanol purchased from a producer in Iowa.

Therefore, to the extent that the tariff is there to offset the VEETC, then I agree that the tariff does this. A tariff of equal value to the VEETC merely means that any taxpayer money that is directed at Brazilian ethanol is refunded via the tariff. (It isn’t clear to me, though, since domestically produced ethanol is assigned a unique serial number called the Renewable Identification Number or RIN, why it isn’t straightforward to make sure the VEETC is only directed at domestic ethanol).

However, the amount of the tariff is higher than the amount of the VEETC. At present, the VEETC is $0.45/gallon, but the tariff is a 2.5 percent tax plus $0.54/gallon. The total tariff is approximately $0.60/gallon, which is 33% beyond merely offsetting the VEETC. Of course I still maintain that with the ethanol mandate, the VEETC is redundant. So if we did away with the VEETC, then that would no longer be a justification for the tariff.

Further, even if the justification for the tariff is to offset the VEETC, the tariff still represents a substantial barrier to trade. For instance, imagine that the wholesale price of ethanol at a U.S. port is $2.00 per gallon. An ethanol exporter’s full costs to put ethanol into a U.S. port must then be below $2.00 per gallon if they are to make money. In fact, under the present system their costs would need to be under $1.85/gal because they would pay the $0.60/gal tariff but a blender could get back $0.45/gal via the VEETC. In this case, with the exporter’s costs at $1.85, the cost to the purchaser of the ethanol is $2.00.

But because of the VEETC, the cost position of the domestic producer is substantially better than for those exporting ethanol to the U.S. For a domestic producer with an ethanol price of $2.00/gallon, the purchaser receives the $0.45/gal VEETC with no offsetting tariff. Thus, the bottom-line costs to the ethanol buyer are $1.55 per gallon, providing a very large incentive for them to purchase the domestic ethanol over potentially cheaper imports.

The second issue is that I have frequently heard that Brazil bypasses the tariff anyway by routing their ethanol through the Caribbean basin, dehydrating it, and then sending it to the U.S. Here was the complete response from Joel Velasco, who is Chief Representative in North America for the Brazilian Sugarcane Industry Association (UNICA) when I asked about this:

Countries in the Caribbean receive preferential trade access by the United States, generally referred to as the Caribbean Basin Initiative (CBI).  In a nutshell, CBI countries don’t pay the tariff on ethanol that they process (i.e. dehydrate) up to a limit of 7% of U.S. ethanol consumption. For details, see page 19 of this Powerpoint by Doug Newman at the U.S. International Trade Commission (ITC).

As an example, Jamaica imports HYDROUS (with 5% water content) ethanol from Brazil and removes that water in Jamaica to turn it into ANHYDROUS ethanol (nearly 0% water). Then the ANHYDROUS ethanol can enter the U.S. as if it were Jamaican product under the trade preferences.

The problem with that is that Jamaica (not picking on them, just an example), like the rest of the Caribbean, is a net energy importer. So, to run their dehydration facility (click here for a Google Maps of one, Jamaica Broilers) they must import fuel from somewhere. Jamaica gets most of its oil from Venezuela and Mexico. That means more emissions (EPA modeled that in their Renewable Fuel Standard), but also more costs.

So, instead of paying 54 cents per gallon to import Brazilian ethanol, we are incentivized to pay 30 cents per gallon (that’s the average cost according to most ethanol traders) to turn Brazilian (hydrous) ethanol into Jamaican (anhydrous) ethanol. Nuts, huh? But Sen. Grassley (R-IA) seems to think it’s a good program. For background, remember when we dehydrate ethanol in Brazil, we don’t use oil, but instead the cogeneration of the bagasse (byproduct) into steam and electricity — more energy efficient, less emissions. On cogeneration benefits, read my comments to EPA’s RFS and California’s Air Resources Board (CARB).

The ethanol lobbying organization Growth Energy issued their own press release:

Growth Energy Responds to Brazilian Ethanol Import Tariff Cut

“We would not support reducing the U.S. import tariff, despite whatever Brazil is temporarily doing, because Brazilian ethanol already enjoys generous subsidies from the Brazilian government and to provide them access to additional subsidies from the U.S. government makes no sense,” said Growth Energy CEO Tom Buis.

Interesting admission from them that the VEETC is a subsidy. Haven’t they stated again and again that it isn’t a subsidy, but a tax credit? Isn’t that a core mantra of Growth Energy – never say “subsidy?”

The third important issue is the possibility – as Growth Energy suggested – that Brazilian ethanol receives generous subsidies from their government. If that is the case, then I agree that this is a legitimate reason to have a tariff on imported ethanol. So once again, I asked UNICA about this. The response, again from Joel Velasco:

I’d love to see Growth Energy substantiate that claim. Bottom line is that there are no generous subsidies today – they are a thing of the past that ended back in the 1980s. And if you want to study the incentives back in the 80s, you will find that they pale in comparison with U.S. biofuels support (e.g., by 2000, before ethanol was used in any scale of five years before the RFS, the Government Accountability Office (GAO) said that these subsidies had topped $11 billion.)

The only things that a purist would consider “subsidies” are credit lines that the Brazilian Development Bank (BNDES) provides to finance new projects and lower sales tax rates in some states. The financing is provided on a competitive basis – domestic or foreign investor – and the interest rates are close to 10% per year, far higher than any rates offered in the U.S. In other words, if high interests are subsidies, hell, we’re guilty. Also, some Brazilian states (3 of 27) charge a lower VAT (Value Added Tax) on hydrous ethanol sold to Flex-Fuel cars compared to VAT imposed on gasoline at the pump. That’s a savings to consumers in that state and does not apply to ethanol exports.

People love to criticize subsidies as all bad. That is not necessarily the case. Alexander Hamilton made a compelling case for subsidies for nascent industries in 1790. The problem is when the subsidy spigot is not turned off after its done its job.

Clearly the government support has helped make this nascent industry a very successful one – and we’re not talking about the mandates. The U.S. is by far the world’s largest ethanol producer, about twice that of Brazil, the world’s second largest producer with about 6 billion gallons last year.

So, after 30 years of support, the question is: Should the U.S. government continue to protect the world’s largest ethanol industry from competition?

We think consumers would benefit from choice. Sugarcane ethanol is a clean and affordable renewable fuel that saves money at the pump, reduces U.S. dependence on oil from our enemies and, as the U.S. Environmental Protection Agency confirmed, reduces greenhouse gas emissions by over 60% compared to gasoline.

My own position on the matter is this. As I have argued before, with the RFS in place we don’t need a VEETC to reward oil companies for complying with the law. However, if we do have a VEETC in place, then a tariff equivalent to the VEETC does serve to prevent U.S. tax dollars from subsidizing imported ethanol. In 2010, that would mean a tariff of $0.45/gallon to offset the $0.45/gallon VEETC – but this is at the expense of taxpayers, consumers, and ethanol exporters because it thwarts competition. Further, if there are legitimate subsidies being granted by the Brazilian government that lower the cost of production there, a tariff to offset that may be warranted. I have yet to see any firm evidence of these subsidies, though.