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Behind the Ethanol Scandal

Dana Blankenhorn

NEW YORK (TheStreet) -- Something about this decade's economic assumptions has never made sense to me.

The idea that you can anticipate a high and rising price for fuel, regardless of demand, never made sense to me.

What I was taught in economics class was that demand encouraged supply, and at some point the two would balance.

That's what seems to be happening. Shale oil, shale gas, and new strikes around the world are dramatically increasing gas supplies and proven reserves, to the point where one-third of natural gas being pumped in North Dakota's Bakken is being flared, burned away, $100 million in gas a month.

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North Dakota's Department of Mineral Resources explained this happens only when the oil flow from a well is being tested. Or, if a producer determines it "is not economically feasible" to connect the gas in a well to a pipeline, they may "seek relief" from paying taxes and royalties on it.

If something is not "economically feasible," doesn't that mean the market has cleared at a price below the cost to bring on production? At its current price of $3.67/MCF, according to the latest report on Investing.com, it's still not economically feasible.

Prices below production costs have long been the problem with ethanol. The Renewable Fuel Standard was created to bridge this gap, enabling production. The idea that traders may be exploiting this program is separate from the question of supply and demand. You wanted supply and you got it. Genetic engineering is coming to the rescue of fuel prices.

A bumper corn harvest, driven by genetically engineered seeds, is driving ethanol prices below those for unblended gasoline. This pressure is going to increase next year.

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Ethanol Producer writes that cellulosic alcohol projects, which don't require food crops as fuel, are starting to come on-stream.

Science & Enterprise writes that non-fuel crops like castor beans, genetically engineered to be used as fuel, are also heading to market.

Venture-funded start-ups like Midori Renewables are preparing new catalysts that get even more fuel sugar from existing feedstocks.

So the only recourse left to oil advocates is to attack the the Renewable Fuel Standard that created all this abundance. Take away the bridge, chop off ethanol supplies at the source, and the price pressure on refiners and oil producers may abate.

Issues that appear political are often just economic, and that's the case here. Ethanol, with government aid, is now putting downward pressure on gasoline prices, and the producers of that fuel are howling about unfair competition.

But take away the market pressure of ethanol, do away with the Renewable Fuel Standard, flare enough gas in enough fields, and the market clears at the higher prices fossil fuel producers have built into their own economic models.

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The lesson should be clear. The economic assumptions of this decade are wrong. There is a limit to how high natural gas and gasoline prices can rise before the market bites back. Now that this has happened, producers are squealing like stuck pigs.

Is the answer to give the old-line producers the political power they need to drive new supplies from the market so that they can keep raising costs and prices? Or is it to see that squealing as a victory and increase the pressure, forcing a permanent re-examination of the fuel industries' cost structures?

The answer to that one, I think, is obvious. The war against oil is being won, and now is the time to go in for the kill.

At the time of publication, the author owned no ethanol stocks.

This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.

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