The biofuels industry in the U.S. has experienced exponential growth in recent years, due in part to the increase in gasoline prices and federal production incentives. The use of ethanol as a motor fuel in the U.S. has grown at an annual average rate of 25% over the past several years, with U.S. overall production of ethanol hitting 9 billion gallons in 2008. Even with this growth, ethanol still remains a small contributor to the U.S. energy supply, and has come under recent heavy criticism for, among other things, possibly increasing the price of food around the globe and having a smaller-than-expected effect on greenhouse gases. Second-generation cellulosic ethanol has been proclaimed as the green fuel of the future, but it is unclear whether cellulosic ethanol can be produced on a commercially viable scale.  

Corn-based Ethanol  

Ethanol is traditionally derived from the fermentation of sugars in corn and sugarcane, with corn accounting for 98% of the feedstock for ethanol in the U.S. Corn-based ethanol can be produced in the U.S. on a cost-effective commercial scale. According to the Renewable Fuels Association, there are around 170 biorefineries in production in the U.S., with a vast majority of these projects using corn as the main feedstock.  

The process of turning feedstocks into ethanol requires the input of a large amount of water, fertilizer and energy, which critics argue negates any greenhouse gas benefits. Recent studies have found that replacing traditional fossil fuels with ethanol from sugar cane produces a substantial reduction of 80% to 100% in net greenhouse gases.  

Corn-based ethanol production has also been the subject of recent criticism, due to the possible link between its production and increased food prices. According to a recent report from the Congressional Budget Office (“CBO”), the increased use of corn-based ethanol as a motor fuel accounted for 10 to 15% of the rise in U.S. food prices between April 2007 and April 2008. This increase in retail food prices is due to higher feed prices for cattle, hogs and poultry. The CBO reports that one-quarter of all corn grown in the U.S. is used to produce corn-based ethanol.  

The recent crisis in the financial markets has put a great deal of pressure on ethanol producers, due to shrinking profit margins. Ethanol producers have also had to contend with high volatility in the price of corn over the past several years.

Further, due to the contraction of credit in the financial markets, producers in the industry have been unable to obtain sufficient injections of debt or equity to stabilize their operations. As a result, VeraSun Energy Corporation and Aventine Renewable Energy Holdings, Inc., which are among the largest ethanol producers in the U.S., declared bankruptcy in early 2009.  

Cellulosic Ethanol  

Cellulosic ethanol, a second-generation ethanol, can be created from all types of organic materials. Cellulosic ethanol is made by releasing sugar enzymes from cellulose using enzymes, steam or other processes. These sugars are then fermented to produce ethanol. Cellulosic ethanol may be produced from feedstocks that are not usually used as food, including corn stover (the stalk and leaves after the grain has been harvested), straw, grasses, wood and nonedible plants.  

Studies have found that net greenhouse gas emissions from cellulosic ethanol are substantially less than ethanol produced from corn. Recent findings by the Argonne National Laboratory suggest that increased use of cellulosic ethanol, combined with continued use of corn-based ethanol in place of gasoline, in the amounts specified in the Energy Independence and Security Act of 2007 (“EISA”) could reduce greenhouse gas emissions by as much as 130 million metric tons of carbon dioxide by 2022. Cellulosic ethanol can reduce greenhouse gas emissions even further if the feedstock comes from wood or perennial grasses, such as switchgrass, grown on non-agricultural land.  

Greenhouse gas emissions benefits aside, cellulosic ethanol is currently more expensive to produce than corn ethanol and traditional fossil fuels. According to a recent report from the Scientific Committee on Problems of the Environment, the cost of producing cellulosic ethanol is estimated at $102 per barrel of crude oil equivalent. Thus, at today’s crude oil prices of around $62 per barrel, cellulosic ethanol is currently not cost competitive with other forms of energy in the market without the development of new cost-efficient technologies that could drive down the price.  

Federal Government Incentives  

Increased production of ethanol in recent years has been driven by federal research grants and federal mandates for specific quantities of biofuels in gasoline. The renewable fuel standard (“RFS”) program was established by the Energy Policy Act of 2005 (“EPAct”) and was further modified in EISA. EISA requires that an increasing amount of renewable fuels, including advanced biofuels and cellulosic biofuels, be blended into U.S. transportation fuels each year. EISA calls for increasing the standard to 9 billion gallons in 2008, with further incremental increases each year, which culminate in 36 billion gallons of renewable fuel to be produced in the U.S. by 2022. EISA increases the mandate for advanced biofuels, which are fuels derived from cellulose, hemicellulose or lignin, to 6 billion gallons by 2009, with an increase to 21 billion gallons by 2022. EISA also includes a special provision for cellulosic biofuels that mandates the production of 1 million gallons by 2010 and 16 billion gallons by 2022. The Environmental Protection Agency Administrator is given the authority to temporarily waive part of the biofuels mandate, if it were determined that a significant renewable feedstock disruption or other market circumstance might occur.  

The American Recovery and Reinvestment Act of 2009 (“ARRA”) contains a number of provisions designed to spur growth in biofuels. ARRA extends the production tax credit for qualified biomass projects that are placed in service before January 1, 2014. The bill also permits taxpayers to elect a 30% investment tax credit in place of the production tax credit for biomass projects placed in service after December 31, 2008, and before January 1, 2014. Alternatively, taxpayers are permitted to receive a grant of up to 30% of “qualified facilities,” which include biomass projects, from the U.S. Department of Treasury, in lieu of tax credits for projects placed in service (i) in 2009 or 2010 or (ii) after 2010 but before the placed-in-service deadline for the facility, if the construction of the facility began during 2009 or 2010.  

The federal government has also provided production subsidies and import tariffs for ethanol. Since 1978, companies that blend ethanol with gasoline receive a tax incentive from the federal government. Today, this incentive amounts to a tax credit of 45 cents for each gallon of ethanol blended into the supply of gasoline. Additionally, a production subsidy for ethanol applies to both domestic and imported ethanol. The U.S. charges importers of ethanol a tariff of 45 cents per gallon and an ad valorem tariff of 2.5% of the value of the imported ethanol. These two tariffs offset the production subsidy for imported ethanol unless the imports arrive duty-free.  

In addition to providing tax credits and grants, ARRA expanded the Department of Energy’s loan guarantee program that was originally enacted under EPAct. The loan guarantee program now provides $6 billion of loan guarantees for projects such as leading-edge biofuels projects. Leading-edge biofuels projects are likely to become commercial technologies and will produce transportation fuels that substantially reduce life-cycle greenhouse gas emissions compared to other transportation fuels. ARRA also provides an additional $2.6 billion to be spent on renewable energy and energy-efficiency demonstration and deployment activities, including biofuels.  

Finally, in the 2008 Farm Bill, the Department of Agriculture was authorized to establish the Biorefinery Assistance Program. This program offers loan guarantees of up to $250 million per project to fund commercial-scale biorefineries and grants for up to 30% of the project cost for demonstration-scale biorefineries that produce advanced biofuels or any fuel that is not corn-based.  

Near-Term Prospects  

In the absence of a technological breakthrough leading to substantial cost efficiencies, the economic viability of corn-based ethanol is dependent on the price of gasoline, the price of corn and the continuation of federal government incentives. According to the CBO, without current federal government subsidies, the breakeven ratio of the price per gallon of gasoline to the price per bushel of corn is about 0.9. This means that when the price of a gallon of gasoline is above 90% of the price of a bushel of corn, it is profitable to produce ethanol.  

The CBO also found that, without federal government incentives, ethanol producers would have only been profitable once, in 2005. However, the production of ethanol could become more profitable in the future as petroleum becomes more expensive due to lack of supply and corn’s yield per acre increases due to new technology. Much of this profitability depends on the continuation of federal policies promoting ethanol, especially the current subsidy of 45 cents per gallon of ethanol produced, but it remains unclear what impact recent criticisms of corn-based ethanol will have on future federal government support.  

The Obama administration has advocated cellulosic ethanol as an alternative to corn-based ethanol. During a recent press briefing, President Obama said that it is “important for us to transition to the next generation of biofuels, that we’ve got to do a much better job of developing cellulosic ethanol, that corn-based ethanol, over time, is not going to provide us with the energy-efficient solutions that are needed.” President Obama also appointed vocal cellulosic ethanol supporters to key positions in his administration, namely, Dr. Steven Chu as the Secretary of the Department of Energy and Governor Tom Vilsack as the Secretary of the Department of Agriculture.  

Even though the Department of Energy’s loan guarantees are limited to $500 million per biofuel project, the expansion of this program to include leading-edge biofuels projects may do a great deal to aid the development of cellulosic ethanol projects. However, it must be noted that, to date, the Department of Energy’s loan guarantee program has not been effective, due to underutilization. Indeed, the Department of Energy’s loan guarantee program has only funded one project since its enactment under EPAct. On the other hand, the Biorefinery Assistance Program run by the Department of Agriculture has been successful. In January 2009, the program awarded Range Fuels, Inc., a conditional commitment for an $80 million loan guarantee to assist in the construction of a commercial cellulosic ethanol plant in Georgia.  

Although it can be reasonably anticipated that federal incentives will help drive the development of cellulosic ethanol, the future of cellulosic ethanol ultimately rests on whether cellulosic ethanol projects can be produced on a commercially viable scale. In what may be viewed as a turning point, major energy corporations, such as Royal Dutch Shell and BP, have recently entered the cellulosic ethanol fray. Royal Dutch Shell announced a new agreement with Codexis to develop super enzymes that will break up starchy feedstock more quickly and on a more cost-effective basis. BP has also partnered with Verenium Corp. to build a full-scale cellulosic ethanol plant in Florida. This plant will likely be among the first full-sized next-generation biofuels refineries in the U.S. and is expected to produce 36 million gallons of cellulosic ethanol a year, starting in 2012.  

Ultimately, cellulosic ethanol has a bright future due to the influx of recent investments and continuation of federal government incentives. However, cellulosic ethanol will need technological breakthroughs that lead to substantial cost efficiencies in order to capture a greater share of the U.S. energy market.