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Biofuel Economics: How Will $700 Wall Street Bailout Affect Biofuels Industry - Part II

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Cole Gustafson, NDSU Biofuels Economist Cole Gustafson, NDSU Biofuels Economist
Oil prices have fallen by more than half since July as the severity of Wall Street’s problems became more apparent.

By Cole Gustafson, Biofuels Economist

NDSU Extension Service

Earlier this month, President Bush signed into law the Emergency Economic Stabilization Act (EESA) of 2008. It provides $700 billion to Wall Street lenders affected by the home mortgage crisis. In a previous column, I discussed a number of key provisions in the legislation that extend and enhance a number of provisions benefitting the biofuels industry.

There are two significant laws in EESA. A new provision enables facilities that produce cellulosic biofuels to write off their original investment more rapidly. The provision establishes a $20 per ton market for carbon that is stored permanently.

These provisions directly affect the biofuels industry. However, what is the indirect impact of the legislation’s $700 billion cost? There are several key implications that must be considered.

The huge cost of the bailout is going to be a drag on the U.S. economy. This will result in a lower gross domestic product and growth. I attended a meeting where the president of the Kansas City Federal Reserve Bank said he expected the growth of the U.S. economy to be slower than expected for the next decade. The bank’s research department has been busy studying the effects of prior Wall Street problems, such as Penn Square Bank’s failure in 1982, as well as similar financial sector problems in Europe and Japan. Most of the downturns occur because large government financing leads to higher deficits and inflation.

I don’t believe the economy will be affected this long. The root of this problem is in credit markets, not labor or product markets that previously caused recessions. Credit markets are very efficient and respond quickly to positive news. Monetary policy usually takes six to 12 months before its effects are felt in the economy. With a $700 billion infusion from the bailout, plus another potential $150 billion from a second stimulus package, the U.S. economy should be turning around next spring.

As the U.S. economy slows, demand for gasoline and ethanol turns lower. Oil prices have fallen more than half since mid-July as the severity of Wall Street’s problems became more apparent. Lower market prices for ethanol will directly reduce ethanol plant profitability. Corn prices are falling due to a higher U.S. exchange rate, which makes our exports more expensive overseas. This slows the economies in foreign countries that don’t have the cash reserves to purchase our commodities. Therefore, ethanol plants are focusing on margins and risk management – trying to determine whether oil or corn prices are going to fall more rapidly.

Finally, financing for new biofuel plants will be more difficult to obtain. Financing for the biofuels industry already was scarce before Wall Street’s problems became evident. As new regulations and credit underwriting standards are imposed on U.S. financial institutions, credit no doubt will face greater regulation, be more difficult to obtain and increasingly expensive. As a niche investment segment, this especially will be problematic for the cellulosic biofuels industry. This industry is on the verge of large-scale commercialization of new technologies that are being evaluated in pilot scale facilities. A limited supply of new investment capital may slow the growth of the entire biofuels industry.

While the specific tax credits and extensions targeted towards the biofuels industry are beneficial in the tax relief act, the bottom line is that the overall slower growth of the U.S. economy may cast a cloud on biofuel margins, profitability and industry expansion.


NDSU Agriculture Communication

Source:Cole Gustafson, (701) 231-7096, cole.gustafson@ndsu.edu
Editor:Rich Mattern, (701) 231-6136, richard.mattern@ndsu.edu
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