President Barack Obama greets President Lula da Silva of Brazil on March 14, 2009 in the Oval Office.

Ed. Note: Robert Rapier writes the R-Squared Energy Blog, one of the best blogs on the Web. He recently published this piece on ethanol tariffs. It is reprinted here with his permission.

Note that in the following essay, I am not trying to come down either for or against ethanol tariffs, but rather to discuss what I see as the key issues surrounding them. U.S. energy policy is slanted to favor U.S. farmers and ethanol producers, and I am merely trying to explain the tariffs within that context.

You are probably aware that the U.S. imposes a $0.54/gallon tariff on ethanol that we import from Brazil. Brazil's President Luiz Inacio Lula da Silva met with President Obama last week and implored him - in the name of a better environmental policy - to remove the "absurd tariffs on ethanol." In response President Obama said the situation is "not going to change overnight."

Brazil wants help lifting US ethanol tariffs

Brazil is a world leader in biofuels and the world's largest exporter of ethanol. But Silva, who met with President Barack Obama on Saturday, has made little progress persuading the U.S. to reduce the tariffs, which are in place to protect American farmers who make ethanol from corn. Brazil makes ethanol from sugar, in a process that is much more efficient and costs less.

By all accounts, ethanol from sugarcane is a more sustainable model than ethanol from corn. The key to this - as I explained here - is that a true waste product (bagasse) is generated and used to fuel the boilers, mostly eliminating the need for fossil fuels for the production of the ethanol. So why do we penalize Brazilian ethanol? Is it pure protectionism?

While I am no fan of the perpetual subsidies we have put in place to prop up our corn ethanol industry, I think the tariffs do make sense in light of what policy-makers are trying to achieve. Gasoline blenders receive a credit of $0.51/gal (soon to drop to $0.45/gal, which should be this year since the farm bill said the credit would drop "beginning in the first calendar year after the year in which 7.5 billion gallons of ethanol is produced").

While the credit indeed goes to the gasoline blender, since it reduces their costs for ethanol, it provides an incentive for ethanol producers. That is why ethanol producers - and not gasoline blenders - are the ones who always scream the loudest when the discussion turns to removing the credit. The question on the ethanol tariff becomes "Do we want to extend that incentive to Brazilian ethanol producers?" In other words, do you want your tax dollars going to incentivize sugarcane ethanol producers?

Here is how the tariff prevents that. A gasoline blender could buy corn ethanol or sugarcane ethanol, blend it into gasoline, and get the same blender's credit in either case. Because ethanol produced from Brazilian sugarcane is cheaper than ethanol produced from corn, without the tariffs in place blenders would likely get all of the ethanol they could from Brazil. Given that this is completely contrary to the goal of creating a U.S.-based ethanol industry, the tariff makes sense in that context. One could argue the point that the tariff isn't there to punish Brazilian ethanol, but rather to prevent them from taking advantage of a provision designed to spur U.S. ethanol production with taxpayer money.

Of course the fact that the tariff is $0.54 while the blender's credit was $0.51 and quickly falling to $0.45 is a different matter. If the tariff is equal to the blender's credit, then indeed one could argue that this is merely the removal of U.S. taxpayer support from Brazilian ethanol. However, if the tariff is greater than the blender's credit, it begins to look like a punitive tariff, designed to do more than just remove U.S. taxpayer support. There is a senate bill currently under consideration to level that playing field back out:

Bipartisan Senate bill seeks lower tariffs on ethanol imports

A bipartisan group of senators is seeking to lower U.S. tariffs on ethanol imports to achieve "parity" with the blender's credit, which was reduced in last year's farm bill.

The farm bill knocked the blender's credit from 51 cents per gallon to 45 cents per gallon. A new Senate measure (pdf) is aimed at knocking down the 54-cent-per-gallon import tariff and the 2.5 percent ad valorem tariff to achieve "parity" with the lowered blender's tax credit.

Sen. Dianne Feinstein (D-Calif.), one of the sponsors, said in a statement that the higher import tariff creates a barrier for sugarcane-based ethanol from Brazil, and hence gives gasoline imports a "competitive advantage."

I don't find myself agreeing with Senator Feinstein very often on energy issues, but here I think she is correct. This is the other side of the coin. While the tariff may have the effect of ensuring that the blender's credit only goes to U.S. ethanol producers, it also has the impact of putting Brazilian ethanol at a competitive disadvantage to gasoline or crude oil imports. Is this desirable? I don't think so. To the extent that we require fuel imports, I fall into that camp of preferring to deal with Brazil over Venezuela.

So, how might I write a better policy than the one we have now but still protect U.S. ethanol producers? First, eliminate both the blender's credit and the tariffs. This removes the barriers to Brazilian ethanol, while leveling the playing field with gasoline imports. Second, given that the present policy is designed to protect U.S. ethanol producers, require that some percentage or some volume of ethanol blended into the fuel system must come from them. Third, even with the current blender's credit in place, U.S. ethanol producers are struggling to survive. If they had to sell their ethanol in a competitive (unprotected) market, they would all go bankrupt. Therefore, you have to keep the mandates in place regarding the amount of ethanol that must be blended into the fuel supply. This ensures that even if they can't compete in an open market, they still have a captive market.

Of course I have said many times that I don't favor mandates at all, nor do I think the corn ethanol industry will ever be viable in an open marketplace. However, it would be disastrous for Midwestern economies to completely pull support from under the industry. I would favor a policy in which we no longer encourage expansion of the industry, and over time phase the mandates out. This would in my opinion be the end of the corn ethanol industry, but a slow end without a shocking impact. If it isn't, and they can survive in a world without mandates, then more power to them. But if they still can't manage to live without subsidies after receiving them for 30 straight years (and even that wasn't enough, hence the mandates), why should we expect that they ever will?

Incidentally, one final note on Brazil. People sometimes ask me which countries I think have a bright future, despite the prospect of peak oil. I think it is hard to make a case that anyone is going to be better off than Brazil. They are sitting on top of huge oil reserves, they can produce ethanol very efficiently and have the infrastructure in place to utilize it, and they have good solar insolation for solar panels, solar hot water, etc. I just don't know of other country as well-positioned as they are. Not only do I think they will survive peak oil, I think they will thrive and their economy will continue to grow. That's just one of the reasons I have invested money in Brazil.