Green Ethanol's Dirty Fuel and the Positive and Negative Externalities

GREEN ETHANOL'S DIRTY FUEL As natural gas prices rise, some ethanol producers are using coal — a move critics say doesn't add up

http://www.twincities.com/mld/twincities/news/columnists/16834568.htm

In this article, the ethanol producers in Minnesota are using coal to produce ethanol. This is ironic because the plants are using a method that produces more green house gases, not to mention other negative externalities, in an attempt to reduce greenhouse gases. Negative externalities are the effects on a third party that has resulted from a transaction between two other parties. (see graph MSC/MSB curves for negative externalities) The original plants used natural gas as a fuel source to produce ethanol but in this case, natural gas plants are using coal to power their plants because natural gas is too expensive. By using coal, the plant's costs are cut but much more green house gases are produced not to mention the other harmful metals and substances that are produced in the burning of coal.

The government could subsidize the natural gas industry and thereby increase the supply of natural gas and allow for the price of natural gas to decrease. (see graph: Market of Natural Gas Subsidized to Increase Supply) A subsidy is when the government feels that a certain good is being under produced and essentially funds the firm to produce more of that good. The government should subsidize natural gas because that would increase the amount of ethanol produced with minimum negative externalities, which is good for everyone because ethanol is a merit good. Merit goods are goods that are under provided by the market and therefore under consumed by consumers. Ethanol would have positive externalities on society by decreasing the amount of greenhouse gases produced, decreasing the global dependence on fossil fuels and increasing the longevity of the supply of the fossil fuels. This subsidy would make natural gas more available to the power plants and result in an increase in demand for natural gas because of its decrease in price. This subsidy would enable the natural gas producers to better manage their costs and perhaps open a new natural gas plant to combat their increased costs thereby permanently decreasing their diseconomies of scale. Once the new natural gas plant was operational then the government could withdraw their subsidy because the new plant, with the old plant, would keep costs low. (see graph: Short Run and Long Run Average Total Cost Curves For Natural Gas Producers) This would also be beneficial to the natural gas industry by increasing competition with the coal industry and perhaps taking some of the consumers of coal because natural gas is a substitute and even if it may be a little more expensive than coal, the new lower prices and the fact that natural gas is cleaner burning than coal make it competitive.

The government could also create tradable pollution permits to decrease the amount of negative externalities. Tradable pollution permits are permits created by the government that dictate how much pollution a firm can produce. (see graph: Pollution Permits to regulate greenhouse gases) These permits are auctioned off so their price is determined by the demand of the firm. By auctioning off the permits then government not only creates revenue for itself but also sets a limit on the amount of pollution that could be produced. Through this method firms that wish to switch to natural gas to lower their emissions could then sell their permits to the firms that are still using coal to power their production of ethanol. If this method were to be used in conjunction with the government subsidizing the natural gas plants to increase supply of natural gas and let it be more readily available than coal, or at least more than it was before, then more firms would willingly switch to natural gas and sell their extra permits to the firms that still use coal. If at some point there was a surplus of permits because more firms have switched to natural gas then the government could buy up those surplus permits and therefore permanently decrease the amount of pollution.

Therefore, to solve the problem of ethanol producers using coal instead of natural gas, the government can internalize the externalities by using a subsidy for the natural gas producers to simultaneously decrease the negative externalities caused by burning coal and to increase the positive externalities by producing ethanol. An improvement upon this solution is that the government creates tradable pollution permits for the ethanol producers and because natural gas doesn’t pollute as much as coal does, then the firms can produce more ethanol because they burn more fuel.