Coop's Corner

This guest post is from venture capitalist Vinod Khosla, writing a rebuttal to pointed accusations flung at him from the Wall Street Journal in an editorial titled "Khosla's Conspiracy." He wants to set the story straight on where he stands with biofuels, government subsidies, and their link to the global food crisis.

Vinod Khosla

(Credit: Kleiner Perkins Caufield & Byers)

To my surprise, this morning I found myself cited by the Wall Street Journal as a strong advocate of subsidies for food-based ethanol, and as a recipient of "federal dole" who ought to "take a vow of embarrassed silence." While I appreciate the Journal's foray into fiction writing (and I'd love to discuss my status on the dole with my accountant, who recently filed my taxes), I would like to clarify a few of the facts and offer a more rounded view of biofuels and ethanol in general.

A few facts:

I have not advocated subsidies for food-based ethanol. In fact, I strongly believe any nascent technology that cannot exist without subsidies beyond an introductory period will not gain market penetration and is not worth supporting. I have consistently argued that food-based ethanol cannot scale beyond roughly 15 billion gallons or so in the US, and that making a material impact on replacing oil requires cellulosic or other advanced biofuels. The corn ethanol subsidies that exist today were part of the 2005 Energy bill, a time when I had no contacts with Washington.

Moreover, I look forward to the WSJ's complaints about oil's subsidy bonanza, from tax breaks for drilling, loopholes that allow royalty-free offshore oil leases, manufacturing tax breaks, as well as roughly $7 billion in subsidies in the wake of the Katrina disaster. At a recent WSJ Conference, 75 percent of its erudite audience "voted" (rightly) that oil was more highly subsidized than ethanol.

It is clear that corn ethanol has served as a stepping stone for cellulosic ethanol and other biofuels, mitigating risk and establishing a market. As a venture capitalist, I would not have invested in cellulosic without corn ethanol's partial alleviation of the risks of creating a market, creating distribution terminals, E85 pumps and starting our flex-fuel fleet. Cellulosic ethanol uses nonfood feedstocks with significant greenhouse gas emission reductions, and the first commercial-scale plant is being built today in Soperton, Ga. Many other nonfood-based biofuels companies will be in the market in the next five years. Should we not look past our noses to the larger issues of dependence on oil?

While corn prices certainly have some impact on biofuels, their impact is constantly overstated by sources like the WSJ. In fact, they would do well to see what the USDA has actually said on the subject. USDA Chief Economist Joe Glauber noted Monday: "On the international level, the President's Council of Economic Advisors estimates that only 3 percent of the more than 40 percent increase we have seen in world food prices this year is due to the increased demand on corn for ethanol."

As the USDA noted previously: "Given that foods using corn as an ingredient make up less than a third of retail food spending, overall retail food prices would rise less than 1 percentage point per year above the normal rate of food price inflation when corn prices increase by 50 percent." Have the editors at the WSJ not been reading the press since they cited the USDA as evidence against me in their op ed? I do believe the UN officials they cite are misinformed and have not done a full food and fuel cost analysis.

I know the American Petroleum Institute (API) has previously engaged in campaigns against corn ethanol, but the current campaign is run by the Grocery Manufacturers Association. In fact, based on presentations at the recent WSJ conference, the API and I have similar views on next generation nonfood-based fuels, though our assessments of timing may differ. We do have shared investments with oil companies.

What is responsible for the bulk of the food price increase? Principally soaring energy costs, increasing demand and droughts in certain countries amongst others. The WSJ fails to note the impact of higher energy prices on food prices: a 2007 study by John Urbanchuk at LECG suggests that increases in petroleum prices have two to three times the impact than increases in corn prices have on the food Consumer Price Index (CPI) alone.

Furthermore, ethanol has played a significant role in reducing costs for consumers elsewhere. Merrill Lynch has estimated that oil prices may be up to 15 percent higher than current levels if not for ethanol. What impact might the withdrawal of biofuels and higher oil prices have on food prices? As noted in a press release issued by the USDA on Monday: "According to the International Energy Agency, the biofuels production that has been available to the United States and European markets over the last three years has cut the consumption of crude oil by one million barrels a day. At today's prices, that's a savings of more than $120 million per day."

In the recent Farm Bill discussions, I have consistently advocated for higher cellulosic biofuel mandates over subsidies. Mandates reduce the ability of any specific party to manipulate or hinder the market by limiting access to biofuels. With regards to these mandates, I have proposed an adjustable Renewable Fuel Standard (RFS) that can go up or down every year, depending on the availability of cellulosic fuels at a fair market price like $2.50 per gallon (more than a dollar below today's gasoline prices). Such a "price capped cellulosic RFS" approach protects consumers by offering them an effective ceiling, while offering investors and producers assurance that all cellulosic fuels that are produced at these reasonable prices will be mandated.

My calculations, available here show that it is conceivable that not one additional acre of land may be needed to replace our gasoline under certain circumstances, but even in more conservative scenarios, the amount of land needed is small. Further insurance to ensure that greenhouse gas reductions from biofuels are significant can come from giving incentives (the carrot) to developing countries to reduce deforestation and providing a stick of banning biofuel (and maybe all agricultural exports) from countries that don't meet deforestation reduction targets.

While I am certainly an advocate of biofuels, it is vital that we understand that biofuels themselves have differences--we can do them poorly, or we can do them right. We cannot discuss drugs without differentiating between cocaine and aspirin. Criticism of biofuels is certainly fair game (such as palm oil-based biodiesel from Indonesia's rainforest, which actually hurts the environment more than it helps it), but there is an obligation to stick to the facts. Unfortunately, today's editorial failed to meet even this basic threshold.