Demand for corn ethanol is raising food prices. What's needed is a policy change.
FORTUNE -- After 30 years of government largesse that would have made even Nancy Pelosi blush, Congress in December let expire the roughly $6 billion annual subsidy for corn ethanol. That's bad news for the big refiners that were paid 45¢ for each gallon of corn ethanol they blended into gasoline supplies. But it's good news for those worried about the "food-fuel dilemma" when the demand for corn to make ethanol has been raising the price of some foods.
Not so fast. It turns out that while the subsidies are gone, U.S. law still requires oil refiners to blend corn ethanol into fuel -- some 12.5 billion gallons this year and at least 15 billion gallons by 2015. That's still a small portion compared with the 133 billion gallons of gasoline that the U.S. Energy Information Administration estimates Americans will burn this year, but nonetheless enough to keep upward pressure on corn prices. That law needs to change, argues Jeremy Grantham -- who oversees nearly $100 billion at his Boston investment firm, is known for calling both the dotcom and housing bubbles and is an environmentalist to boot. "It [U.S. ethanol policy] is truly diabolical," he says. "The subsidy was decoration. The mandate is the villain here."
Those mandates have been working all too well. Over the last decade the U.S. jumped past Brazil to become the world's top ethanol producer. Some 40% of the U.S. corn crop, the world's largest, is now used for fuel and byproducts. The irony is that a study done at Princeton suggests that corn ethanol does little to reduce greenhouse gas compared with gasoline. It has helped the U.S. reduce its dependence on foreign oil, but with new sources of domestic oil coming online, the role of corn ethanol in achieving national energy security will become less significant.
Those aren't the only reasons Grantham, 73, gets upset. How can we even consider using a food crop like corn, he argues, for fuel? He has calculated that ethanol demand increases the global price of a bushel of corn by 20%. "It inflicts unnecessary pain on anyone who eats," Grantham laments. "And one day people will starve because of it." Not surprisingly, the agriculture lobby disagrees with Grantham's assessment, contending that the price increase is minimal.
There is hope. A next-generation ethanol called cellulosic, made from nonfood feedstocks such as switchgrass and wood chips, could solve the problem, says Grantham. He advocates scrapping the mandate for corn-based ethanol while leaving one in place that favors cellulosics. Dozens of companies have struggled mightily for years to produce this kind of ethanol affordably and at scale. (Grantham himself has invested in one, New Hampshire-based startup Mascoma.) The question is whether the technology will arrive soon enough to make a difference in world hunger.
This article is from the February 6, 2012 issue of Fortune.
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