In the 1980s, Congress, searching for domestic energy supplies, created incentives in the form of production tax credits for ethanol and for unconventional natural gas.

The history of those two programs, and the current state of affairs in the energy world, speaks volumes about the relative merits of these two fuels.

Tax-paying capitalists find tax credits highly motivating. Whereas deductions reduce your taxable income, and so are worth maybe 35 cents on the dollar, a tax credit is a direct dollar-for-dollar saving off your tax bill.

The ethanol tax credit of about 54 cents per gallon has been in place continuously since 1984. Despite a 2007 Congressional mandate to ramp up ethanol consumption dramatically, the product is floundering in the marketplace, falling well short of Congress’s wishes.

Facing the scheduled year-end 2010 expiration of their vital tax credit, ethanol processors have opened up their wallets. They’ve hired a former Democratic Presidential candidate, Gen. Wesley Clark (ret.) as co-chairman of a new trade group, Growth Energy. They’ve kicked off a $2.5 million TV ad campaign to help change the public perception of their “green” but underperforming fuel. The ultimate strategy is to lobby the EPA to mandate an increase in the percentage of ethanol in gasoline, from 10% to 15%, the marketplace be damned.

Likewise, the unconventional natural gas tax credit also began in the early 1980s. To combat planners’ fears that conventional gas supplies were limited, the “Section 29″ credit hoped to spur research and development of new technologies to enable production from “unconventional” sources: gas from low-permeability, or “tight” sands, gas from shale, and gas from coal seams. The credits applied to wells drilled before 1992. Those wells earned 50 cents to one dollar tax credit per thousand cubic feet of production through the year 2002. Thousands of wells were drilled, and new technologies were developed, spurred on by the additional economic incentive the credit offered. Today, eight years after the last tax credit dollar, some 40% of natural gas production comes from the unconventional sources made possible by the tax credit’s R&D.

The “Section 29″ natural gas credit was an unqualified success. By any objective (i.e., non-political) measure, the ethanol program has been a bust. The difference is a reflection of the properties of the respective fuels. Natural gas production is a net energy gain process that has benefited from the application of new technologies (seismic exploration, horizontal drilling, hydraulic fracturing), thereby enabling large scale leaps in efficiency. Corn ethanol, on the other hand, is inherently inefficient, possibly even a net energy loss. Incremental gains may be made in processing or in crop yields, but it is impossible to make the same kind of gains as have been seen in natural gas in recent years.

Bottom line, the R&D helped, but natural gas doesn’t need tax credits to be economic. Corn-based ethanol can’t survive without them.

Conservatives, liberals and environmentalists alike are skeptical about ethanol’s economic and environmental benefit, particularly in the case of the corn-based product: to conservatives, it’s another Climate Change boondoggle, to liberals it’s corporate welfare and “food for fuel”. Environmentalists decry the soil depletion and the watershed damage of large scale corn agriculture. It is foolish and wasteful for our government to mandate the use of an inferior fuel in spite of its well-known engineering, economic and environmental shortcomings.

Cross-posted at VladEnBlog.