The Impact of Alternative Domestic and Trade Policies for Biofuels on Market

Variability in the United States

Yuki Yano (SLU), David Blandford (Penn State), and Yves Surry (SLU)

The Economics of Alternative Energy Sources and Globalization: The Road Ahead, Orlando, Florida

11/17/2009

Background

• Increasing attention on biofuel use

• Tighter linkage between agricultural commodity markets and energy markets (Tyner and Taheripour 2008)

• The impacts of biofuel policies on agricultural markets, energy markets, the environment, and social welfare

Existing Studies

• Little literature on the impact of multiple policy instruments (de Gorter and Just 2008, 2009; FAPRI-MU 2009)

• Limited attention on the impact of variability in petroleum price and feedstock supply (Thompson et al. 2009)

• The impact of trade policies for biofuels on market variability has not been assessed

Objectives

• Analyze the implications of U.S. domestic and trade policies for biofuels for market variability (corn price and ethanol use)

• Focus on how changes in policy measures influence U.S. market variability

• Variability: unanticipated (short-run - annual) fluctuations in the domestic supply of feedstock (e.g., weather) and/or the price of petroleum

Policies (No Trade in Biofuels)

• Domestic policy options– Tax credit for blending ethanol with gasoline

(fixed in the short-run)

– An ethanol blending or consumption mandate

• Trade policy– Prohibitively high duties on imported ethanol

Policies with Trade in Biofuels

• Domestic policy options– Tax credit or production subsidy (only for

domestically-produced ethanol)

– An ethanol blending or consumption mandate

• Trade policy– Non-prohibitive tariffs

1. A specific tariff (fixed in the short-run)

2. An ad valorem tariff (fixed in the short-run)

3. A variable tariff (counter-cyclical)

Key Assumptions for U.S. Markets

• Exogenous world oil price

• Perfect substitutability between ethanol and gasoline

• Constant returns to scale in ethanol production

• Competitive markets

• Fixed aggregate non-ethanol demand for corn and fixed mixed fuel demand in the short-run

• Multiplicative inverse corn supply shifts

U.S. Corn and Energy Markets

U.S. Corn and Energy Markets

A Binding Mandate (No Trade)

Ethanol Use Exceeds the Mandate

The Impact of Policy Changes

• As the likelihood that the mandate becomes binding increases, variability in ethanol use declines, the impact of fluctuations in petroleum price on corn price is reduced, and the impact of fluctuations in corn supply on prices is accentuated

• The likelihood of a binding mandate increases as:a. The level of tax credit is reduced

b. The mandated ethanol use is increased

The Impact of Policy Changes

• Thus, the impact of changes in biofuel policy on corn price depends on the relative magnitudes of world oil price and corn supply shocks

• When fluctuations in oil prices are relatively large, an increase in the level of tax credit or a decrease in the mandated ethanol use is expected to result in higher variability in corn prices and vice versa

• When fluctuations in corn supply are relatively high, increased variability in corn prices will result from reducing the tax credit or increasing the level of the minimum requirement and vice versa

Key Assumptions for The Trade Model

• Imported ethanol available from Brazil

• A two-country model (U.S. and Brazil)

• Exogenous world oil price

• Stable supply of sugar cane

• Ethanol mandate in Brazil

• Consumer price of ethanol is lower than gasoline price (70% of domestic gasoline price) in Brazil

Brazilian Ethanol Market

Import Supply Curve in the U.S.

Oil Price and Import Supply

U.S. Ethanol Use Exceeds the Mandate

The Binding Mandate with Imports

The Impact of Corn Supply Reduction

The Impact of Oil Price Reduction

The Impact of Policy Changes• If the import supply curve is not affected by

world oil price– Again, as the likelihood that the mandate becomes

binding increases, variability in total ethanol use declines, the impact of variations in petroleum price on corn price is reduced, and the impact of variations in corn supply on prices is accentuated

• The likelihood of a binding mandate increases as:a. The tax credit is reducedb. Mandated ethanol use is increasedc. The tariff is increased

The Impact of Policy Changes• The impact of corn supply fluctuations on corn

prices under a non-prohibitive tariff is less than under a prohibitive tariff

• Fluctuations in the world oil price could affect corn prices, even when the U.S. ethanol mandate is binding, through changes in the minimum supply-inducing price for imported ethanol

The Impact of Policy Changes

• If oil price and domestic corn supply affect corn prices simultaneously under a mandate, variability in corn prices could be high

• Policies in supplying countries also influence U.S. market variability - e.g., the level of mandates in Brazil

Specific VS Ad Valorem Tariff• When the aggregate quantity of ethanol used

in the United States exceeds the mandate, it is less susceptible to fluctuations in petroleum prices under an ad valorem tariff than under a specific tariff

• With a binding mandate fluctuations in domestic corn supply have a larger impact on corn prices under an ad valorem tariff (compared to a specific tariff)

A Variable Tariff• The use of a variable tariff for imported

ethanol (one that varies inversely with the price of ethanol) could stabilize corn prices with a mandate, but could also lead to increased variability in world ethanol prices

Conclusions• The mechanism of price transmission is

complicated, in particular when imports are allowed

• Factors influencing market variability and their impacts depend not only on domestic and trade policies for biofuels but also on policies in supplying countries

• Further analysis is needed for stabilization policy