The Relative Impacts of U.S. Bio-Fuel Policies on Fuel-Energy Markets: A Comparative Static Analysis

Article excerpt

Rapidly declining gasoline prices from their record high during the summer of 2008, while ethanol prices remained relatively high, made it difficult for many bio-fuel policy modelers to fully explain the impacts of U.S. bio-fuel policies on fuel prices. Using profit-maximization models for blenders, refiners, and distillers, we conduct a comparative static-analysis to measure the relative magnitudes of the impacts of tax credits and blending mandates on fuel-energy market equilibrium prices. Our results indicate that first, the prices of all fuels including conventional gasoline, ethanol, and blended gasoline decline as the bio-fuel tax credit increases, but they increase as the rate of the blending mandate increases. Second, the shadow value of a blending mandate represents the marginal rate of substitution between the marginal price change associated with a blending mandate and the marginal price change associated with a bio-fuel tax credit. Therefore, bio-fuel policies can affect the prices of all fuels including conventional gasoline, ethanol, and blended gasoline. Finally, ethanol imports are affected by domestic blender's market-power effects, more than by the import duty imposed to offset the tax credit associated with the use of imported ethanol in the blending process.

Key Words: bio-fuel tax credits, blended gasoline, blender's market power, mandated blending, tariff

JEL Classifications: Q11, Q21, Q42, Q48

Bio-fuel related policies, such as those specified in the American Jobs Creation Act (AJCA) of 2004, the Energy Policy Act of 2005, import tariffs,1 and the Energy Independence and Security Act (EISA) of 2007 are, arguably, now much more influential policies affecting commodity and fuel-energy markets. Under the AJCA, the Federal ethanol tax incentive was set at $0.5 1 ($0.45 beginning in January 2009) per gallon of ethanol used for fuel, replacing the prior excise tax exemption with an excise tax credit (Koplow, 2006; Yacobucci and Schnepf, 2007). While the Energy Policy Act mandated a total renewable fuels requirement, allowing for ethanol and bio-diesel production substitution to meet the mandate, the EISA now mandates the volume of each bio-fuel separately. Blenders must now blend 10.5 billion gallons of ethanol in 2009, with the mandate rising to 15 billion gallons in 2015 and thereafter.2

Given the complexity and the magnitude of economic and environmental effects of U.S. bio-fuel policies, results from fuel-energy/ commodity economic models have been increasingly relevant to economic and policy discussions (de Gorter and Just, 2009a, b; Du and Hayes, 2008; Schmitz, Moss, and Schmitz, 2007; Tyner and Taheripour, 2008; Vedenov and Wetzstein, 2007; Westhoff, 2008). However, the net effects on ethanol, conventional gasoline, and blended gasoline prices of both the bio-fuel tax credit under the AJCA and the blending mandate under the EISA have not been adequately discussed in the literature.1 A major difficulty in analyzing bio-fuel policies is a lack of sufficient information on ethanol market prices. In addition, researchers have often assumed that ethanol price is largely determined by the conventional gasoline price, based on a high correlation coefficient between ethanol and conventional gasoline prices without any theoretical justification (de Gorter and Just, 2009a,b; Tyner and Taheripour, 2008). A correlation coefficient does not provide any information as to a cause and effect relationship. For instance, the correlation coefficient between monthly average ethanol and unleaded gasoline rack prices from January 2008-July 2009 (Free-on-Board [F.O.B.] Omaha, NE) is estimated to be 0.84, but Figure 1 does not reveal any cause and effect relationship between ethanol and conventional gasoline prices.

Ethanol, cherished for years by oil blenders as a cheap blending ingrethent for motor fuel, has now become a burden for blenders, because ethanol price has remained stubbornly expensive compared with conventional gasoline, whose price crashed as the economic slowdown crimped demand in late 2008 (Gardner, 2008). …