Academic journal article Journal of Agricultural and Applied Economics

Biofuels: Potential Production Capacity, Effects on Grain and Livestock Sectors, and Implications for Food Prices and Consumers

Academic journal article Journal of Agricultural and Applied Economics

Biofuels: Potential Production Capacity, Effects on Grain and Livestock Sectors, and Implications for Food Prices and Consumers

Article excerpt

We examined four evolution paths of the biofuel sector using a partial equilibrium world agricultural sector model in CARD that includes the new RFS in the 2007 EISA, a two-way relationship between fossil energy and biofuel markets, and a new trend toward corn oil extraction in ethanol plants. At one extreme, one scenario eliminates all support to the biofuel sector when the energy price is low, while the other extreme assumes no distribution bottleneck in ethanol demand growth when the energy price is high. The third scenario considers a pure market force driving ethanol demand growth because of the high energy price, while the last is a policy-induced shock with removal of the biofuel tax credit when the energy price is high. Standard results hold where the biofuel sector expands with higher energy price, raising the prices of most agricultural commodities through demand side adjustment channels for primary feedstocks and supply side adjustment channels for substitute crops and livestock. On the other hand, the biofuel sector shrinks coupled with opposite impacts on agricultural commodities with the removal of all support including the tax credit. Also, we find that given distribution bottlenecks, cellulosic ethanol crowds marketing channels resulting in a corn-based ethanol price that is discounted. The blenders' credit and consumption mandates provide a price floor for ethanol and for corn. Finally, the tight linkage between the energy and agricultural sectors resulting from the expanding biofuel sector may raise the possibility of spillover effects of OPEC's market power on the agricultural sector.

Key Words: biofuel, EISA, ethanol, tax credit, world agricultural sector model

JEL Classifications: Q13, Q18, Q38

The biofuels industry experienced a period of enormous change in 2007 and 2008. World energy prices soared in the summer of 2008, as did grain prices and food prices in general. These market changes attracted attention to biofuel policies and eroded some of the political support that the sector had received. The 2008 farm bill reduced the size of the blenders' credit from $0.51 per gallon to $0.45 per gallon for corn-based ethanol and introduced a new $1.01 per gallon blenders' credit for cellulosic ethanol. It also created a transportation subsidy for cellulosic ethanol producers. The Renewable Fuels Standard (RFS) of the 2007 Energy Independence and Security Act (EISA) mandated large quantities of starch-based ethanol and other advanced biofuels. With lower energy prices and a slightly reduced credit, the provisions of this act may become very important because it now appears unlikely that market forces will be sufficient to generate the use of ethanol required under the act.1 In other related developments, the rapid production of ethanol in the U.S. is estimated to have a modest impact on U.S. gasoline prices (Du and Hayes, 2008). Also, high energy prices in general would increase farm-level production costs even as they increased output prices through biofuel production.

Tokgoz et al. (2007) analyzed the likely impact of the growing biofuel sector on the grain and livestock sectors and on consumer prices. This report updates that earlier paper to allow for the economic and policy changes previously described. The analysis in this article introduces the provisions of the EISA, endogenizes gasoline and ethanol prices, adjusts for the new blenders' credits, and increases international farm-level production costs when energy prices rise.

Specifically, this article examines four scenarios in the evolution of the biofuel sector. At one extreme, one scenario eliminates all support to the biofuel sector when the energy price is low, while the other extreme assumes no bottleneck (e.g., E85 [85% ethanol and 15% gasoline blend] distribution infrastructure constraint) in ethanol demand growth when the energy price is high. The remaining two scenarios are in-between cases: one scenario considers a pure market force driving ethanol demand growth because of the high energy price, while the remaining scenario is a policyinduced shock with removal of the biofuel tax credit when the energy price is high. …

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