CARD Study Shows U.S. Ethanol Production and Corn Demand Will Grow With or Without Subsidy and Tariff

Bruce A. Babcock ;
Sandy Clarke;

July 20, 2010

America's growing interest in renewable fuels has spurred a robust discussion about the pros and cons of continuing or changing current U.S. federal government ethanol policies, specifically, (1) mandates to increase the use of renewable fuels like ethanol from approximately 13 billion gallons today to 36 billion gallons by 2022, (2) a 45-cent-per-gallon tax credit for "blenders" who add ethanol to gasoline, and (3) a 54-cent-per-gallon tariff, which increases the price of foreign imports.

A new staff report by Bruce A. Babcock, director of the Center for Agricultural and Rural Development (CARD) and a professor of economics at Iowa State University, projects that allowing the blender credit and tariff to expire would have neither the dramatic, adverse effect U.S. ethanol producers claim nor create the export bonanza foreign producers hope for. The report also projects that American drivers and taxpayers stand to benefit if the supports are allowed to lapse.

Some key highlights from the staff report:

• U.S. ethanol production would increase to some 14.5 billion gallons by 2014 without the tax credit and import tariff; U.S. imports of Brazilian ethanol would rise modestly to about 740 million gallons—less than 5 percent of the total U.S. ethanol market.

• If the mandates are kept in place but the tax credits and trade protection are allowed to expire, no more than 300 jobs would be lost in the ethanol industry in 2014.

• Ending the tax credit and tariff would reduce ethanol prices by 12 cents per gallon in 2011 and by 34 cents per gallon in 2014. Because most gas sold in the United States contains 10 percent ethanol—a limit the Environmental Protection Agency may increase to 15 percent this fall—lower ethanol prices lead to modest savings at the pump: a penny or two per gallon next year and 3 to 5 cents per gallon in 2014.

• Opening the U.S. market to all producers would reduce price volatility by acting as a price shock absorber, meaning that in years when domestic ethanol production is low, imports would lower the consumer cost of meeting blending mandates.

• The Renewable Fuel Standard (RFS) is the primary driver of ethanol demand. The tax credit prompts blenders to use about 900 million gallons of ethanol each year above mandated levels. This costs taxpayers some $6 billion annually (or almost $7 per gallon). Ending the subsidy would save that amount.

The staff report is based on an economic model developed by Dr. Babcock and his staff that randomly drew corn yields and gasoline prices—the two key factors affecting the profitability of U.S. ethanol—and then calculated how the U.S. and Brazilian ethanol markets would react to each draw. The U.S. and Brazil were used because they are the two largest ethanol markets in the world. The calculations were repeated 5,000 times to derive an average market response for each scenario.

Partial funding for this report came from a research grant to CARD from UNICA—the Brazilian Sugarcane Industry Association.

This report, titled "Costs and Benefits to Taxpayers, Consumers, and Producers from U.S. Ethanol Policies," is available online on the CARD Web site: Permission is granted to excerpt or quote this information with appropriate attribution to the authors.