The 84th Annual Conference of the Agricultural Economics Society. Edinburgh. 29th to 31st March 2010

Transcription

1 The 84th Annual Conference of the Agricultural Economics ociety Edinburgh 29th to 31st March 2010 The Imlications of Alternative U.. Domestic and Trade Policies for Biofuels Yuki Yano, David Blandford and Yves urry 1 Coyright 2010 by Yuki Yano, David Blandford, and Yves urry. All rights reserved. Readers may make verbatim coies of this document for non-commercial uroses by any means, rovided that this coyright notice aears on all such coies. Abstract The U.. Renewable Fuel tandard rogram (RF), which involves mandates for various biofuels, is comlex and has been often misinterreted or oversimlified in revious studies. In this aer we analyze the imlications of the RF for the U.. domestic and international ethanol markets. We demonstrate the vital role of the advanced biofuel mandate within the RF. Imacts of changes in tariffs on imorted fuel ethanol and subsidies for U.. domestic ethanol roduction are examined. One of our imortant findings is that the RF could result in serious misallocation of resources in both a national and international context. There is a ossibility that the United tates could be required to imort sugarcane-based ethanol to meet the advanced biofuel mandate, simultaneously exorting corn-based ethanol, while satisfying the national overall mandate. ince the rovision of subsidies for domestic ethanol roduction can stimulate exorts of corn-based ethanol, they are equivalent to exort subsidies in this situation. The removal of tariffs can reduce the burden imosed on consumers in the United tates from the oeration of the RF. Our analysis shows that it is extremely imortant to understand the otential imact of the RF on agricultural and energy markets. Keywords: Ethanol, trade liberalization, Renewable Fuel tandard, mandate, subsidies JEL codes: F13, Q18, Q42, Q48 1 Yano is a research associate and urry is a rofessor in the Deartment of Economics at the wedish University of Agricultural ciences (LU). Blandford is a rofessor in the Deartment of Agricultural Economics and Rural ociology, The Pennsylvania tate University, University Park, PA 16802, U..A. Tel: Fax: dblandford@su.edu. 1

2 Introduction The use of first generation biofuels has increased raidly around the world as countries ursue a range of goals, such as reducing greenhouse gas emissions and enhancing energy security. In articular, the growth of the biofuel industry in the United tates and Brazil has been exlosive. According to OECD (2008), these two countries account for roughly 73 ercent of world biofuel roduction and a large ercentage of ethanol (about 75 ercent) in The United tates uses corn as the rimary feedstock for ethanol roduction and Brazil roduces ethanol from sugarcane. An increase in the feedstock demand for biofuel roduction, which is generally olicy driven, has strengthened the linkage between agricultural commodity markets and energy markets (Tyner and Taheriour, 2008). There has been a great deal of debate on the design of biofuel olicies and their imact on agricultural markets and the environment 2. Currently the volume of fuel ethanol traded among countries reresents a small ercentage of world consumtion (about 10 ercent). According to Gallagher (2007), ethanol trade volume was about 1.46 billion gallons in The major exorters are Brazil, China, and the Caribbean countries and Brazil has been the dominant exorter (more than 85 ercent), whereas the major imorters are the United tates, the Euroean Union, and Jaan, and the United tates has been the dominant imorter. Allowing imorts from develoing countries that have a comarative advantage in the roduction of biofuel feedstock (e.g., cane sugar and alm oil) could allow the United tates to diversify its sources of energy suly and reduce greenhouse gas emissions at a lower cost than relying exclusively on domestic sulies of biofuel 3. With a reduced tariff, fuel ethanol is likely to be imorted from Brazil, 2 everal studies have concluded that biofuel olicies can have unintended economic consequences (Vedenov and Wetzstein, 2008; Khanna et al., 2008). Desite such criticisms it seems inevitable that biofuels will lay an imortant role in future energy olicies in many countries. 3 In many develoing countries there is significant otential for biofuel roduction (Jank et al., 2007). This is because troical and subtroical feedstocks for biofuels usually have more favorable energy and environmental balances than cros grown in temerate latitudes. 2

3 which can roduce ethanol from sugarcane at lower costs than the corn feedstock used in the United tates 4. Therefore, changes in domestic and trade olicies for biofuels in the United tates and Brazil could have a large imact on the world ethanol market. In addition, changes in their olicies are exected to affect the feedstock (for ethanol roduction) markets and other agricultural commodity markets. If, for examle, changes in the U.. ethanol trade olicies affect the corn rice, the rices of other agricultural commodities, such as wheat and soybeans, could be affected (rimarily through land reallocation). Because of the role of the United tates in global markets, ethanol trade liberalization could also have an imact on world cro and feed markets (Elobeid and Hart, 2007; Muhammad and Kebede, 2009). Hence, it is imortant to examine how changes in trade olicies affect the level and variability of U.. domestic ethanol suly rice (linked to the corn rice) and world ethanol rice (linked to the sugar rice). Although a number of studies have evaluated the imact of biofuel rogrammes on agricultural and fuel markets and on social welfare, using either artial or general equilibrium analysis (Lundgren, 2008), the imlications of U.. trade olicies for biofuels in the resence of domestic biofuel olicies, such as subsidies and mandates, have received limited attention. Martinez-Gonzalez et al. (2007) calculate the imact of ethanol trade distortions for the U.. and Brazil. A artial equilibrium trade model is estimated using two-stage least squares. The results suort their hyothesis that the removal of distortions in the U.. ethanol market would be beneficial for both countries. de Gorter and Just (2008b) investigate the static effects of U.. ethanol tariffs with or without the biofuel mandate and/or a tax credit. Elobeid and Tokgoz (2008) develo an international ethanol model to examine the effect of removing trade and domestic distortions in the U.. on the world ethanol market. ince the United tates is exected to be a large imorter, the world ethanol rice will be affected by ethanol 4 According to Jank et al. (2007), there is a large otential for sugarcane ethanol roduction in other develoing countries such as Colombia. 3

4 trade liberalization. Under free trade, the world ethanol rice increases as U.. ethanol imorts increases. Brazil would benefit from the tariff elimination. The U.. ethanol market is less suscetible to rice volatility arising from demand and suly shocks. Current U.. biofuels olicy is a combination of mandates, tax credits, and tariffs. A key comonent is the U.. Renewable Fuel tandard rogram (RF), which was revised in the Energy Indeendence and ecurity Act 2007.The RF, which involves mandates for various biofuels, is comlex and has been misinterreted or oversimlified in many revious studies. It is extremely imortant to understand the comlicated requirements of the RF mandate in order to examine the imact of otential changes in U.. domestic and trade olicies for biofuels accurately (Thomson et al., 2009). In this aer we formally analyze the imlications of the RF for U.. domestic and international ethanol markets. We emhasize the vital role of the advanced biofuel mandate within the RF. In addition, the imacts of changes in the level of tariffs and subsidies are examined. We rimarily focus on the consequences in the U.. ethanol market and the linkage with the corn market. In terms of the federal government suort for ethanol, we assume that if the imort tariff were reduced, the current mechanism would be modified such that the tax credit aid to blenders would aly only to domestically roduced ethanol or alternatively a roduction subsidy would be aid directly to domestic ethanol refiners. This would be necessary to avoid the olitically unattractive otion of subsidizing the use of imorted ethanol (tyles, 2008). The aer is organized as follows. The next section summarizes the U.. domestic and trade olicies for biofuels, with focus on the Renewable Fuel tandard rogramme and the ossible subsidy reform. An ethanol trade model incororating the U.. RF and subsidies for domestic ethanol roduction is resented in section 3. The imlications of imort tariffs are discussed in the enultimate section. The final section rovides concluding remarks. 4

5 U.. Domestic and Trade Policies In this section we discuss the U.. Renewable Fuel tandard (biofuel mandate) in detail and the subsidy reform that would be required if the tariffs were reduced or eliminated. Renewable Fuel tandard (U.. Biofuel Mandate) The Renewable Fuel tandard was created by the Energy Policy Act of 2005 (EPAct) and amended by the Energy Indeendence and ecurity Act of 2007 (EIA). It requires that transortation fuel in the United tates contain at a minimum secified volumes of renewable fuel, advanced biofuel, cellulosic biofuel, and biomass-based diesel (EIA. H.R.6 Title XV, ubtitle A, ec. 202). Table 1 shows the renewable fuel volume requirements (taken from EPA 2009). In the table alicable volume of renewable fuel is interreted as the overall mandate requiring blenders to incororate billion gallons of renewable fuels with gasoline and other transortation fuels in 2010, increasing to 36 billion gallons by There are also sub-mandates (secondary mandates) which are art of the overall mandate. Alicable volume of advanced biofuel is the largest sub-mandate (advanced biofuel mandate) and embraces other two sub-mandates: alicable volume of cellulosic biofuel and biomass-based diesel. The cellulosic biofuel mandate has to be met by renewable fuel, derived from any cellulose, hemicelluloses, or lignin, which achieves a 60 ercent greenhouse gas (GHG) emission reduction requirement. The alicable volume of biomass-based diesel is determined only for the calendar years 2009 through 2012 in EIA. The advanced biofuel mandate has to be met by renewable fuel other than ethanol derived from corn starch, including sugarcane-based ethanol from foreign countries (most likely sourced from Brazil), biomass-based diesel, and cellulosic biofuel 5. ugarcane-based ethanol 5 According to Thomson et al. (2009), forecasts suggest that conventional ethanol will be cheaer to roduce than advanced non-cellulosic ethanol in the United tates. Cellulosic ethanol is exected to be more exensive. The feasibility of ethanol from sugarcane or sugar beets will deend on the U.. olicies for sugar. Currently, 5

6 Table 1: Renewable fuel volume requirements for RF (billion gallons) Year Total renewable fuel requirement Advanced biofuel requirement Cellulosic biofuel requirement Biomass-based diesel requirement n/a n/a n/a n/a a a a a a a a a a a b b b b a To be determined by the Environmental Protection Agency through a future rulemaking, but no less than 1.0 billion gallons. b To be determined by EPA through a future rulemaking. can be used to fill the ga between the advanced biofuel mandate and other two sub-mandates (the advanced mandate less the cellulosic mandate less the biomass-based diesel mandate). If no chea alternative other than foreign sugarcane-based ethanol is available, the United tates must imort this to meet the advanced biofuel mandate unless the mandate is waived. high domestic sugar rices make it more rofitable to convert sugarcane and sugar beets to sugar than to convert it to ethanol (Jacobs, 2006). 6

7 This has significant imlications for ethanol trade because the United tates has to imort regardless of the situation of the world sugar and ethanol markets. The difference between the overall mandate and the advanced mandate can be filled by any combinations of renewable fuels. The U.. domestic corn-based ethanol (conventional biofuel) can be used for this urose. If conventional biofuel, which is defined as ethanol derived from corn starch, is relatively costly, sugarcane-based ethanol (or other biofuels if available) can be used to make u for conventional biofuel (corn-based ethanol). It is articularly imortant to note that there is no mandate for conventional biofuel (corn-based ethanol) 6. Conventional biofuel does not count against the overall mandate above the difference between the overall mandate and advanced mandate. The maximum volume of conventional biofuel that can count against the overall mandate is 15 billion gallons from 2015 to Non-Prohibitive Tariffs and ubsidy Reform For olitical reasons, reducing or eliminating the imort tariff on ethanol would require changes in the mechanism through which the federal government suorts the use of domestic ethanol. The U.. government currently rovides a tax credit of 46 cents er gallon to comanies that blend ethanol with gasoline 7. All ethanol imorted into the U.. (excet for imorts under the Caribbean Basin Initiative) is subject to an imort tariff (a 2.5 ercent ad valorem tariff) and a secondary duty (secific tariff of 54 cents er gallon) amounting to a combined total of roughly 60 cents er gallon. If the imort tariff were reduced or eliminated under the current mechanism, taxayers could end u subsidizing foreign (Brazilian) ethanol roducers. The tariff currently imosed on imorted ethanol exists to offset the credit that foreign suliers would otherwise receive. 6 Thomson et al. (2008) mention about this fact in their aer. 7 There are also state tax credits. According to de Gorter and Just (2008b), the overall tax credit was cents er gallon in

8 Two otions could be considered to avoid subsidizing foreign ethanol suliers (tyles, 2008). 8 First, the tax credit could be modified so that it alies only to domestically roduced ethanol. However, administering a two-tier ethanol subsidy system could be roblematic. A second otion would be to shift the oint of subsidy from the blender to the ethanol roducer by roviding an ethanol roduction subsidy. Although some roblems may arise regarding such changes, not least through international obligations through the World Trade Organization, we assume that if the imort tariff were to become non-rohibitive, the subsidy mechanism would be modified so that American tax dollars would not subsidize the use of foreign ethanol. Ethanol Trade Model Consider a cometitive world ethanol market with an aggregate excess suly E (mainly from Brazil) and an aggregate excess demand for sugarcane-based ethanol ED 0 (excluding U.. excess demand). The right side of the artial-equilibrium diagrams in figure 1 illustrates the world ethanol market. The initial international equilibrium (without the U.. demand) is given by the rice, with the quantity of ethanol traded Q TE. ince roducers (Brazilian mills) determine what ortion of sugarcane goes to ethanol roduction or sugar roduction flexibly, deending on the relative rices of these commodities, sugar and ethanol rices tend to move together (Elobeid and Tokgoz, 2008). For examle, an increase in the demand for ethanol shifts sugarcane from sugar roduction to ethanol, resulting in tightened sugar sulies and increased world sugar rices (Brazil is also a large exorter of sugar). 8 de Gorter and Just (2008b) assume that the tax credit is alicable to both domestic and imort sulies. If the aim is solely to increase the use of ethanol in reference to gasoline this could be a cheaer alternative than subsidizing domestic roduction. However, it is unlikely to be feasible olitically. 8

9 $/gal United tates $/gal World Ethanol E GU 0 Q Q Qˆ Q Gallons 0 EOA AE AE Q TE U.. advanced mandate less cellulosic mandate ED 1 ED 0 Gallons Figure 1: Ethanol trade with the U.. RF: ethanol use exceeds the overall mandate For simlicity we assume that: a) Three tyes of ethanol are available for the United tates: i) domestically roduced cornbased ethanol (conventional biofuel); ii) imorted sugarcane-based ethanol (regarded as advanced biofuel); and iii) cellulosic ethanol. We ignore other biofuels. b) The U.. mandates (overall, advanced and cellulosic mandates) are legally enforced through monitoring and high enalties for violation (in reality, any mandates can be waived 9 ). The biomass-based biofuel mandate is ignored because it will be small comared to other mandates. c) The mandates require a minimum volume of ethanol to be consumed. Hence, all mandates are consumtion mandates. In reality, the mandate is likely to be imlemented through the use of an annual minimum blending requirement (de Gorter and Just 2009). d) ubsidies in the United tates are only alied to domestically roduced ethanol. e) There is no technical constraint on the use of ethanol. If an increase in the blend ratio is limited technically and/or the number of flex-fuel vehicles is limited, the otential 9 The U.. Environmental Protection Agency (EPA) is authorized to waive all or ortions of the RF mandates if EPA determines that imlementation of the mandate would severely harm the economy of a state, region, or the United tates. 9

10 maximum consumtion (or blend ratio) of ethanol is limited. If that is the case, however, the mandates are exected to be waived. f) There is no difference in fuel efficiency between gasoline and ethanol. Therefore, if the ethanol use exceeds the mandated level, its consumer rice equals to the consumer gasoline rice including any fuel tax at the equilibrium. In other words, ethanol demand will increase u to the oint where these rices are the same. In reality, as the ethanol concentration in the blended fuel increases, ethanol s lower heat content will start to offset the octane and oxygen benefits, and its retail rice will be lower than the retail rice of gasoline (Xavier, 2007; Gallagher, 2007). Even so, both rices are exected to move together (co-move). g) Transortation costs are ignored. According to Tokgoz and Elobeid (2006), they are about 16 cents er gallon. First, consider the case in which the U.. imort tariff on fuel ethanol is eliminated and (all tyes of) cellulosic ethanol will be too costly to be sulied beyond the volume required by the cellulosic mandate. The cellulosic mandate is binding and the rice of this biofuel is high. In this case, sugarcane-based ethanol, which is less costly than the cellulosic ethanol, has to be used to meet the difference between the advanced biofuel mandate and the cellulosic mandate. Given the quantity of imorted ethanol that fills the difference (the excess demand curve shifts outward, ED 1), the world ethanol rice will be increased u to, which defines the minimum suly-inducing rice for marginal imorted ethanol (the intercet of the marginal imorted ethanol suly curve (corn-based) ethanol suly curve in the United tates). The original domestic is derived from the horizontal difference between an aggregate suly curve for corn and an aggregate non-ethanol demand curve for corn which includes domestic food and livestock feed demand, and foreign demand for corn. Therefore, 10

11 the suly rice of domestic ethanol is directly linked to the corn rice (see de Gorter and Just, 2008a; Yano et al., 2010). The fuel tax and subsidy-inclusive domestic ethanol suly curve is denoted by (the subsidy er gallon is greater than the fuel tax er gallon in this case). As the subsidy for domestic ethanol increases, ethanol suly curve shifts downwards. The aggregate AE is the horizontal sum of and. GU reresents the consumer gasoline rice, including fuel tax in the United tates. The left side of the artialequilibrium diagram in figure 1 illustrates the U.. (marginal) ethanol market in which the horizontal axis shows the quantity of ethanol used beyond the volume required by the advanced mandate. Qˆ EOA denotes the ethanol volume required by the overall mandate less that required by the advanced mandate. After the advanced biofuel mandate is met, the United tates determines the quantity of domestic corn-based ethanol and/or the additional quantity of foreign sugarcane-based ethanol, deending on their relative costs and the U.. gasoline rice. Given the advanced biofuel mandate, there are two imortant cases to be considered: either GU or > GU. CAE 1: GU If < the U.. always has an incentive to imort additional ethanol because the GU ethanol rice is, at the minimum, the U.. consumer rice of gasoline. If the marginal cost of ethanol use (the aggregate suly) is lower than GU, total ethanol use exceeds Qˆ EOA since blenders increase ethanol use u to the oint at which the marginal cost is equal to the gasoline rice in order to maximize their benefits. This situation corresonds to that in figure 1. Total (marginal or additional) ethanol use isq AE 11, being comosed of domestic ethanol Q and (marginal) imorted ethanol Q. The (new) world rice of ethanol and the demand rice of domestic ethanol are equal to the U.. gasoline rice. The suly rice of

12 domestic ethanol (corn rice) is determined by the original curve and is the sum of the world oil rice and a subsidy (er gallon) whatever the level of domestic ethanol use. Hence, when the mandate is exceeded, the higher the rice of etroleum, the higher domestic ethanol demand and the higher the corn rice. The use of marginal imorted ethanol deends on how changes in the world oil rice affect, but the world ethanol rice equals to the U.. gasoline rice as discussed above. An increase in the level of subsidy results in increased use of domestic ethanol and a higher corn rice, ceteris aribus. If the marginal cost of ethanol is above the gasoline rice at the mandated level, the U.. overall mandate is binding (total marginal ethanol use equals the difference between the overall mandate and the advanced biofuel mandate). Figure 2 illustrates this case. $/gal United tates $/gal World Ethanol E GU 0 Q Q Qˆ Gallons 0 EOA AE Q TE ED 0 ED 1 Gallons Figure 2: Ethanol trade with the U.. RF: the overall mandate is binding The demand rice of ethanol would have to rise above the gasoline rice in order to satisfy the mandate; otherwise blenders would be unwilling to use that amount of ethanol. Consumer ethanol rices (both domestic and world rices) are equal to the marginal cost of ethanol use at the required level. The quantities of domestic and imorted ethanol are determined according to the ositions of their suly curves. The suly rice of domestic ethanol is the sum of its demand rice and the net subsidy (subsidy less fuel tax). When the mandate is 12

13 binding, the oil rice affects the rice of corn only through its imact on. With a binding mandate, an increase in the subsidy for domestic ethanol has two imortant effects. First, it reduces the demand rice of ethanol, resulting in a reduced mixed fuel rice and higher consumtion of gasoline. econd, since the suly of domestic ethanol becomes cheaer than before, the demand for domestic ethanol is increased and the use of imorted ethanol is reduced (holding unchanged). Consequently, the rice of corn is increased. The rice of world ethanol is reduced and so is the world sugar rice if sugar mills in Brazil can flexibly determine what roortion of sugarcane goes into ethanol or sugar roduction. If =, marginal (additional) sugarcane-based ethanol imorts will occur only GU when the marginal cost of domestic ethanol roduction is higher than the gasoline rice at Qˆ EOA (in which case the overall mandate is binding). If the marginal cost of domestic ethanol is exactly equal to or lower than the gasoline rice, domestically roduced corn-based ethanol can satisfy the required ethanol use. CAE 2: > GU Given U.. demand for cane-based ethanol to meet the advanced mandate, the world ethanol rice could be forced higher than the U.. gasoline rice even if initially it is lower. Of course, the initial international ethanol rice (without U.. mandates) could be higher than GU due, for examle, to a shar rise in world sugar rices (as observed in 2009) or an increase in mandated biofuel use in the rest of the world. In any case, the United tates has to imort sugarcane-based ethanol from foreign countries (robably from Brazil) unless the advanced mandate is waived or cellulosic ethanol (or other biofuels) becomes commercially viable. 13

14 The U.. imorts ethanol if the marginal cost of domestic corn-based ethanol roduction (including subsidies) at the required level is above. In this case the U.. overall mandate becomes binding and >. Figure 3 deicts this situation. $/gal United tates $/gal World Ethanol E GU 0 Q Q Qˆ Gallons 0 EOA AE Q TE U.. advanced mandate less cellulosic mandate ED 0 ED 1 Gallons Figure 3: Ethanol trade: the overall mandate is binding > GU If the marginal cost of domestic ethanol at Qˆ EOA is equal to, only domestic ethanol is used to meet the overall mandate, which again becomes binding. But, if the marginal cost of domestic ethanol at Qˆ EOA is lower than, what haens? ince the domestic ethanol rice is lower than the world ethanol rice (there is no demand in the domestic market beyond the mandated use at that higher world rice), this will oen the door for exorts of U.. cornbased ethanol into markets, such as Euroe or Asia (or even northern Brazil), deending on trade olicies in other countries. Under this scenario there is a ossibility that the United tates will imort sugarcane-based ethanol to meet the advance biofuel mandate while simultaneously exorting corn-based ethanol, while satisfying the overall mandate! If U.. becomes a large country exorter, the world ethanol rice will be reduced (but will still be higher than the U.. gasoline rice), largely deending on the elasticity of excess demand in the rest of the world. Also, the rice of corn will deend on the quantity of corn-based 14

15 ethanol exorted. This weird situation could occur if, for examle, cellulosic ethanol or other biofuel is not economically viable, world sugar rice is high, the demand for ethanol from the rest of the world is high (mandated), the U.. advanced biofuel mandate is increased and high (strictly seaking, the difference between the advanced mandate and the cellulosic mandate), the world oil rice is not so high, and U.. corn-based ethanol is cometitive at revailing rices. A weak dollar would also make U.. exorts more cometitive. Hence, the current mechanism of the U.. RF (rovided that it is fully enforced) might result in serious misallocation of resources in both a national and international context. ince the rovision of subsidies for domestic ethanol roduction can stimulate exorts of corn-based ethanol they are equivalent to exort subsidies and distort trade. $/gal United tates $/gal World Ethanol E GU E with U.. suly ED 1 ED 0 0 Qˆ Q Gallons 0 EOA Q TE Gallons Figure 4: U.. imorts cane-based ethanol while simultaneously exorting corn-based ethanol > GU Thus far we have assumed that cellulosic ethanol is not viable beyond the mandated level. If cellulosic ethanol becomes cometitive beyond the volume required by the cellulosic mandate, (art of) sugarcane-based ethanol can be relaced with it and the quantity of cornbased ethanol will be reduced if the overall mandate is initially binding (because the minimum suly-inducing rice for marginal (additional) imorted ethanol falls). Also, this 15

16 will reduce the ossibility that the United tates becomes an exorter of corn-based ethanol with the advanced mandate. If the overall mandate is initially exceeded, an increase in the suly of cellulosic ethanol just results in the increased use of total ethanol. Of course, these consequences will hinge on domestic and trade olicies for biofuels, such as the level of subsidy and tariffs. The Effects of Tariffs For simlicity, suose that a secific tariff, t, is imosed on imorted fuel ethanol in the United tates. The tariff-inclusive marginal imorted ethanol suly is denoted by CAE 1 in the revious section, with a binding mandate the United tates does not use additional imorted ethanol if the intercet of domestic ethanol, inclusive of a subsidy, at t is higher than the marginal cost of 16 t. For Qˆ EOA. Below that oint, as the tariff is reduced, the demand rice for ethanol (the mixed fuel rice) falls due to cometition (the aggregate ethanol suly with tariffs, t AE shifts downward), the imorted ethanol use is increased (the world ethanol rice rises), and the quantity of domestic ethanol is reduced (thus the corn rice falls). The U.. demand rice of ethanol is the sum of the world ethanol rice (suly rice) and a tariff. The ethanol trade with U.. imort tariff with a binding overall mandate is described in figure 5. Once the demand rice of ethanol reaches to the U.. consumer gasoline rice (i.e., if the overall mandate is exceeded), a reduction in the tariff just increases the quantity of imorted ethanol and hence the world ethanol rice. When the advanced biofuel mandate is initially binding (i.e., there are no additional imorts), the imosition of a tariff increases the demand rice of imorted ethanol in the United tates by the amount of the tariff, and the burden is comletely borne by U.. consumers because imort demand is erfectly inelastic. When the overall mandate is exceeded with imorted (and domestic) ethanol, the imosition of a tariff reduces the suly rice of imorted ethanol by the amount of the tariff, and the tariff revenue is comletely aid

17 by foreign suliers because they face a erfectly elastic U.. imort demand (at the consumer gasoline rice in the United tates). $/gal D E GU 0 Q Q Qˆ Gallons 0 United tates t EOA t AE $/gal World Ethanol Q TE E ED ED 1 0 Gallons Figure 5: The ethanol trade with U.. imort tariffs: the overall mandate is binding For CAE 2, the imosition of a tariff reduces the likelihood of ethanol imorts (the exected quantity of imorted ethanol). Additional imorts occur only when the marginal cost of domestic ethanol roduction at Qˆ is greater than + t. If it lies between EOA and + t, only domestic ethanol is used to meet the overall mandate. But the imosition of a tariff does not affect the ossibility that the U.. exorts corn-based ethanol to other countries. This is because the world ethanol rice is unchanged by imosing the tariff and the rice of corn-based ethanol in the United tates deends on the domestic ethanol suly curve and the level of the overall mandate. ince the advanced biofuel mandate is binding when the U.. exorts ethanol, the imosition of the tariff simly increases the U.. demand rice of imorted ethanol and (as discussed above) the tariff revenue is aid by consumers in the United tates (the mixed fuel rice is increased). 17

18 Concluding Remarks The develoment of first generation biofuels, roduced from feedstock such as corn and sugarcane, has been exlosive esecially in Brazil and the United tates. It is essential to investigate how changes in domestic and trade olicies for biofuels in these countries affect ethanol rices, feedstock rices, and other agricultural commodity rices. The U.. Renewable Fuel tandard (RF), which is a major domestic biofuel olicy and involves mandates for various biofuels, is comlex and has been often misinterreted or oversimlified in revious studies. It is extremely imortant to understand the comlicated requirements of the RF in order to analyze the imlications of domestic and trade olicies for biofuels accurately. This aer examines the imacts of the RF on the U.. domestic and world ethanol markets incororating the advanced biofuel mandate into our model. We emhasize the key role of the advanced biofuel mandate within the RF. The effects of changes in the level of subsidy for domestic ethanol roduction and the level of tariffs on imorted fuel ethanol are also considered. We mainly focus on the consequences in the U.. ethanol market and the linkage with the corn market. An imortant finding is that the current mechanism of the U.. RF could result in serious misallocation of resources in both a national and international context. If cellulosic ethanol or other biofuel is not economically viable, the advanced biofuel mandate will force the United tates to imort sugarcane-based ethanol regardless of the situation of the world sugar and ethanol markets. As a result, the United tates could imort sugarcane-based ethanol to meet the advanced mandate while exorting corn-based ethanol to other countries, while satisfying the national overall mandate. Under this situation, subsidies for domestic ethanol are equivalent to exort subsidies because they stimulate exorts of corn-based ethanol. In addition, the removal of tariffs can reduce their burden borne by consumers in the United 18

19 tates. Our analysis suggests that olicy makers may need to reconsider the resent RF rogramme, esecially the advanced biofuel mandate. 19

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