Alternative Domestic and Trade Policies for Biofuels and Market Variability in the United States

The development of first-generation biofuels has strengthened the linkage between agricultural commodity markets and energy markets. This chapter analyzes the implications of U.S. domestic and trade policies for ethanol in the face of year-to-year fluctuations in the domestic supply of feedstock (corn) and petroleum prices. The current U.S. policy mix involves a prohibitive tariff on imported ethanol, a fixed subsidy for blending ethanol with gasoline, and a blending or consumption mandate. We find that as the likelihood that the mandate is binding increases, the variability of ethanol use declines; the impact of corn supply variations on corn prices is increased due to greater inelasticity in demand, but the impact of oil price variations on corn prices is reduced. Tariffs could be reduced to allow ethanol imports, given a modification of the subsidy mechanism, which would reduce the impact of corn supply fluctuations on corn prices. But, if the minimum supply-inducing price for imported ethanol is sensitive to petroleum prices, corn prices could be affected by petroleum price fluctuations even when the U.S. mandate is binding. With freer trade, the impact of U.S. domestic and trade policies for ethanol on the variability of domestic corn prices depends on the relative magnitude of external shocks as well as on ethanol policies in supplying countries. In addition to examining a reduction in the current specific tariff, the implications of using an ad valorem tariff or a variable tariff are assessed.