West Lafayette, Indiana
February 15, 2008
The recent boom in production of
ethanol from corn grain has tightly linked the agriculture and
energy sectors in an unprecedented fashion.
Purdue University
researchers developed a model, based on a range of possible oil
prices, that predicts impacts of federal economic policies on
future consumer and government costs, ethanol production and
many other aspects of the two sectors.
"We are living through a revolution in American agriculture,"
said Wally Tyner, a Purdue professor of agricultural economics.
Tyner presented his results Friday (Feb. 15) at the annual
meeting of the American Association for the Advancement of
Science in Boston.
Tyner said the prices of corn and crude oil, which prior to 2007
fluctuated almost independent of one another, have become more
closely linked thanks to the use of massive quantities of corn
to make ethanol. This year that's about one-third of the total
national harvest.
"Now, oil and ethanol are both big players in agriculture," he
said. "In the future, they will march together, and their march
will depend upon government policies."
The model shows that the fixed 51-cent per gallon subsidy paid
to ethanol producers will become increasingly expensive for the
federal government as oil prices - and levels of ethanol
production - rise.
One alternative policy option, a variable subsidy that changes
relative to crude oil prices, would only be paid by the
government when crude oil sinks to less than $70 per barrel.
When oil prices are higher, ethanol production should be
profitable and would not need to be subsidized, Tyner predicts.
Tyner analyzed four policy options - the current 51-cent fixed
subsidy, the variable subsidy, no subsidy and a renewable fuel
standard - at oil prices ranging from $40 per barrel to $120 per
barrel. The renewable fuel standard contained in the 2007 Energy
Act mandates that energy companies purchase 35 billion gallons
of ethanol by 2022, with a maximum of 15 billion gallons coming
from corn.
"Regardless of the policy, results become similar at high crude
oil prices where the market dominates," Tyner said. "At low oil
prices, however, government policies have huge effects, and all
the results are enormously different. The policy choices we make
will be critical."
With oil at $40 per barrel, for example, ethanol production is
not profitable without a subsidy or higher fuel costs. With a
fixed or variable subsidy in effect at this oil price, the
government spends $5 billion per year to subsidize ethanol
production, Tyner said. Ethanol is considerably more expensive
than fuel made from petroleum in this scenario, but with the
renewable fuel standard in effect, fuel companies are required
to buy 15 billion gallons of corn ethanol per year. At $40
crude, the standard would cost consumers an extra $12 billion
per year at the pump, Tyner said.
Subsidies are paid out of taxpayer dollars by the federal
government, while the renewable fuel standard costs consumers at
the pump, Tyner said.
Therefore, the standard does imply costs at low oil prices, when
buying ethanol would otherwise be uneconomical. His model
calculates the hidden cost of the standard, which tacks on an
extra $1.05 per gallon when oil is $40. In such a situation, in
other words, ethanol costs $1.05 more per gallon to produce from
corn grain than gasoline costs to produce from crude oil, and
the consumer indirectly makes up the difference, he said.
If oil surpasses $100 per barrel, however, the renewable fuel
standard costs consumers little or nothing extra. That's because
at this price, ethanol production costs are very close to
gasoline production costs, he said.
With today's oil greater than $90 per barrel, $40 oil might seem
unlikely. In the last two decades, however, oil has only
surpassed $40 since 2004 and cost an average of only $20 per
barrel for most of that period, Tyner said. Reduced oil demand,
global recession or any number of factors could cause oil prices
to sink to $40 once again, he said.
One of the most dramatic aspects of the ethanol "revolution" is
a ballooning percentage of corn crops being made into ethanol,
which prior to 2004 had always been lower than 10 percent. This
year, for the first time, ethanol replaced exports to become the
second largest use of the grain behind that of domestic animal
feed. With a fixed subsidy in effect, the amount of corn used
for ethanol increases from 12 percent for $40 oil to 52 percent
for $120 oil, the model predicts. With the renewable fuel
standard, the ethanol share is quite stable, ranging from 44
percent for $40 oil to 47 percent for $120 oil, Tyner said.
With the fixed subsidy in effect, ethanol production ranges from
3.3 billion gallons a year at $40 oil to 17.6 billion gallons
with $120 oil, according to Tyner. The variable and no-subsidy
policies yield 6.5 billion gallons at $80 oil and 12.7 billion
for $120 oil.
The renewable fuel standard seems to guarantee ethanol's future,
but further decisions need to be made to develop a "bridge
policy" to spur investment in cellulosic ethanol, Tyner said.
Cellulosic ethanol - derived from grasses, waste materials and
agricultural residues - has potential to be more efficient than
ethanol from corn grain, he said.
Cellulose, a complex carbohydrate present in all plant tissues,
is more abundant in plants than starch. The renewable fuel
standard mandates that fuel companies purchase 20 billion
gallons of cellulosic ethanol by 2022. But exactly how this will
be achieved remains to be seen, and future policies need to take
into account the newly emerged oil-corn link, he said.
Predictions from Tyner's model point to a time in the future,
roughly 2020, when gasoline and ethanol pricing follow a more
stable long-run pattern, he said.
Ethanol has potential to reduce America's dependence on foreign
petroleum and reduce greenhouse gas emissions, which are goals
that cannot be fixed by the market alone, Tyner said. Economists
call these "externalities" and suggest fixing these market
failures through taxes, subsidies or some form of regulation. In
this work, Tyner has focused on subsidies or regulations because
taxes have not generally been used in this situation in the
United States, he said.
Tyner's paper will be published this year in the Review of
Agricultural Economics, co-authored by Purdue researcher Farzad
Taheripour. The authors evaluated two future scenarios: one
assumes that fuel standards will increase sufficiently to reduce
oil demand while the other assumes global oil demand will grow
faster than oil supply, resulting in what economists call a
demand shock.
Tyner's paper, entitled "Policy Options for Integrated Energy
and Agricultural Markets," and others are available online at
http://www.agecon.purdue.edu/papers/.
"In the past, when you asked people what policies were important
for agriculture, they would talk about target prices, loan rates
and efficient payments," Tyner said. "For now all of these are
gone, inoperative with high corn prices. It's a whole new
paradigm."
Writer: Douglas M. Main |
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