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Ethanol and government policies: options and consequences

Provided below is an excerpt from Bruce Babcock’s ethanol testimony before the U.S. Senate Committee on Homeland Security and Government Affairs on May 7. Among his comments:

“The three federal policies that I consider in this testimony are the Renewable Fuels Standard (RFS), the blenders tax credit, and the tariff on imported ethanol.

“What impact would a change in federal policy have on the supply of ethanol and the market price of corn during the period Sept. 1, 2008, to Aug. 31, 2009? This period corresponds to the marketing year for the 2008 corn and soybean crops.

“I want to focus on three (scenarios): (1) waive the mandates, but keep the tax credit and the import tariff; (2) keep the mandates but eliminate the import tariff and the tax credit; and (3) eliminate all three.

“Because both the blenders tax credit and the mandate increase the demand for ethanol, elimination of only one of these policies would have little impact because the other one would effectively keep the industry operating at close to current capacity.

“Elimination of the mandate would reduce expected ethanol production by about 4 percent, the ethanol price would drop by less than 2 percent, imports would fall by 18 percent, and the price of corn would be largely unchanged. Maintenance of the tax credit keeps demand for ethanol high, and the import tariff keeps imports down. Thus, recent calls for an easing of the RFS would do almost nothing to reduce food prices or ease the financial pain of the livestock industry.

“The impact of eliminating both the blenders tax credit and the import tariff would be somewhat larger because increased imports would reduce the amount of domestic ethanol that would be needed to meet the mandate. Domestic ethanol production would decline by about 11 percent, imports would double, and the price of corn would drop by 7 percent. The price of ethanol would drop by 13 percent. The impacts of this policy change are not any larger because the RFS keeps total ethanol demand high and the supply of imported ethanol is not unlimited.

“A rollback of all ethanol incentives and protections would have the largest impacts.

“Domestic ethanol production would drop by 21 percent. The loss of demand subsidies would cause the price of ethanol to drop by 18 percent. The price of corn would drop by almost 13 percent, to just below $5 per bushel. We estimate that the drop in ethanol supply would increase blended fuel prices by about 4 cents per gallon because increased gasoline prices would more than offset the reduction in ethanol prices.”

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