The Economic Effect of
Governmental Incentives on the
Ethanol Fuel Market
Quinn Kelley
Graduate Student
University of Georgia
1
Problem Statement
• Limited research available on the
market for ethanol.
• To determine the effectiveness of
current subsidies for ethanol, the
economic structure of the fuel-blending
market for ethanol is required.
2
Objectives
•
•
•
Investigate the impact market
determinants have on the ethanol market.
Develop an econometric model of the
fuel-blending market demand and supply
for ethanol.
Based on this econometric model,
elasticities are calculated and implications
for this highly subsidized market are
discussed.
3
Alternative Fuel Legislation
• Alternative Motor Fuels Act (AMFA) of
1988
• Clean Air Act Amendments (CAAA) of
1990
• Energy Policy Act (EPACT) of 1992
• Federal Ethanol Subsidy of $0.54 per
gallon
• Additional State Subsidies
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Ethanol
• Ethanol is an alcohol-based, colorless
liquid fuel with a characteristic odor.
• Currently, ethanol is used as a fuel
additive in gasoline.
• In the U.S., corn is the predominant
feedstock in ethanol production.
• Ethanol is produced through a process of
fermenting and distilling starch crops that
have been converted into simple sugars.
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Competition
Methyl Tertiary-Butyl Ether (MTBE)
• First synthesized in the early 1960s and
commercial production began in 1979.
• Classified as a volatile organic
compound (VOC).
• Produced by a chemical reaction
between methanol and isobutylene.
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Empirical Model
Demand
QitD = β0 + β1Pwt + β2Pgt + β3Vit + β4CAAAit + Σ5j=1βj+4Rji + εitD
Q
Pw
Pg
V
CAAA
R
= annual ethanol quantity sold
= lagged price wedge (Peth – Pmtbe)
= annual grade-weighted wholesale price of gasoline
= annual number of registered vehicles by state
= Clean Air Act non-attainment dummy variable
= regional dummy variable
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Empirical Model
Supply
QitS = α0+ α1 Pwt + α2Pcit + α3Si + Σ5j=1αj+3Rji + εitS
Pc = state-level annual corn price
S = state-level annual subsidy
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Data
• Data were collected from the Economic
Research Service, the U.S. Department of
Transportation, the Energy Information
Administration, and the U.S. Environmental
Protection Agency.
• The data set includes: 1988 to 2002 annual
observations by state.
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Tobit Two-Stage Least Squares
Results
Demand
Coefficients
Standard
Errors
Elasticities
Intercept
-58.820*
8.490
Price Wedge
-99.199*
12.924
0.81
Price of Gasoline
17.014*
4.565
0.86
No. of Vehicles
18.095*
2.613
0.28
CAAA
13.935*
2.613
Regions
1
2
3
4
5
3.329
8.339*
56.534*
-2.567
2.557
3.843
2.685
4.614
2.961
2.340
*Significantly different from zero at the 5% significance level
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Tobit Two-Stage Least Squares
Results
Supply
Intercept
Coefficients
Standard
Errors
Elasticities
347.292*
34.307
Price Wedge
0.889*
0.093
8.17
Price of Corn
-38.804*
4.342
-4.23
Subsidy
-0.837*
0.043
-2.36
Regions
1
2
3
4
5
-2.021
-20.211*
37.001*
-20.583*
-7.651*
4.207
3.569
8.131
3.070
2.863
*Significantly different from zero at the 5% significance level
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Price
Share borne by
fuel- marketing firms
pf

QS
pm
Share borne by
manufacturers
0
Q ’
D
QD
Ethanol
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Market Implications
• With fuel-marketing firms bearing the
major impact of any ethanol subsidy
removal (91%), any reduction in the
subsidy will negatively impact ethanol’s
competitiveness over MTBE.
• A gradual phase-down of the subsidy will
be dramatic for the industry.
• A 45% reduction in the ethanol subsidy will
result in the elimination of the ethanol
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market.
Impacts
• If a state is designated in non-attainment,
ethanol demand will increase by 14 million
gallons.
• An elastic input demand for corn limits any
bargaining leverage corn producers have
in their attempts to influence market price.
• The increases in state ethanol subsidies
over the last decade have not resulted in
inducing a positive ethanol supply
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response.
Conclusions
• The economic structure of the ethanol
market indicates ethanol agents are
addicted to the federal tax exemption on
ethanol blended fuels.
• The potential for demand expansion
resides in structural shifts occurring from
clean air and water regulations, health
restrictions, renewable fuels, and global
warming.
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