Impacts of U.S. Production-Dependent Ethanol Policy on Agricultural Markets

U.S. agricultural commodity prices have been volatile in recent years, attributed to many factors, including renewable fuel standard (RFS) mandates. While the RFS is legislatively able to be altered, the mandate largely required the same volume of corn for ethanol in the 2012 drought year as it would have if 2012 were a normal production year. This contributed to a surge in corn prices, having significant economic ramifications throughout the agricultural industry. An important question that arose from these events was if this variability was avoidable with a RFS relaxation policy? In this work, the economic effects of a policy that relaxes ethanol mandates in cases of major corn production shortfalls is investigated to determine the market relationships between RFS policy and commodity markets. This is done in a three step process. First the historical incidence of shortfalls is addressed by developing a stationary probability distribution of total and regional production using econometric procedures. Second, the short-run economic impact of RFS relaxation alternatives is investigated using an optimization modeling framework where crop mix and livestock breeding herds are held fixed. Third, the long-run implications of RFS relaxation are investigated by incorporating a stochastic optimization framework of ag-producer decisions with recourse. When a shortfall driven relaxation policy is in place, crop mix/livestock breeding decisions are able to adjust. The results show RFS relaxation has a significant impact on reducing price spikes and livestock production impacts due to reduced feeding costs when shortfalls occur. Although an ethanol waiver benefits consumers through decreased commodity prices, the reduction in producer welfare was found to be larger, resulting in an overall negative agricultural sector welfare impact. In the long-run, the RFS relaxation mitigates price spikes during production shortfall years but also stimulates a producer response of decreasing corn acreage due to lower expected prices. This caused corn prices in non-shortfall years to increase, resulting in a negligible impact on the average long-run corn prices, while reducing commodity price variability. The model findings demonstrated that risk reduction implications could exist from a production-dependent conventional ethanol waiver, with limited long-run changes to future expected prices.