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Assessing the impact of US ethanol on fossil fuel markets: A structural VAR approach

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  • McPhail, Lihong Lu

Abstract

Despite the growing importance of biofuels, the effect of biofuels on fossil fuel markets is not fully understood. We develop a joint structural Vector Auto Regression (VAR) model of the global crude oil, US gasoline, and US ethanol markets to examine whether the US ethanol market has had any impact on global oil markets. The structural VAR approach provides a unique method for decomposing price and quantity data into demand and supply shocks, allowing us to estimate the distinct dynamic effects of ethanol demand and supply shocks on the real prices of crude oil and US gasoline. Ethanol demand in the US is driven mainly by government support in the form of tax credits and blending mandates. Shocks to ethanol demand therefore reflect changes in policy more than any other factor. In contrast, ethanol supply shocks are driven by changes in feedstock prices. A principle finding is that a policy-driven ethanol demand expansion causes a statistically significant decline in real crude oil prices, while an ethanol supply expansion does not have a statistically significant impact on real oil prices. This suggests that even though US ethanol market is small, the influence of US biofuels policy on the crude oil market is pervasive. We also show that ethanol demand shocks are more important than ethanol supply shocks in explaining the fluctuation of real prices of crude oil and US gasoline.

Suggested Citation

  • McPhail, Lihong Lu, 2011. "Assessing the impact of US ethanol on fossil fuel markets: A structural VAR approach," Energy Economics, Elsevier, vol. 33(6), pages 1177-1185.
  • Handle: RePEc:eee:eneeco:v:33:y:2011:i:6:p:1177-1185
    DOI: 10.1016/j.eneco.2011.04.012
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    More about this item

    Keywords

    Crude oil; gasoline; and ethanol; Demand or supply shocks; Structural Vector Auto Regression (VAR);

    JEL classification:

    • Q1 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Agriculture
    • Q2 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Renewable Resources and Conservation
    • Q4 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Energy
    • C1 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General

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