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Ethanol, Mandates, and Drought: Insights from a Stochastic Equilibrium Model of the U.S. Corn Market

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  • Lihong Lu McPhail
  • Bruce A. Babcock

Abstract

The outlook for U.S. corn markets is inextricably linked to what happens to the U.S. ethanol industry, which depends, in turn, on the level of government subsidies and mandates. We develop a stochastic partial equilibrium model to simulate outcomes for the corn market for the 2008/09 marketing year to gain insight into these linkages. The model includes five stochastic variables that are major contributors to corn price volatility: planted acreage, corn yield, export demand, gasoline prices, and capacity of the ethanol industry. Our results indicate that integration of gasoline and corn markets has increased corn price volatility and that the passage of the expanded ethanol mandates in the Energy Independence and Security Act (EISA) has had modest effects on corn prices. Model results indicate an expected average marketing year price of $4.97 per bushel and a price volatility of 17.5% without the 10 billion gallon EISA mandate but with maintenance of the $0.51-per-gallon tax credit. Imposition of the mandate increases the expected price by 7.1% and price volatility by 12.1%. The effects of the mandate are modest, as ethanol production would average 9.5 billion gallons without the mandate because of high gasoline prices. The mandate is binding with a probability of 37.8%, which indicates that an additional tax or subsidy will be needed to ensure that the mandate is met. High corn prices caused by drought can cause the mandate to bind. Fixing 2008 corn yields at extreme drought levels increases expected corn prices to $6.59 per bushel without a mandate and to $7.99 per bushel with the EISA mandate. An average additional subsidy of $0.73 per gallon of ethanol would be needed to ensure that the mandate is met in this drought scenario. Elimination of the current blenders tax credit would result in the mandate not being met in all cases. On average, a subsidy of $0.41 per gallon would ensure that ethanol production is at least 10 billion gallons in the 2008/09 marketing year.

Suggested Citation

  • Lihong Lu McPhail & Bruce A. Babcock, 2008. "Ethanol, Mandates, and Drought: Insights from a Stochastic Equilibrium Model of the U.S. Corn Market," Center for Agricultural and Rural Development (CARD) Publications 08-wp464, Center for Agricultural and Rural Development (CARD) at Iowa State University.
  • Handle: RePEc:ias:cpaper:08-wp464
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    References listed on IDEAS

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    Cited by:

    1. McPhail, Lihong Lu & Babcock, Bruce A., 2012. "Impact of US biofuel policy on US corn and gasoline price variability," Energy, Elsevier, vol. 37(1), pages 505-513.
    2. Qiu, Cheng & Colson, Gregory & Escalante, Cesar & Wetzstein, Michael, 2012. "Considering macroeconomic indicators in the food before fuel nexus," Energy Economics, Elsevier, vol. 34(6), pages 2021-2028.
    3. Condon, Nicole & Klemick, Heather & Wolverton, Ann, 2015. "Impacts of ethanol policy on corn prices: A review and meta-analysis of recent evidence," Food Policy, Elsevier, vol. 51(C), pages 63-73.
    4. Wang, Xiaolei & Ouyang, Yanfeng & Yang, Hai & Bai, Yun, 2013. "Optimal biofuel supply chain design under consumption mandates with renewable identification numbers," Transportation Research Part B: Methodological, Elsevier, vol. 57(C), pages 158-171.
    5. Yano, Yuki & Blandford, David & Surry, Yves R., 2011. "International Variability in Biofuel Trade: An Assessment of U.S. Policies," 2011 International Congress, August 30-September 2, 2011, Zurich, Switzerland 115793, European Association of Agricultural Economists.
    6. Christopher Lant & Timothy J. Stoebner & Justin T. Schoof & Benjamin Crabb, 2016. "The effect of climate change on rural land cover patterns in the Central United States," Climatic Change, Springer, vol. 138(3), pages 585-602, October.
    7. Tristan Skolrud & Gregmar Galinato & Suzette Galinato & Richard Shumway & Jonathan Yoder, 2014. "The Role of Market Structure and Federal Renewable Fuel Standards in the Growth of the Cellulosic Biofuel Sector," Working Papers 2014-02, School of Economic Sciences, Washington State University.
    8. Araujo Enciso, Sergio René & Fellmann, Thomas & Pérez Dominguez, Ignacio & Santini, Fabien, 2016. "Abolishing biofuel policies: Possible impacts on agricultural price levels, price variability and global food security," Food Policy, Elsevier, vol. 61(C), pages 9-26.
    9. Gal Hochman & Scott Kaplan & Deepak Rajagopal & David Zilberman, 2012. "Biofuel and Food-Commodity Prices," Agriculture, MDPI, Open Access Journal, vol. 2(3), pages 1-10, September.
    10. Lihong Lu McPhail & Bruce A. Babcock, 2008. "Short-Run Price and Welfare Impacts of Federal Ethanol Policies," Center for Agricultural and Rural Development (CARD) Publications 08-wp468, Center for Agricultural and Rural Development (CARD) at Iowa State University.

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    Keywords

    EISA mandate; ethanol; price volatility of corn; stochastic equilibrium.;

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