Ethanol and Energy Security

I propose a framework to evaluate the impact of ethanol on energy security from an economic perspective. In this model, economic energy efficiency maximizes a social or governmental objective function with respect to energy price levels and shocks. This tradeoff can entail raising expected energy prices while lowering price volatility. I develop a theoretical model showing ethanol's potential to lower overall fuel price volatility and estimate this relationship with both structural and reduced form approaches. I show that ethanol does not substantially lower U.S. gasoline price volatility or insulate gasoline prices from oil shocks in the absence of a binding quantity mandate. Ethanol can lower gasoline price volatility under a binding mandate, but this comes at substantial expected cost. In sum, ethanol is not an effective way to mitigate world oil price shocks and does not substantially enhance US energy security.