Clean air and renewable fuels: the market for fuel ethanol in the US from 1984 to 1993

Abstract

Ethanol made from corn has become an increasingly important fuel additive in the US over the past decade. The market for ethanol has grown from 550 million gallons in 1984 to approximately 1.5 billion gallons in 1995. Recent clean-air legislation has mandated the use of cleaner burning fuels in the US in specific regions and seasons. The fundamental role of fuel ethanol is changing from a gasoline substitute and octane enhancer to being one of a number of possible clean-air additives. In addition to these changing market conditions, the institutional structure surrounding the ethanol market has changed. While there is a uniform national subsidy for ethanol use, each state has its own supplemental subsidy level which varied from zero to over $0.40 per gallon. Recently, many state subsidy levels have been declining, but significant incentives still remain (including the federal $0.54 per gallon incentive). This paper explores the economic characteristics of the US ethanol market. The market supply and demand for ethanol are estimated econometrically. The results highlight the importance of the state and federal incentives and mandates, along with transportation costs, in making corn-based ethanol an attractive alternative to gasoline. Further investigation using a probit model to predict whether a state has an ethanol market or not reinforces the results of the supply–demand market model. The implications of the market characteristics for current and future US ethanol policy and clean-fuels use are discussed.