DEVELOPMENT OF VARIABLE ETHANOL SUBSIDY AND COMPARISON WITH THE FIXED SUBSIDY

Abstract

The federal government currently subsidizes ethanol with a fixed payment of $.51/gallon of ethanol blended with gasoline. Ethanol profitability is closely linked to the prices of corn and ethanol. The purpose of this paper was to develop a variable subsidy based on corn and ethanol prices and then to compare that variable subsidy with the fixed subsidy. This analysis proceeded in several distinct steps: • First, we estimated ethanol profitability over a wide range of ethanol, corn, and distillers grains prices. • This data was used in a regression analysis to estimate the ethanol profitability from the set of corn and ethanol prices. The regression coefficients became the basis for the variable subsidy. • A version of the subsidy that used gasoline prices instead of ethanol prices was also developed. • Administratively, it would be burdensome to have a subsidy that changed every month, so we implemented both variable subsidies using quarterly data. • We then compared the average annual government cost and monthly private profitability using historical data and assuming the variable subsidy and the $0.51 fixed subsidy was applied. When using historic gasoline and corn prices from the last ten years, the variable rate subsidy cost the government nearly 40% less than the flat rate subsidy. Profit received by producers on average is a little less; however, producer’s risk is lower with the variable subsidy than the flat rate subsidy.