Which biofuel market does the ethanol tariff protect? Implications for social welfare and GHG emissions

Abstract

The ethanol tariff is one of the instruments used by the government to encourage domestic ethanol production. Existing literature analyzing the market and welfare effects of the US ethanol tariff has concluded that removing the tariff would increase social surplus and reduce greenhouse gas (GHG) emissions, due to the replacement of corn ethanol with lower cost and lower GHG intensive sugarcane ethanol. This paper re-examines these findings in the presence of a domestic cellulosic ethanol industry. The current RFS mandate requires 21 billion gallons of advanced biofuel, a portion of which could be met by any non-starch based biofuel that reduces emissions by at least 50% compared to an energy equivalent amount of gasoline. Sugarcane ethanol has been classified as an advanced biofuel, and competes for market share with domestic advanced biofuels such as cellulosic ethanol. In addition, it also competes with corn ethanol for market share in the non-advanced biofuel market. The dual market for sugarcane ethanol raises the question of which domestic biofuel market the tariff protects. Our results show that the effect of removing the tariff on social welfare and GHG emissions is ambiguous and depends on which biofuel market the tariff is protecting. If the tariff protects the corn ethanol market, its removal increases welfare and GHG emissions. However, if the tariff protects the cellulosic ethanol market, removing the tariff could increase emissions. Whether the tariff protects either the corn ethanol or cellulosic ethanol market, or both depends on the relative costs and supply elasticities of the three types of biofuel. In general, the removal of the tariff leads to an increase in social surplus, although in some cases, such as when the excess supply elasticity of sugarcane ethanol is not very elastic, net welfare could decrease when the tariff is removed. Removal of the tariff also reduces the share of domestically produced fuel, and this effect is greater when the tariff is protecting both the cellulosic and corn ethanol markets, i.e. the removal of the tariff causes a reduction in the production of both biofuels.