Comparison of Fixed Versus Variable Biofuels Incentives

We evaluated several variants of a variable biofuel subsidy and compared them with the fixed subsidy and Renewable Fuel Standard. We used two different modeling approaches. First we used a partial equilibrium model encompassing crude oil, gasoline, ethanol, corn, and ethanol by-products. Second, we used a stochastic simulation model of a prototypical ethanol plant. From the partial equilibrium analysis, it appears the variable subsidy provides a safety net for ethanol producers when oil prices are low; yet, it does not put undue pressure on corn prices when oil prices are high. At high oil prices, with a variable subsidy, the level of ethanol production is driven entirely by market forces. From the plant level stochastic analysis, essentially the same conclusions are reached. The variable subsidy can provide essentially the same expected NPV as the fixed subsidy but with a lower risk for the producer, a lower probability of a loss from the investment, and often at a lower expected cost to government. Finally, in the U.S., the ethanol industry is up against a blending limit called the blend wall. If the blending wall remains in place, it does not matter much what other policy options are used.