Slide 1 U.S. Energy Situation, Ethanol, and Energy Policy Wally Tyner

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Slide 10 Energy and National Security n A common perception in the US is that there is a national security cost of imported oil that makes the real cost of oil products much higher than the cost consumers pay n Economists commonly advocate internalizing the cost of such an externality

Slide 11 Demand and supply side options n On the demand side, the major options are a fuel tax and stronger fuel economy standards – for the moment, these options have been rejected in the political process n On the supply side, government support of domestic alternatives to oil can take many forms n The key is risk reduction for private investments

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Slide 13 U.S. Energy and Ethanol n U.S. is the world’s largest energy consumer (in total and per capita) n U.S. imports over 60% of our oil n 40% of our energy consumption is oil n Ethanol is now about 3% of our gasoline consumption

Slide 14 Bio-fuels: Ethanol n Ethanol – ethyl alcohol, produced through fermentation of starch and sugars. In the U.S., about 90% comes from corn. n Ethanol is used as a gasoline extender, octane enhancer, and oxygenate, –Extender – just an addition to fuel supply –Octane enhancer – increases gasoline octane –Oxygenate – adds oxygen to make gasoline burn cleaner

Slide 15 Additional Information n Ethanol has higher octane than gasoline, but it has lower energy content. n Ethanol blends get slightly less mileage than equivalent gasoline. n Ethanol blends burn cleaner than standard gasoline because of the increased oxygen, but may increase evaporative emissions n MTBE will not be used much in the US after May 8, so in the short-run, ethanol demand is very high

Slide 16 Key Legislation n Energy Tax Act of 1978, provided a 54 cent per gallon subsidy for ethanol ($0.14/l). n Clean Air Act of 1990 mandated more oxygen in fuels (ethanol has more oxygen than standard gasoline). n American Jobs Creation Act of 2004 extended the 0.51/gal. (0.135/l.) federal subsidy through 2010 and changed the subsidy mechanism so it no longer comes from the gasoline tax. n Energy Policy Act of 2005 – renewable fuels standard and eliminated oxygen requirement

Slide 17 Energy Policy Act of 2005 n Energy Policy Act of 2005 – renewable fuels standard that starts at 4 bil. gal. in 2006 and goes to 7.5 bil. in 2012 n Standard encompasses both ethanol and bio-diesel n Will not reduce gasoline prices n Will not stimulate energy conservation n Does provide some funding for research (authorized but not appropriated)

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Slide 19 Ethanol Economics n Until very recently, ethanol has not been economic without a government subsidy. n However, with $70 oil and $2.25 corn, ethanol is profitable with no subsidy. n In addition, some states provide subsidies as well n Under current conditions, ethanol is very profitable with market conditions plus subsidies n Renewable fuel standard should provide an assured market for the product

Slide 20 Corn Use for Ethanol n Currently about 1.5 bil. bu. of corn is used for ethanol n That will at least double in the next 5 years n With more corn used for ethanol, we might expect: –More corn to be produced and higher prices –Less corn to be exported –Less corn to be fed –Higher price volatility

Slide 21 Ethanol Impacts n Currently the ethanol subsidy costs about $2.5 billion per year. n Over the past 25 years, ethanol has been an industry that exists solely due to government subsidies. Today, however, it could be viable without subsidies so long as oil prices stay high and corn prices low. n If the subsidies and the RFS continue, corn use for ethanol will increase beyond the 7.5 billion gallon standard by 2012.

Slide 22 Ag and Energy Policy Links n With 15 percent or more of the corn crop going to ethanol, there will be upward price pressure on corn –Costs of agricultural subsidies could fall –Subsidizing ethanol or bio-diesel is WTO legal, whereas coupled crop subsidies are likely to be limited in the future –Corn to ethanol produces DDGS, which is a moderate protein animal feed

Slide 23 Policy Analysis n We are doing policy analysis on both bio-fuels and coal liquids n Will describe here research leading to a new subsidy mechanism for corn based ethanol n The coal liquids risk reduction research applies equally well to ethanol from cellulose

Slide 24 Objectives of Ethanol Research n Given the increasing annual cost of the corn ethanol subsidy, is there a more efficient way to achieve the same results? n Determine a relationship between corn and ethanol prices and ethanol profitability n Create a variable payment ethanol subsidy based on above relationship n Compare results of both subsidies using historic prices

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Slide 26 Research Methods The research took place in 4 major steps: 1. Estimation of profitability under a wide range of corn and ethanol prices 2. Use data from step 1 to quantify the relationship between corn and ethanol prices and ethanol profitability and use the results as the basis for the variable subsidy 3. Develop a variable subsidy based on gasoline and corn rather than ethanol and corn 4. Compare results of the variable subsidy with the $0.51 flat rate subsidy using historic prices.

Slide 27 Government Savings n Using historical data total subsidy cost for the time period was: Fixed Subsidy = $17.19 billion Variable Subsidy = $10.81 billion Total Government Savings = $6.38 billion Average Annual Government Savings = $642 million or 37%

Slide 28 Fixed Subsidy Variable Subsidy is less than fixed subsidy 88% of the months.

Slide 29 Producer Risk

Slide 30 Producer Risk Fixed Subsidy Average Profit = $0.39 Coefficient of Variation = 0.43 Variable Subsidy Average Profit - $0.21 Coefficient of Variation = 0.34 CV = Standard Deviation/Mean

Slide 31 Results n Over the historic period: –Average annual government savings were 37% –Average annual producer risk reduction was 21% If the variable subsidy were in effect today, the cost for the first half of 2006 would be $0, but producers would be protected from future oil price drops or corn price increases

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Slide 33 Future Energy Policy Choices n Need to find cost effective ways to stimulate national production of liquid fuel alternatives to imported oil n Today, almost anything is profitable, but that could easily change tomorrow, so reducing the risk from oil price drops is key n Corn ethanol will play a prominent role n Cellulose ethanol and diesel from oilseeds and coal could also be important if we reduce investor risk n The policy set that works for corn ethanol may be different from policy to stimulate other sources

Slide 34 Thanks very much! Questions and Comments