# Presentation: 925264

## Policy Options for Integrated Energy and Agricultural Markets

**Policy Options for Integrated Energy and Agricultural Markets**

- Wally Tyner
- Farzad Taheripour

## Market Failures and Policy Pathways

- Both energy security and GHG emissions are examples of situations when markets alone cannot deliver an optimal solution.
- Economists call these externalities, and suggest using taxes, subsidies, or some form of regulation to correct the market failure
- In the U.S., we do not generally use taxes in this situation, so I will focus on subsidies and renewable fuel standards even though they may not be the best options

## Market Integration

- In the past, agricultural markets have been well integrated.
- Markets for different energy commodities, especially liquid energy products, also have been tightly linked.
- But agricultural markets and energy markets have not been closely correlated.

## Agricultural and Energy HistoricPrice Correlations

| Data Pair | Correlation Coefficient |
| --- | --- |
| Crude-gasoline | 0.98 |
| Crude-ethanol | 0.88 |
| Gasoline-ethanol | 0.86 |
| Ethanol-corn | 0.25 |
| Crude-corn | 0.16 |
| Crude-soybeans | 0.13 |
| Corn-soybeans | 0.72 |

## Policy Alternatives

- Stay the course with current policy
- No subsidy
- Variable subsidy
- Renewable fuel standard

## Review of Policy Options

- We will review the policy alternatives first from the perspective of a firm in the industry; that is, it is a micro level analysis based on the economic conditions at the firm level
- Then we will use a partial equilibrium model to evaluate many of the same policy alternatives
- With both approaches, we will be able to see the new linkages between energy and agriculture

## Slide 7

## Variable Subsidy

- The energy security externality can be handled through either a fixed or variable subsidy.
- A subsidy that varies with the price of crude oil would be a means of reducing the cost of the government subsidy while still providing a safety net if crude oil prices fall significantly
- The variable subsidy has two parameters:
- Crude price at which it begins ($75)
- Increase in the subsidy for each $1 crude falls below that price (0.03 cents/$)

## Slide 9

## Renewable Fuel Standard

- The  2007 Energy Independence and Security Act contains a 36 bil. renewable fuel standard by 2022:
- Current production is about 7 billion
- Five fold increase in 15 years
- A max of 15 bil. gal. can come from corn ethanol.
- This level will displace around 15% of 2022 gasoline, depending on the growth in gasoline consumption.
- With a binding mandate in place, it would no longer be necessary to subsidize alternative fuels, although they continue at least through 2010.

## Difference Between a Fuel Standard and a Subsidy

- The fundamental difference between a fuel standard and a subsidy is who pays:
- With a subsidy, the taxpayers pay the tax credits received by fuel blenders – it is part of the government budget
- With a fuel standard, consumers see changes in prices at the pump depending on what the alternative fuel costs relative to gasoline from crude oil
- If we wanted to capture the higher GHG impacts of cellulose ethanol, the standard would need to be partitioned with cellulose receiving a higher proportion

## Slide 12

## Model Integrating Corn and Energy Markets

- Partial equilibrium model encompassing corn, ethanol and by-products, crude oil and gasoline
- Endogenous variables:
- Gasoline supply, demand, and price
- Ethanol supply, demand, and price
- Corn supply and price
- Corn use for ethanol, domestic use, and exports
- DDGS supply and price
- Operating costs of corn production

## Model Description

- The model is driven and solved by market clearing conditions that corn supply equal the sum of corn demands and that ethanol production expands to the point of zero profit
- Exogenous variables include crude oil price, corn yield, ethanol conversion rate, ethanol subsidy rate and mechanism, and gasoline demand shock

## Model Simulations

- The model is simulated over a range of oil prices with no demand shock and a 10% demand shock (due to increases in incomes and population)
- No demand shock assumes higher CAFE standard
- 10% demand shock is DOE base case out to 2015 and essentially assumes that crude oil supply cannot keep up with rising gasoline demand as it has in the past

## Policy Simulations

- For each demand scenario, we simulate the following policies:
- Continuation of the 51 cent/gallon subsidy
- No ethanol subsidy
- A variable ethanol subsidy beginning at $70 oil and increasing $0.0175 for each dollar crude falls below $70
- A renewable fuel standard of 15 billion gallons for corn, such as contained in the energy bill

## 0.23

- 0.42

- 0.61

- 0.82

- 1.05

## 0.13

- 0.44

- 0.78

- 0.0

- 0.0

## Slide 19

## Slide 20

## Slide 21

## Slide 22

## Slide 23

## Slide 24

## Sensitivity to 30% Corn Yield Increase(compared with the base cases)

- Ethanol production up substantially
- Corn price down 15-39% depending on the case
- Corn production up 7-22% depending on the case
- Larger share of corn used for ethanol in all cases except RFS at lower oil prices
- Sensitivity results conform to expectations – yield increase means lower corn price, more corn produced, more profitable ethanol, and more ethanol production

## Slide 26

## Slide 27

## Conclusions

- Model results clearly illustrate the linkage between crude oil prices and corn prices and therefore with most agricultural commodities
- There are substantial differences among the policy alternatives evaluated.
- These model results are consistent with the firm level results illustrated earlier

## Summing Up

- Today’s high oil prices are largely demand driven
- Global recession could lead to significant oil price drops
- Investments in alternative energy sources are risky in the face of future potential price falls without policy measures that insure against major price drops
- Policy analysis must incorporate the new paradigm of close linkages between oil and agricultural prices
- If we want to reduce dependence on foreign oil, we must develop **policy pathways** that will lead us towards greater reliance on alternative energy and provide a **policy bridge **to cellulose based ethanol
**The policy choices we make will be critical**

## Thanks very much!

Questions and Comments

		For more information:
		http://www.ces.purdue.edu/bioenergy
		http://www.agecon.purdue.edu/papers/

*Questions and Comments*
- 		For more information:
- 		http://www.ces.purdue.edu/bioenergy
- 		http://www.agecon.purdue.edu/papers/

## Correlation Coefficients