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Description of Iowa State Stochastic Model Used in EPA Analysis

Memo to the Docket

2012 Decision in Response to Requests for a Waiver of the RFS November 15, 2012

The model that was used to estimate the impacts of a mandate waiver solves for market clearing prices and quantities in the following eight markets: corn, U.S. corn ethanol, Brazilian sugarcane ethanol, soybeans, soybean oil, soybean meal, and U.S. biodiesel. The model is solved 500 times. The following

variables are varied across the 500 m odel solutions: U.S. corn production, U.S. wholesale gasoline prices, U.S. soybean production , Brazilian s o y b e a n y i e l d s
, A r g e n t i n e soybean yields, and Brazilian ethanol production . Following are summary descriptions of each of these markets.

Corn

U.S. sup ply for the 2012/13 marketing year equals beginning stocks plus U.S. production. Production

wa s treated as a random variable by fixing acres harvested at 87.7 million acres and then var ying yield s

. Y ields were draw n from a beta distribution with minimum and maximum values determined by the minimum and maximum percent errors in production projections as reported by the United States Department of Agriculture ( USDA ) . The mean yield was set at USDA’s projec ted yield for the 2012 /13

crop. All exogenously determined U.S. agricultural inputs (e.g.

, corn production, corn yields, beginning

stocks ) were set to the values provided in USDA’s October 2012 World Agricultural Supply and Demand Estimates (WASDE) report.

Linear demand curves were calibrated to WASDE projections of demand for feed, food, and exports. Demand elasticities at the WASDE price (mid

- point projection) and quantity are

- 0.25,

- 0.096, and

- 0.65 for these three markets respectively. A beta distribution was used to model stocks to account for the likely stock

- out condition that the U.S. will likely find itself in during at the end of this marketing year.

The four demand curves are summed to obtain the non

- ethanol corn demand curve. The sup ply of ethanol is derived from the excess supply curve of corn.

Corn Ethanol

The supply curve for corn ethanol is obtained from the excess supply curve of corn. The quantity of ethanol is set equal to the supply of corn multiplied by 2.75 gallons per b ushel. The supply price of ethanol is the price of ethanol that is needed to cover all variable costs of production.

The demand for ethanol was specified by EPA as a function of the price of ethanol relative to wholesale gasoline prices. These specificat ions were determined in consultation with the U.S. Department of Energy based on internal analysis and information provided by the refining industry.

Brazilian Ethanol

The market for Brazilian ethanol closely follows the specification shown in the appendix of Babcock, Barr, and Carriquiry (2010). 1 Ethanol demand is the sum of hydrous demand and anhydrous demand plus export demand. Hydrous demand is a function of the retail price of hydrous relative to gasoline and the

number of flex

- fuel vehicle s in Brazil. Anhydrous demand is a function of hydrous demand (more hydrous demand means less anhydrous demand because anhydrous is used in gasoline ). Supply of ethanol is treated as a stochastic variable. Trade with the United States is allowed. Impor ts flow into

1 “ Costs and Benefits to Taxpayers, Consumers, and Producers from U.S. Ethanol Policies .” Staff Report 10

- SR 106 July 2010

. Center for Agricultural and Rural Development Iowa State

.

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Brazil when the domestic Brazilian price of anhydrous ethanol is greater than the U.S. domestic price plus transportation costs. Exports flow to the U.S. when the demand for either conventional or advanced biofuel pushes the U.S. price of one of these fuels above the Brazilian domestic price plus transportation costs. Two way trade in biofuels is allowed in the model.

Soybeans

The world soybean sector is broken down into the U.S., Brazil, Argentina, and the rest of the world.

Demand for soybean meal and so ybean o il create a demand for soybean crush in each of the three countries. The amount of crush determines the supply of soybean oil and soybean meal. The supply of soybeans equals the products of acreage and yield in the three modeled countries. Distributions of soybean yields in Argentina and Brazil a re formed from historical de

- trended yield data with a mean set equal to WASDE projections. WASDE acreage estimates were used. U.S. soybean yields were modeled identically to corn yie lds with harvested acreage fixed at WASDE projected levels and variability determined by the historical errors in WASDE projections.

World prices for soybeans, soybean oil, and soybean meal are determined endogenously in the model.

U.S. Biodiesel

The supply of biodiesel is determined by the operating margins of biodiesel plants assuming that soybean oil is used as a feedstock. 680 million gallons of biodiesel are produced from feedstocks other than soybean oil. The demand for biodiesel is perfectly elastic at a price that is discounted from diesel. The diesel price is determined by the stochastic gasoline price.

Model Solution

Market

- clearing prices and quantities are solved for given assumptions about the level of mandates and for 500 draws of g asoline price, corn production, soybean production in the U.S., Brazil, and Argentina, and Brazilian ethanol production.

Equilibrium corn prices clear the market for corn. Ethanol supply prices allow ethanol plants to cover their production costs where th e quantity of production is determined by the excess amount of corn that is

available after non

- ethanol corn demands are met. The RIN price for conventional biofuel covers any gap between the supply price that ethanol plants receive and the demand price t hat blenders pay.

Similarly, equilibrium soybean prices clear the crush and export markets for each country. Soybean oil demand from biodiesel increases the demand for soybean oil

, which leads to an increase in the price of soybean oil . Higher soybean oil prices increases the crush margin

, which leads to an increase in the demand for soybeans . Higher demand for soybeans increases the price of soybeans

, which increases the supply of soybean meal and soybean oil. Equilibrium prices that clear all three markets (soybeans, soybean oil, and soybean meal) are determined endogenously by the model . Any gap between the demand price for biodiesel and the supply price that biodiesel plants need to cover the cost of pr oducing biodiesel plus their required margin is covered by the biodiesel RIN price.

Equilibrium in Brazil’s ethanol market is determined jointly with the U.S. ethanol market accounting for U.S. demand for Brazilian sugarcane ethanol to meet advanced and possibly conventional mandates and

Brazilian demand for U.S. ethanol.

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Differences between Current Model and 2008 Model

The model that was used to determine the impact of waiving the RFS mandate in 2008 differs from the model that is currently in use in a number of ways. The most promi nent differences are as follows:

The current model treats gasoline prices as exogenous. The 2008 model endogenously solved for gasoline prices simultaneously with ethanol prices , using an exogenous assumption of crude oil prices based on futures market prices for crude oil at that time

.

The 2008 model included heterogeneous efficiency across ethanol plants. The current model assumes uniform efficiency.

Because the 2008 modeling exercise was carried out in the spring, there was more uncertainty about the level of production so both yield and harvested acreage were made stochastic with a relatively high variance. The current model fixes harvested acreage and uses WASDE historical error bounds to

determine the variance of harvested yield.

The current model models the soybean sector to enable interaction between sugarcane ethanol and biodiesel in the advanced biofuel market. The 2008 model did not include soybeans.

The current model includes the Brazilian ethanol sector as both a supplier of sugarcane ethanol and as an export market for US corn ethanol.

In 2008

, the capacity of the ethanol industry was not known so it was made stochastic. The current model does not have this stochastic component.

Corn export demand was made stochastic to capture the effects of volatile exchange rates. The current model has a fixed corn export demand curve.