International Trade, Policy and Biofuels in California Energy and Agriculture: Implications of Biofu

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International Trade, Policy and Biofuels in
California Energy and Agriculture
Implications of BiofuelsBerkeley,
CaliforniaOctober 5, 2007

• Hyunok Lee and Daniel A. Sumner
• University of California Agricultural Issues
  Center and Department of Agricultural and
  Resource Economics, UC Davis

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Agricultural Issues Center

• Small research unit dealing with many practical
  issues facing agriculture California and the
  world.
• Based in Davis, but drawing on University of
  California people all over the state.
• We have begun a program of work on energy and
  agriculture to assess issues from a California
  perspective.
• www.aic.ucdavis.edu
• agissues_at_ucdavis.edu
• 530-752-2320 (Laurie Treacher)

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California is a major importer of bothcorn and
ethanol

• California produces about 0.5 of US corn (still
  mostly used for livestock feed)
• California produces about 0.5 of US ethanol
  (mostly from corn shipped from the Midwest)
• California is major importer of corn mainly for
  livestock feed
• California is a major importer of ethanol
• Given policy shift in 2005 to meet Clean Air Act
  rules (replacement of MTBE), California accounts
  for about 1 bil gallons, about 17 of U.S.
  ethanol use (declining as total US use rises)

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Plants follow feedstock
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Ethanol Plants in California
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Plant location and California agriculture

• Consider a medium ethanol plant -- 60 million
  gallons, equivalent of 20 million bushels of
  corn. Not big by national standards but big for
  California
• At 200 bu./acre that requires about 100,000 acres
• Note, California corn price has been 0.50/bushel
  higher than the national price (only 0.25/bushel
  higher in 2006)
• Plants here located next to rail lines from
  Midwest.
• How much suitable land available in California in
  a contiguous block to minimize transport costs?
• California has planted 620,000 acres of corn in
  2007, but in the past only about 120,000 has been
  harvested for grain, the rest is used as silage
  for the dairy industry.
• San Joaquin County harvested 43,000 acres of corn
  for grain
• Tulare County (concentrated dairy) harvested
  140,000 acres of corn for silage.

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Transport of Ethanol and Corn is a major issue
for California Ethanol Economics
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Clearly government policy drives bioenergy
economics and that is likely to continue

• For the foreseeable future, bioenergy can pay
  only if the subsidy is substantial enough!
• Currently focus is on government to aid the
  biofuels on both the demand side and the supply
  side. Much of this is outside agricultural
  legislation and is in energy or environmental law
• Demand side now relies on blender tax credit,
  import tax on imported ethanol (and not on
  imported oil) and mandates
• California also has demand side policies that may
  stimulate biofuels use
• Supply-side subsidy is in the farm Bill, energy
  bill (or state subsidy programs)

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Example ethanol economic calculations(round
figures at current technology and recent but not
current prices)

• Consider a unit cost of production of 1.
  50/gallon for ethanol (to cover all inputs
  including capital investment).
• Consider a gasoline price of 1.50/gallon
  (wholesale), but ethanol has only 68 as much
  power as gasoline, so in rough ethanol-equivalent
  terms 1.50 X 0.68 1.00/gallon.
• How does ethanol compete? The blender gets a tax
  credit of 0.51 per gallon of ethanol. So, the
  blender is willing to pay 1.00 0.51
  1.51/gallon for ethanol as a gas extender.
• With these cost figures if costs of corn are
  higher, or byproduct value is lower, or gas price
  is lower, then ethanol does not compete as a fuel
  extender and mandates matter.
• If gas price is higher than ethanol or ethanol
  costs lower, then plants make money and there are
  incentives to expand.

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Policy clout matters and that is something that
the US industry has in abundance
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Biofuels mandates

• Clean air rules and regulations require
  reformulated gasoline (ethanol has taken over
  from MTBE) and oxygenated fuel. Use in
  California is at the limits required for blending
• About 5.7 of total fuel use is ethanol
• The projected ethanol supply exceeds current
  national requirements of 7.5 billion gallons by a
  wide margin
• The mandates and standards no longer drive
  ethanol use
• On the policy horizon--new policy requirements
  for use of renewable fuels
• The Administration and Congress are talking about
  new mandates for of renewable fuels in the mix
• Demand may be driven by government mandates even
  when ethanol is more expensive counting the
  blender credit. This is a fuel tax, that
  consumers do not see.

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International trade patterns and policy

• US is a major producer but has recently been an
  important import market for ethanol
• California is a natural destination
• Import policy (tariffs) is not consistent with
  biofuels consumption policy, but follows from a
  production policy that is hard to link to stated
  long term objectives
• Implications of tariff cuts?

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Ethanol Import Policy

• One rationale for the 0.51/gallon tax benefit
  for ethanol relative to gasoline is that ethanol
  consumption provides externalities in term of
  reduced oil imports from unstable or hostile
  places (Middle East or Venezuela).
• This demand side benefit suggests importing
  ethanol rather than oil.
• But, ethanol has a 2.5 ad valorem tariff plus a
  0.54/gallon specific tariff. (Except as noted
  next in limited quantities from CBI countries.)
• Nonetheless foreign producers (Brazil) produce as
  such lower costs that ethanol continues to enter
  over the tariff at least in some months when the
  U.S. price is unusually high

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Caribbean Basis Initiative

• Duty free access for the region for most
  products, including ethanol
• Strict local content rules preclude simple
  transshipment
• 50 local feedstock, or
• limited access to 7 of U.S. market (TRQ)
• Sugar produced there but costs are high and
  ethanol processing costs are high.
• In practice, hydrous ethanol is shipped from
  Brazil, dehydrated (so that it meets the basic
  domestic content rules of the CBI) and then
  shipped to the U.S.
• More ethanol now comes directly from Brazil than
  through the duty free CBI countries and that
  amount is far less than the 7 limit.
• Therefore, for most shipments paying the duty is
  cheaper than going through the CBI countries.
• CBI country imports facing rising marginal cost
  that mean they stop well before the TRQ
  constraint.

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California is a prime market for ethanol imports

• Transport costs from Midwest are significant but
  below transport costs from Brazil.
• Plants for blending are at the ports. Oil arrives
  the same way as the imported ethanol

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CARD Study on the Impact of Change in US Ethanol
Trade Policy

• (Elobeid and Tokgoz, October 2006)
• Two scenarios
• 1) Remove duties on ethanol imports
• 2) Remove duties US federal tax credit
• Model US, CBI and Brazil, multi-market
  (transportation fuel, ethanol, inputs and
  co-product markets)
• Approach
• US transport fuel D and S gt Derived Demand for
  ethanol
• US supply of ethanol lt profit maximization
  framework (endogenous prices of co-products,
  corn)
• Brazil demand for ethanol Supply of ethanol lt
  profit maximization (sugar cane)
• Calibrated on 2005 market data and policies, and
  compares simulation results with the baseline,
  2006-2015.

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Demand for ethanol in the US

• Derived demand for ethanol(ethanol demand/gal of
  blended gasoline)total blended gasoline
• Ethanol demand/gallon of blended gasoline
  f(ethanol price, credit, oil price, mandate,
  renewable fuels standard)
• This may suggest complex function forms, but not
  explored in this paper
• Ethanol and gasoline complements under ethanol
  mandates
• Substitutes when ethanol is used as a fuel
  extender

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Removal of tariffs only

• Shift out supply of ethanol available in US
  market and draw this supply off the world market
• World price of ethanol increases by 24
• US ethanol price decreases by 13.6
• 7.2 decline in US ethanol production and
• 3.6 increase in US ethanol consumption
• US net ethanol imports increase three fold
• From base of 400 mil gallons to 1.2 billion
  gallons
• Lots more results for US corn, other products
  etc. and for Brazil, relatively inelastic world
  supply
• These results hinge on US supplies and demands
  that are relatively inelastic

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Removal of Duties and Tax Credit

• Shift out supply in US and shift back demand for
  ethanol in the US market
• World ethanol price increases by 16.5
• US ethanol price decreases by 18.4
• 9.9 decline in US ethanol production and 2.1
  decrease in US ethanol consumption
• US net ethanol imports increase by 137
• From 400 million to about 900 million gallons
• (Just about enough to satisfy California)

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Results of cutting the tariff or the blenders tax
credit hinge on what we think drives the demand
for ethanol in the US market

• If ethanol demand is driven by the mandate then
  demand is inelastic. Increasing supply lowers
  price but does not affect use. Imports simply
  replace domestic consumption.
• If ethanol is really a fuels extender i.e.
  ethanol can compete with gas at current prices,
  imports do not drive prices down because ethanol
  remains a small share of fuel market.

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Demand Considerations and Price Response to
Expanded Supply(think also of shifting demand to
the right with new mandates or to the left with
lower or removed mandates)
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Potential WTO Dispute Issues for Biofuels Trade
Canada and Brazil also have made claims that
the U.S. is over its 19.1 billion "aggregate
measure of support." Besides questioning direct
payments, Brazil is questioning the 51-cent
blenders tax credit for ethanol and the 1 per
gallon tax credit for bio-diesel fuel. Brazil
argues certain tax breaks for farmers should be
added into the amber-box figures as
well. WTO-Tinged Farm Bill Unlikely Chris
Clayton, DTN Fri Sep 28, 2007 0933 AM CDT
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US WTO obligations and negotiations

• Aggregate Measure of Support (AMS) under the WTO
  is limited to 19.1 billion this is a special
  and detailed accounting of domestic subsidies
  such as payments, input benefits and price
  supports, etc. It includes buyer side subsidies
  that benefit producers.
• US finally released yesterday the official
  notifications for AMS for 2002 through 2006
• The US did not include direct payments (5.3 bil)
  or any ethanol subsidies.
• Ethanol tariff is not being challenged nor is
  anyone challenging the price suppression effects
  of domestic subsidy in the US

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Not official US notifications (Congressional
Research Service approximations)
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Brazil and Canada suggest that US has left
subsidies out of the AMS

• They suggest that AMS was over the limit because
  WTO will rule that direct payments and other
  subsidy count in AMS
• Brazil also question that blenders tax credit and
  ethanol supply side subsidies belong in the AMS
• The claim is a legal and accounting point not an
  economic point about price suppression. The tax
  credit raises US and world price.
• Credit 0.51 times 7 billion gallons 3.5
  billion this is a big number to add to the AMS
• It is also a big number to add to overall subsidy
  in the new WTO framework

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Brazil and Canada suggest that US has left
subsidies out of the AMS

• They suggest that AMS was over the limit because
  WTO will rule that direct payments and other
  subsidy count in AMS
• Brazil also question that blenders tax credit and
  ethanol supply side subsidies belong in the AMS
• The claim is a legal and accounting point not an
  economic point about price suppression. The tax
  credit raises US and world price.
• Credit 0.51 times 7 billion gallons 3.5
  billion this is a big number to add to the AMS
• It is also a big number to add to overall subsidy
  in the new WTO framework

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Summary remarks

• Currently US corn ethanol can compete with
  gasoline this requires the high oil price,
  government subsidies and import tariff on ethanol
  
• The future of bioenergy depends on government
  subsidy (or bigger mandates) and on RD
• Transport costs determines plant location and
  feedstock use
• Much political effort is underway on subsidy
• Import policy benefits ethanol producers but is
  hard to square with externality arguments of
  biofuels consumption (or environmental concerns)
• Demand conditions crucial in determining
  incidence
• WTO compliance issues may weight in