$0.51. 51¢. Two quarters and a penny. Not enough money to buy a candy bar or a can of soda pop at most places. Or even dry a load of laundry at the local laundromat. 51 cents may get you a copy of the daily newspaper in some cities, but probably very few. That amount of change in your pocket at the end of the day would probably get tossed into the coffee can on the dresser with little after thought. However, that seemingly paltry sum has been a powerful economic engine that has driven the success of a major new industry, spurred demand for a surplus commodity, and may create a future force in international trade that will impact everyone who…who….everyone. period!

51¢ is the amount of the federal tax credit awarded to petroleum blenders for including a gallon of ethanol with nine gallons of gasoline. That tax credit was authorized several years ago and has weathered Congressional storms to remove it. One of its reasons for popularity has been to ensure ethanol is competitive with gasoline, but with the summer’s high prices, ethanol was selling for more than petroleum, and the ethanol blends were more costly than the pure petroleum. Amani Elobeid and Simla Tokgoz, a pair of economists at Iowa State University’s Food and Agriculture Policy Research Institute have analyzed what would happen, just about everywhere, if the 51 cent blending credit were removed. Their research is entitled: Removal of U.S. Ethanol Domestic and Trade Distortions: Impact on U.S. and Brazilian Ethanol Markets. Make your own educated guess about the outcome, and then read on.

You are well aware of the US ethanol industry, particularly since it will be forcing up the price of corn in the next several years as billions of gallons are produced. But the 3.9 billion gallons produced by the US in 2005 is only second best to the 4.8 billion gallons produced in Brazil last year, where sugar cane is the preferred feedstock. Brazil has a major interest in what US policy is, since it is ready to ship ethanol into the US market, if the 54¢US tariff and 2.5% ad valorum tax on imported ethanol are lifted and various US states continue to ban the MBTE alternative.

The ethanol engine here in the US has a full head of steam, thanks to the 2005 Renewable Fuels Standard that set a renewable fuel target at 7.5 billion gallons per year by 2012. Economists Elobeid and Tokgoz say, “In 2005, U.S. ethanol production capacity was 4.3 billion gallons from 95 ethanol refineries. Capacity expansion totaled 0.2 billion gallons, while capacity under construction was 1.8 billion gallons. Ethanol production consumed 1.4 billion bushels of corn (about 12.6 percent of U.S. corn production) in 2005; 3.3 billion bushels of corn are expected to be utilized by 2015 (about 24.9 percent of a 13 billion bushel crop). Thus, ethanol production has already exceeded the 2006 target of the renewable fuels mandate. Despite the rapid increase in production, consumption of ethanol has been outpacing production for the past few years, which has led to increased imports into the U.S.”

In Brazil, the government implemented similar ethanol promotion programs, designed to reduced the dependence on foreign oil and find an alternative use for surplus sugar cane. The Iowa State economists say, “The government promoted the production of ethanol by offering credit guarantees and low-interest loans for construction of new plants and by setting ethanol prices at favorable levels relative to gasoline. This resulted in a dramatic increase in ethanol production by the end of the 1970s. The ethanol sector was further boosted by the introduction of ethanol cars that ran on hydrous ethanol in 1979. The government also imposed mandates on blending ratios of ethanol with gasoline and provided incentives to citizens to drive ethanol cars.” The US and Brazilian ethanol promotion programs were like the oriental Yin and Yang chasing each other.

Before the recent run-up in gas prices, which pushed ethanol prices higher, sugarcane-based ethanol from Brazil was selling at a 26 cent discount to corn-based US ethanol. Sugar prices have not climbed with the price of oil, which has driven the ethanol market. After the gas price surge began, the economists say Brazilian ethanol flowed into the US, “Volatility in U.S. domestic ethanol prices, which sometimes leads to spikes, provided Brazil with the opportunity to export ethanol to the U.S. For example, in October 2005 the Brazilian anhydrous ethanol price was $1.38 per gallon. Adding freight and the import tariff, the price for ethanol would reach $2.07 per gallon (including the 11¢-per-gallon transportation cost), which was below the $2.47-per-gallon U.S. domestic price for the same month.”

The question at hand is: What would happen to ethanol pricing (corn demand, corn prices, livestock production costs, ethanol coop investments, etc.) if the trade barriers and tax credits were eliminated, as some in Congress have suggested? In the first scenario, just the 54 cent import tariff and 2.5% tax are eliminated. The result is:
• The U.S. domestic ethanol price decreases by 14.1 percent, which results in a 7.5 percent decline in ethanol production and a 3.2 percent increase in consumption.
• The lower domestic price leads to a rise in the share of fuel ethanol in gasoline consumption by 2.5 percent.
• Given the lower domestic ethanol price, consumers are substituting gasoline blended with ethanol for gasoline blended with other additives.
• The removal of trade distortions in the U.S. and the corresponding higher U.S. ethanol demand increases the world ethanol price by 23.2 percent on average over the simulation period.
• Net ethanol imports of the U.S. increase by 192.8 percent. Given that net imports make up only 5.3 percent of domestic consumption in the baseline, the large increase in net imports in the first scenario translates into a 14.9 percent share of imports in total domestic consumption.
• Since the duties are removed, Brazil can now export ethanol to the U.S. directly without having to go through the Caribbean Basin Initiative countries. Therefore, trade diversion occurs, with ethanol imports from CBI countries declining to zero and with Brazil making up for the decline with higher exports to the U.S.
• The lower domestic production of ethanol translates into reduced demand for corn in the U.S. Thus, the corn price declines by 1.6 percent on average relative to the baseline.
• Given the decline in corn used in ethanol production, the production of by-products decreases, by 7.5 percent on average for DDG, and by 1.8 percent each for gluten feed, gluten meal, and corn oil.
• The reduction in the production of DDG increases the price of DDG by 0.7 percent. The price of gluten meal increases by 0.9 percent because of its production decline.
• However, the prices of gluten feed and corn oil fall by 0.5 percent and 0.2 percent, respectively, as the impact from the lower corn price, which decreases the cost of production, exceeds the impact from lower production.
• Brazil responds to the higher world ethanol price by increasing its production by 8.8 percent on average relative to the baseline. Total ethanol consumption decreases by 3.2 percent and net exports increase by 61.9 percent.
• The higher ethanol price leads to a 4.7 percent increase in the share of sugarcane used in ethanol production.
• This results in less sugarcane used in sugar production, which decreases sugar production in Brazil. The lower supply of Brazilian sugar leads to an increase in the world raw sugar price of 1.7 percent on average.

Whew! All that for just removing the 54 cent tariff and 2.5% tax. But what happens if the 51 cent per gallon blending credit is also removed? The economists predict:
• U.S. ethanol consumption increases by 2.7 percent, which is less than the increase in the first scenario, as the tax credit benefit that was passed on to the consumers is removed.
• The U.S. domestic ethanol price decreases slightly more in this scenario relative to the first scenario, since U.S. ethanol demand is lower.
• In response to the lower domestic price, production decreases slightly more compared to the first scenario. The world ethanol price increases by 22.5 percent on average compared to the baseline, which is also lower than in scenario 1.
• The impact on the corn byproducts market is similar to that in the first scenario in both direction and magnitude.

But the economic structure of farm cropping patterns can also be affected because of the impact on commodity prices, which Elobeid and Tokgaz predict, “The effect of the removal of trade distortions extends beyond the ethanol market, affecting the corn market and its by-products, as well as the sugar market. The price of corn in the U.S. is impacted by the change in the demand for corn used in ethanol production. This affects the prices of other crops in the U.S. and the area allocation between them. This has implications for the U.S. livestock sector because the prices of feed by-products from ethanol production change as well as the prices of other feeds such as the price of soy meal.”

The economists acknowledge there are many asterisks to their study, including the fluctuating price of petroleum, expansion of the US ethanol industry, adaptation of flex-fuel cars in the US and Brazil, and state-level promotions of ethanol production and use.

Summary:
It is rare when individual farmers consider the impact of an industrial tax credit or import tariff on their own farm budget, but since ethanol has had such an economic impact in rural America, its complex economy extends to nearly all farm families. The economic model that predicts the impact on the farm economy, resulting from a lifting of the tax credits and import duties, affects ethanol production and use, corn and soybean prices, livestock production costs, and many other pocketbook issues.