Hyunok Lee and Daniel A. Sumner

1. 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

2. 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@ucdavis.edu 530-752-2320 (Laurie Treacher)

3. 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)

5. Plants follow feedstock

6. Ethanol Plants in California

7. 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.

9. Transport of Ethanol and Corn is a major issue for California Ethanol Economics

11. 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)

12. 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.

13. Policy clout matters and that is something that the US industry has in abundance

14. 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.

15. 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?

16. 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

17. 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.

18. 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

21. 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 => Derived Demand for ethanol US supply of ethanol <= profit maximization framework (endogenous prices of co-products, corn) Brazil demand for ethanol; Supply of ethanol <= profit maximization (sugar cane) Calibrated on 2005 market data and policies, and compares simulation results with the baseline, 2006-2015.

22. 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

23. 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

24. 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)

25. 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.

26. Price Demand in three segments S0 S2 Quantity of ethanol 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)

27. 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 09:33 AM CDT

28. 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

30. Not official US notifications (Congressional Research Service approximations)

31. 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

32. 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

33. 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 R&D • 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