Variable subsidy for ethanol better for producers and government

August 24, 2010

WEST LAFAYETTE, Ind. - A variable subsidy for ethanol producers could cost the government less and provide more security for producers than current fixed rates, according to a Purdue University study.

Wally Tyner

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A variable subsidy rate would insulate producers from risk because as oil and ethanol prices drop, the subsidy for producers would increase, said Wally Tyner, a Purdue agricultural economist and an author of the study. The government would save money because it would not have to pay any subsidy when oil prices are high.

"There will be times when oil prices are high and the subsidy will be low or nothing at all," Tyner said.

The current government subsidy for ethanol producers - a fixed rate of 45 cents per gallon of ethanol - will expire at the end of the year. Congress will have to decide whether to create a new fixed rate, implement a variable rate or go with no subsidy at all.

Tyner said his study, which was published in the October issue of the journal Energy Policy, shows that a variable rate would be the most beneficial. A subsidy that lowers risk for producers could entice new cellulosic ethanol production, he said.

"We could see ethanol plants close if the subsidy isn't renewed in some form," Tyner said.

Tyner said producers would be profitable when ethanol prices and oil prices are high. When they dip, the subsidy would kick in to ensure that those producers continue that profitability. That assurance could attract new cellulosic producers who would see less risk to invest in the capital required to make ethanol.

In the analysis, the government would save money using a variable subsidy compared with the current fixed rate except when oil is at the highest prices. Based on Tyner's calculations, the government would pay $316 million under the current fixed subsidy over the life of a typical ethanol plant.

Under a variable rate, there would be no subsidy at $90 per barrel of oil. The subsidy would kick in at 17.5 cents per gallon when oil is at $80 and increase 17.5 cents for every $10 decrease in oil prices.

Using that scenario, the government would pay between $58 million and $360 million over the life of the plant, depending on the subsidy rate.

Tyner said the study's findings would be moot if the Environmental Protection Agency does not increase the amount of ethanol that can be blended with gasoline from 10 percent to 15 percent. He said without that increase, the United States is at the blending wall, the point at which growth in ethanol production has to stop because the maximum amount possible is being purchased and used by consumers. The EPA is expected to make a decision on the blending limit this fall.

Tyner calculated the costs of the fixed and variable subsidies using data from the U.S. Department of Energy and the Dry Milling Model, a Purdue-developed model designed to make projections about ethanol production.

The National Science Foundation funded the research.

Writer: Brian Wallheimer, 765-496-2050,

Source: Wally Tyner, 765-494-0199,

Ag Communications: (765) 494-2722;
Keith Robinson,
Agriculture News Page



Comparison of Fixed Versus Variable Biofuels Incentives

Wallace E. Tyner, Farzad Taheripour, David Perkis

We evaluated several variants of a variable biofuel subsidy and compared them with the fixed subsidy and Renewable Fuel Standard using two different modeling approaches. First, we used a partial equilibrium model encompassing crude oil, gasoline, ethanol, corn, and ethanol by-products. Second, we used a stochastic simulation model of a prototypical ethanol plant. From the partial equilibrium analysis, it appears the variable subsidy provides a safety net for ethanol producers when oil prices are low; yet, it does not put undue pressure on corn prices when oil prices are high. At high oil prices, the level of ethanol production is driven by market forces. From the plant level stochastic analysis, essentially the same conclusions are reached. As with the fixed subsidy, the variable subsidy can increase the net present value (NPV) sufficiently to encourage investment, but with lower risk for the producer, lower probability of a loss from the investment, and often lower expected cost to government. Finally, in the US, the ethanol industry is up against a blending limit called the blend wall. If the blending wall remains in place and no way around it is found, it does not matter much what other policy options are used.