DEVELOPMENT OF VARIABLE ETHANOL SUBSIDY AND COMPARISON WITH THE FIXED SUBSIDY

The federal government currently subsidizes ethanol with a fixed payment of $.51/gallon of ethanol blended with gasoline. Ethanol profitability is closely linked to the prices of corn and ethanol. The purpose of this paper was to develop a variable subsidy based on corn and ethanol prices and then to compare that variable subsidy with the fixed subsidy. This analysis proceeded in several distinct steps: First, we estimated ethanol profitability over a wide range of ethanol, corn, and distillers grains prices. This data was used in a regression analysis to estimate the ethanol profitability from the set of corn and ethanol prices. The regression coefficients became the basis for the variable subsidy. A version of the subsidy that used gasoline prices instead of ethanol prices was also developed. Administratively, it would be burdensome to have a subsidy that changed every month, so we implemented both variable subsidies using quarterly data. We then compared the average annual government cost and monthly private profitability using historical data and assuming the variable subsidy and the $0.51 fixed subsidy was applied. When using historic gasoline and corn prices from the last ten years, the variable rate subsidy cost the government nearly 40% less than the flat rate subsidy. Profit received by producers on average is a little less; however, producer's risk is lower with the variable subsidy than the flat rate subsidy