The Theory of Biofuel Policy and Food Grain Prices

Abstract

We develop an analytical framework to assess the market effects of alternative biofuel policies (including subsidies to feedstocks). U.S. corn-ethanol policies are used as an example to study the effects on corn prices. We determine the ‘no policy’ ethanol price; analyze the implications for the ‘no policy’ corn price and resulting ‘water’ in the ethanol price premium due to policy; and generalize the unique interaction effects between mandates and tax credits to include ethanol and corn production subsidies. The effect of an ethanol price premium depends on the value of the ethanol co-product, the value of production subsidies, and where the world ethanol price is determined. U.S. corn-ethanol policies are a major reason for the increases in corn prices – an estimated increase of 33 – 46.5% in the period 2008-2011.

Keywords: biofuel policies, corn prices, tax credit, mandate, ethanol subsidy, corn subsidy, water, price premium

JEL Classification: Q02, Q18, Q19