An Analysis of the Effects of Government Subsidies and the Renewable Fuels Standard on the Fuel Ethanol Industry: A Structural Econometric Model

This paper analyses the effects of the expiration of the volumetric ethanol subsidy and the implementation of the renewable fuels standard (RFS) on the U.S. fuel ethanol industry. Analyses that ignore the dynamic implications of these policies, including their effects on incumbent ethanol firms’ investment, production, and exit decisions and on potential entrants’ entry behavior, may generate incomplete estimates of the impact of the policies and misleading predictions of the future evolution of the fuel ethanol industry. In this paper, we construct a dynamic model to recover the entire cost structure of the industry including the distributions of fixed entry costs and of exit scrap values. We use the estimated parameters to evaluate 3 different types of subsidy: a volumetric production subsidy, an investment subsidy, and an entry subsidy, each with and without the RFS. Results show that the RFS is a critically important policy to support the sustainability of corn-based fuel ethanol production, and that investment subsidies and entry subsidies are more effective than production subsidies.