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AUTUMN 2015 – GROUP 21

Advantages and Disadvantages of Ethanol as a Motor Fuel

Cross-Country Comparisons between the U.S. and Brazil

Prepared By:

Jessica Loo Raymond Dong Ted Barrett Basak Sunar Clay Fisher Jiani Chen Andrew Lindsay Prepared For:

Dr. George Tolley Dr. Stephen Berry Jing Wu Jaeyoon Lee

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Table of Contents

Abstract………………………………………………………………………………………………………………. 3 PART I – Introduction……………………………………………………………………………….………………. .5 Overview of Ethanol………………………………………………………………………….……………...5 Uses of Ethanol…………………………………………………………………………………….………...6

Ethanol and Its Significance……………………………………………………….………………………...7 Global Ethanol Production………………………………………………………………….………………11 Overview of the U.S. Ethanol Market………………………………………………………………………13 Overview of the Brazilian Ethanol Market…………………………………………………………………17

PART II - Production Process of Ethanol…………………………………………………………………………….22 Overview…………………………………………………………………………………………………….22 Dry Milling Process…………………………………………………………………………………………23 Wet Milling Process………………………………………………………………………………………...26 Dry Milling and Wet Milling Comparisons…………………………………………………………………27 PART III - Science of Ethanol as Fuel……………………………………………………………………………….28 Introduction to Types of Crops……………………………………………………………………………..28 Ethanol Production from Starch…………………………………………………………………………….29 Implications for Cars and Engines………………………………………………………………………….33 Ethanol Production from Cellulose…………………………………………………………………………34 Combustion Process of Ethanol vs. Gasoline……………………………………………………………….37 PART IV - U.S. and Brazil Economic Analyses……………………………………………………………………..38 Costs and Benefits of Ethanol for the U.S. …………………………………………………………………38

Literature Review on Cost-Benefit Analysis for the Ethanol Industry………………………………….......40 Literature Review on Cellulosic Ethanol……………………………………………………………………43 Literature Review on the Effects of Ethanol Subsidies……………………………………………………..45 Household’s Demand for Ethanol Economic Model………………………………………………………..48 Commodities Pricing Economic Model…….……………………………………………………………….54 Cost Benefit Analysis Economic Model …………………………………………………………………...59 Costs and Benefits of Ethanol for Brazil……………………………………………………………………62

PART V – Policy Implications……………………………………………………………………………………….64

U.S. Ethanol Regulation and Policy History………………………………………………………………..64 U.S. Regulation and Production Forecasts………………………………………………………………….66 RINS in Depth………………………………………………………………………………………………67 Ethanol Blend Regulations………………………………………………………………………………….70 Relationship Between RINS and Gas……………………………………………………………………….71 Brazil Ethanol Regulation and Policy History………………………………………………………………73 U.S. and Brazil Policy Comparison…………………………………………………………………………77

PART VI – Conclusion and Recommendation……………………………………………………………………….81 Glossary………………………………………………………………………………………………………………85 Works Cited…………………………………………………………………………………………………………..88

Pictures Cited…………………………………………………………………………………………………………92

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Abstract

The U.S. is currently the world’s largest producer and exporter of corn-based ethanol,

with output levels double those of Brazil, the second largest producer of corn-based ethanol. The

low-cost production along with an excess supply enabled the U.S. to not only be the leading

producer of ethanol, but also be the leading exporter of ethanol as of 2014. In order to secure

such a position in the global ethanol market, the U.S. took several measures that led to its

international success.

Although biofuels in the U.S. have been in existence since the 1930s, the government

launched tax credits in the 1970s that in turn stimulated the biofuel market to expand. More

specifically, the government supported the producers by implementing a 40 cents per gallon tax

credit, and increased that to 51 cents per gallon in 2005, the level it’s still at today. Beyond the

tax credit, the most significant regulation on ethanol in the history of the U.S. has been the

Energy Policy Act of 2005, which resulted in the formation of the Renewable Fuel Standard

program. The Energy Independence and Security Act of 2007 (EISA) further enhanced the scope

of the Renewable Fuel Standard program to set specific annual fuel requirements to be met by

the production of particular biofuels, which in turn impacted the ethanol production targets in the

U.S.

Following these stimulating changes in policies and regulations, ethanol production has

been a growing part of the American energy sector over the past few years. Ethanol has become

a key component of fuel production in the pursuit of switching from depletable fossil fuel to

sustainable energy sources, and particularly for the U.S., to achieve American fuel independence

from foreign fossil fuel sources.

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Yet, despite the rapid growth of ethanol in the U.S. to make up a US$40 billion industry,

which has been stimulated by the 2005 and 2007 federal mandates such as the Renewable Fuel

Standard, ethanol is far from fulfilling the energy targets set by the U.S. Even though the global

demand of ethanol is growing, the fuel ethanol domestically accounts for is only 10% of the total

volume of consumed motor gasoline, and it has been difficult to increase ethanol’s share of

motor fuel beyond 10%. The higher cost of ethanol to the consumer given a per mileage basis, as

well as its market limitations regarding higher gasoline blends of ethanol such as E85, is also not

helping. In addition, corn, the main feedstock for ethanol in the U.S. is less efficient, less

environmentally friendly than the sugarcane used in Brazil for making ethanol, and has

traditionally been heavily subsidized by national and state governments.

In light of these limitations on ethanol, the purpose of this paper is to determine whether

the U.S. can take further measures to improve its ethanol market via a cross-country comparison

between the U.S. and Brazil. By utilizing an array of various government reports, academic

resources and other published research papers relevant to the topic, the paper explains the

relevant background information on the subject, summarizes the cost-benefit analysis of the

ethanol policies in recent years, and delivers a forward-looking policy recommendation to lay out

measures that the U.S. can take to further improve its ethanol market.

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PART I: Introduction

An Overview of Ethanol

Ethanol, also commonly known as ethyl alcohol, is a chemical with the formula

CH3CH2OH (C2H6O), mostly seen in the form of a colorless, flammable and volatile liquid. It is

mainly produced in two different ways, one chemical and one biological. The chemical method

utilizes the hydration of ethylene (a colorless flammable gas which can be produced by

converting ethanol to water and ethylene, and has the formula C2H4), whereas the biological

method involves the fermentation of starch, sugar, cellulosic, and other feedstocks, where each

feedstock results in different theoretical ethanol yields as shown in Figure 1.1.

Figure 1.1

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Uses of Ethanol

Ethanol has many uses for the average household. For instance, ethanol is used as an

intoxicating ingredient for alcoholic beverages such as wine, beer and distilled spirits.

Additionally, ethanol is also widely used as a solvent to dissolve compounds that are insoluble in

water. Due to this property, ethanol is found in perfumes, cosmetics, and medicines.

However, the most promising application of ethanol is fuel, where it provides high

quality and high octane, resulting in better engine performance as well as reduced emissions. In

fuel production, ethanol functions as both an effective fuel additive to form common fuel types

such as E10 (10% ethanol, 90% gasoline) and E85 (85% ethanol and 15% gasoline) as well as a

stand-alone fuel, which is 100% made up of ethanol and is denoted as E100. Unlike the E10 mix,

which can be used by all major auto brands, E85 can only be used by Flex-Fuel Vehicles (FFVs)

- vehicles that are designed to run on gasoline or gasoline-ethanol blends of up to 85% ethanol

(E85) (EPA). The high-octane characteristics of ethanol also mean that the vehicle can have

higher power, torque, and efficiency on average, leading to better performance. For instance,

ethanol’s octane rating of 113 causes it to remain as the highest rated performance fuel available

at the moment such as gasoline and diesel variations with different additives. Another additional

benefit of using ethanol as a fuel is that it can prevent issues arising from low temperatures.

Normally, antifreeze, an additive that lowers the freezing point of a water-based liquid, is used in

the gasoline engines to prevent a rigid gas line from exploding due to expansion when water

freezes. Since ethanol already acts as a gas-line antifreeze, there is no need to use other

chemicals to keep the gas-line from freezing.

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Ethanol and Its Significance

Today, more than ever, clean energy is the key to a sustainable world. Our energy needs

have been exponentially increasing in the past decade, and studies have proven the

unsustainability of our energy consumption both with regards to scarcity of energy and the

increasing severity of global pollution. Over the past couple of decades, while the environmental

impacts of petroleum production and usage have gradually gotten worse, the environmental

impacts of ethanol production have significantly been reduced due to technological advances in

the production processes which will be further discussed in The Production Process of Ethanol.

These technological advances have caused “the amount of natural gas required to make a gallon

of ethanol to fall 36% since 1995, while electricity use [has decreased by] 38%. Water use has

also been cut in half since 1998” (Renewable Fuels Association).

Since ethanol is a renewable energy source, it is also more environmentally friendly than

fossil fuels while also handling the issue of fossil fuel depletion. Fossil fuel depletion explains

how oil, natural gas, and coal exist in limited, irreplaceable reserves. Due to our global

dependence on these resources, we may run out in the relatively near future, and therefore must

find alternate means of fulfilling our energy requirements (Al-Suwaidi).

An example that shows how ethanol is more environmentally friendly than fossil fuels is

that when biofuels are used as fuel, their carbon emissions are recycled; however, in the use of

fossil fuels as an energy source, the carbon emissions that are released during the combustion

process remain in the atmosphere. Deposits of fossil fuel resources were formed and contained

for millions of years, effectively partitioned from the carbon cycle, but upon their combustion,

they are released into the atmosphere and never return to their deposits. In contrast, plant-based

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fuels are derived from atmospheric carbon, release carbon upon combustion, and then a new

generation of fuel crops uptake that carbon dioxide. In theory, all carbon released in the burning

of biofuels came from carbon that was originally taken out of the atmosphere, although some

amount of the input energy typically comes from nonrenewable sources.

Figure 1.2

Figure 1.2 reflects an idealized usage of biofuel. However, in virtually all cases, some type of

non-renewable energy source is used as an input energy in the production of biofuel, so

atmospheric carbon dioxide does increase to some degree in the biofuel combustion cycle.

In addition to combusting more sustainably, there are typically low environmental risks that

result from transportation, storage, processing, and conversion of biomass energy. Very little or

no net carbon dioxide is produced when energy crops are grown and harvested properly. The ash

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nutrients that result from the combustion process are also recyclable, and growing perennial

plants for use in biomass energy protect the local soil from erosion.

Moreover, the advantages of ethanol are even more apparent due to the increase in

efficiency of production, where producers are able to generate 12% more ethanol from the same

amount of raw material. “Ethanol’s energy balance is [also] continually improving, [where] 1

unit of energy invested in making ethanol yields up to 2.3 units of energy available to the

consumer” (Renewable Fuels Association). Adding on, a study published by Yale University’s

Journal of Industrial Ecology (What is Ethanol?) has shown that greenhouse gas emissions can

be reduced by 48-59% by simply replacing gasoline with ethanol. Beyond the greenhouse gas

emissions, ethanol also decreases carbon monoxide emissions. We believe that these benefits of

ethanol make it the cleanest available energy source for octane.

Another compelling reason that makes ethanol essential is its significant role in energy

security. The U.S. is becoming more dependent on other countries to fulfill its energy needs for

personal and industrial purposes. “In 2014, ethanol displaced gasoline refined from 512 million

barrels of crude oil, slightly more than the amount of oil imported annually from Saudi Arabia”

(Renewable Fuels Association). This comparison illustrates how much impact ethanol can have

in the energy independence of the U.S. as well as other countries. Furthermore, achieving this

energy independence through a sustainable, renewable energy source would enable the U.S. to

keep its leading market position in the long run and allow it to remain unaffected by shifts in

foreign energy prices.

The U.S. ethanol industry has been growing rapidly over the last decade as displayed in

Figure 1.3 (Renewable Fuels Association). Compared to just 1% over 20 years ago, 10% of the

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U.S. gasoline supply today consists of ethanol. Total production from the domestic ethanol

refineries has also reached 14.3 billion gallons in 2014, up from 350 million gallons before. The

growth of the ethanol industry also played an essential role in spurring employment and income

levels in the rural areas. “In 2014, ethanol production supported 83,949 direct jobs, as well as

295,265 indirect jobs across all sectors of the economy. The industry also added US$52 billion to

the nation’s Gross Domestic Product and boosted household income by US$26.7 billion” by

creating job opportunities (Renewable Fuels Association). Beyond leading to the increase in

stable and well-paying jobs, ethanol production also benefits the average U.S. customer by

causing a decrease in fuel prices. This decrease has been discussed in a 2011 paper published by

the Center for Agriculture and Rural Development (CARD). This paper written by economists

from Iowa State University and the University of Wisconsin found that the use of more than 13

billion gallons of ethanol reduced gasoline prices by an average of US$0.89/gallon in 2010.

Nonetheless, considering the extremely low oil prices that have been prevalent for the past year,

the calculations based on 2010 prices may not give a result that holds true today (Du).

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Global Ethanol Production

Figure 1.3

The U.S. is the world’s largest producer of ethanol, accounting for almost 60% of global

output in 2014 as seen in Figure 1.3 above. The other players in the market are Brazil with 25%,

the E.U. with 6% as well as China and Canada as of 2014. “Since 2011, U.S. ethanol has been

the lowest cost motor fuel and octane source on the planet” (Renewable Fuels Association). The

low-cost production along with an excess supply enabled the U.S. to be not only the leading

producer of ethanol, but also the leading exporter of ethanol as of 2014. Responding to the

demand in the international markets, the U.S. exported nearly 825 million gallons in 2014 to 51

different countries, surpassing Brazil as the leading exporter, as illustrated by Figure 1.4

(Renewable Fuels Association).

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Figure 1.4

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Overview of the U.S. Ethanol Market

In recent years, ethanol production has been a growing part of the American energy

sector, and FFV’s have been a growing part of the country’s automotive industry. While ethanol

has become a key component of fuel production in an attempt to shift towards sustainable energy

sources as fossil fuels deplete, even more importantly for the U.S., a large factor in the shift to

ethanol and other biofuels is moving away from foreign fossil fuel sources and moving towards

American fuel independence. As shown in Figure 1.5, both production and consumption of

ethanol have grown, and, as of 2013, the U.S. has gone from a net exporter to a net importer of

ethanol as ethanol has grown in popularity as a source of energy.

Figure 1.5

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Yet, on the whole, domestic ethanol consumption has plateaued in recent years. The 2009

recession led to people purchasing smaller, less fuel-intensive vehicles, diminishing sales of

more expensive FFVs. The recession also led to a decreased amount of funding for alternative

energy projects, especially for newer, more advanced biofuels that are not corn-based, because of

the inherent risk of investing in new technology. Adding on, although the U.S. government has

mandated large-scale consumption of cellulosic biofuel, targeting 250 million gallons consumed

in 2011 in a 2007 mandate, the U.S. has grossly undershot these mandates and refiners ended up

only producing 280,000 gallons in 2011 - just over 1% of the 2007 mandate’s target. Refiners

have also been able to mitigate fines for their underproduction, and were able to pass along a lot

of the charges onto consumers (Gay).

The combined effect of this severe underproduction of cellulosic ethanol and halt in

technological development to utilize more efficient ethanol sources has resulted in our ethanol

remaining almost entirely corn-based, despite it being less efficient that a number of ethanol

sources. The inefficiency of corn-based ethanol, coupled with concerns about food security as we

use more corn for fuel instead of food, has lowered public support for biofuels, ultimately

stagnating U.S. ethanol production growth (Gay). This ultimately leads to the motivation of our

paper, where we seek to determine ways in which the U.S. can enhance the efficiency of its

ethanol program through learning from Brazil or redirecting more of its efforts towards

developing cellulosic ethanol and reaching its targets for cellulosic biofuels.

Despite the slowdown in domestic ethanol consumption in the U.S., virtually all gasoline

pumps have up to around 10% of ethanol, but may or may not specify its inclusion as such a low

percentage of ethanol has a negligible effect on the engine and can run in any standard American

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vehicle. In terms of FFVs available in the American market, the largest part of the market share

belongs to E85 vehicles. However, these vehicles and their fueling stations are found almost

exclusively in the Midwestern U.S., where the bulk of corn production occurs, as it is most

effective to produce, transport, and sell ethanol there. Figure 1.6 shows a breakdown of the

number of ethanol production plants by state, as well as national net annual ethanol production

by year, highlighting how most ethanol production plants, like fueling stations, are also

concentrated in the Midwestern U.S.

Figure 1.6

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Additionally, Figure 1.7 shows a breakdown of biomass resources grown in the U.S. It is worth

noting that, despite the large amount of biomass resources in certain southeastern states, such as

Louisiana and Florida, these states have bagasse and sugarcane, which have not yet been readily

adopted by American ethanol producers at the level that corn has.

Figure 1.7

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Overview of the Brazilian Ethanol Market

Brazil is the world’s second largest producer and exporter of ethanol. To put this in

numbers, in 2014, Brazil produced approximately 25.0% of the world’s (or 6.76 billion gallons)

ethanol and exported approximately 1.4 billion gallons of ethanol (USDA).

The relative historical successes of ethanol in Brazilian markets have several sources.

The first is the relatively low production costs of Brazilian sugarcane ethanol. In 2011, it was

estimated that the production costs for sugarcane ethanol was US$0.48/liter, or 58% lower than

the production costs of U.S. produced corn ethanol (Du). Much of the lower production costs can

likely be attributed to sugarcane’s efficiency in land usage, as sugarcane can produce 45% more

ethanol per unit of land than corn. The second source of ethanol’s relative historical success in

Brazil is the continuing expansion of the FFV fleet. These FFVs are able to run using pure

gasoline, pure ethanol, or a mixture of the two. In fact, the gasoline sold at pumps is actually

“gasohol”, or a blend of gasoline and 18-25% ethanol (Moreira). Though there was previously

technology available that allowed cars to run solely on pure ethanol, FFVs were beginning to be

developed in the late 1990s. FFVs began to enter the Brazilian market in 2002, and by 2005 had

captured about 10% of the vehicle market. Since then, the FFV fleet has flourished, making up

over 40% of the entire vehicle fleet in 2010 (Du). As shown in Figure 1.8 below, it is estimated

that FFVs could make up as much as 86% of the fleet by 2020. As of 2009, more than 80% of

new vehicles produced in Brazil have flex-fuel capabilities, up from 30% in 2004 (Balat).

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Figure 1.8

It must also be noted that, as of the last few years, the Brazilian ethanol industry has seen

considerably lower levels of success, as is shown in Figure 1.9 below. In their analyst report

from 2014, Bain & Company claims that the reason ethanol prices are now higher than gasoline

prices in Brazil is related to higher production costs for ethanol (Gay). However, this is in direct

contradiction to the above research done by other economists, who all contribute Brazil’s

historical success in the ethanol industry to the nation’s technological and productive

capabilities. To address this contradiction, we argue in Brazil Ethanol and Policy History that the

success and recent decline of the Brazilian ethanol industry is primarily due to the government’s

regulations and policies surrounding biofuels, and conclude that the recent attempts to reenact

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previously successful policies are promising for a future revitalization of the ethanol industry.

For instance, the main reason for the fall in Brazilian exports of ethanol in 2014 was due to a

lower sugar-cane harvest with reduced demand from the U.S. Adding on, growth in domestic

consumption of ethanol has also slowed. In order to address these problems, the Brazilian

government raised the blend mandate in Brazil from 25% to 27%, which should spur growth in

its ethanol industry (USDA).

Figure 1.9

Another interesting point that past research shows is that a vast majority of FFV users in

Brazil choose their fuel based on which is more cost-effective, not whether their fuel is from a

renewable source; Brazilian policy leads to increased production of FFV and greater availability

of ethanol fuel, but this shift to biofuel usage is usually only adapted by consumers when it is

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financially beneficial to them. Because of the energy yield of ethanol as compared to E20

gasoline, FFV owners tend to purchase E100 fuel, which is a fuel blend with almost 100%

ethanol, when ethanol is under 70% of the price of E20, a fuel blend with 20% ethanol and 80%

gasoline. Alternatively, FFV owners tend to purchase E20 when the price of ethanol is 70% over

the price of E20. Because of this 70% efficiency ratio shown in Figure 1.10 below, prices tend to

dip either above or below the ratio and then come back to the 70% breakeven point as consumers

adapt to the more cost-effective fuel. Because of the proximity of production facilities and local

policies, different regions of Brazil tend to have higher or lower ratios of ethanol to fuel prices.

This is telling for the American market; while there is a large environmentalist driven

push for divestment from fossil fuels, ultimately pricing incentives may drive American

consumers to purchase biofuels such as ethanol for their vehicles if they otherwise would have

had no other desire to move away from fossil fuels such as gasoline. Nevertheless, as will be

further analyzed in Combustion Process of Ethanol vs. Gasoline and Household’s Demand for

Ethanol Economic Model, it is also important to look at the differences in mileage per gallon of

fuel for both ethanol and gasoline when coming up with policy incentives. Although many

consumers look at the price at the pump to determine whether or not they should use ethanol or

gasoline, pricing is not the only factor that should be considered as the costs per mile or costs per

gallon differ between ethanol and gasoline.

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Figure 1.10

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Part II - Production Process of Ethanol

Overview

Ethanol is produced using different processes based on the starting product. In this

section we will discuss the two methods of fermentation, whereas in Science of Ethanol as a

Fuel we will discuss the overall scientific methodologies. In regards to fermentation, the two

processes are wet milling and dry milling, which differ in how the grain is treated prior to

fermentation. In dry milling, the process begins with grinding the whole grain into flour before

the next step, whereas in the wet milling process the first step is to soak the grain in water to

separate the grain kernels.

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Dry Milling Process

Figure 2.1 displays the steps of the dry milling process, and illustrates how ethanol is produced

for use in fuel production and what co-products it has (Renewable Fuels Association).

Figure 2.1

At first, the whole starchy grain (mostly corn kernel in the U.S.) is grinded into flour, and that is

mixed with water to make up a “mash.” In order to convert the starch in the mash to dextrose, a

simple sugar, enzymes are added. After this, some ammonia is also added as a nutrient to the

yeast and as a pH controller. The mash is then processed in high temperature to eliminate

bacteria, and then is cooled down. The yeast is then added, and the conversion of sugar to

ethanol and carbon dioxide (CO2) takes place (Renewable Fuels Association).

After 40 to 50 hours in the fermentation phase, the distillation columns separate the

ethanol from the remaining “stillage”. Ethanol is then concentrated, dehydrated and blended with

approximately 5% denaturant (e.g. natural gasoline) to distinguish it as an undrinkable liquid that

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is not subject to any alcoholic beverage taxes as it becomes ready to be sent to gasoline terminals

(Renewable Fuels Association).

As for Brazil, the biggest competitor of the U.S., the production of ethanol is typically

from sugarcane rather than corn. Sugarcane’s “bagasse” (crop wastes) is used in the energy

conversion process. In order to process the sugarcane, a process that is similar to that of corn’s is

followed: first the sugar is pressed out of the sugarcane, and then fermented (C2ES).

As for the co-products, the CO2 released during fermentation is used in carbonating

beverages and in producing dry ice. The remaining stillage is centrifuged to distinguish the

solubles from the coarse grain. As the solubles become more concentrated and dried with the

grains, it makes up a nutritious livestock feed that is more formally called “dried distillers grains

with solubles” (Renewable Fuels Association). Thus, beyond generating ethanol, ethanol

production also proves to have some co-products that are incredibly useful as exemplified here

with the high quality livestock feed and manufacturing of ice and beverages.

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Figure 2.2

According to the data from Renewable Fuels Association (RFA), “a modern dry-mill

ethanol refinery produces approximately 2.8 gallons of ethanol and more than 17 pounds of

distillers grains from a bushel of corn” and in 2014, ethanol bio-refineries produced

approximately 39 million metric tons of feed, making the renewable fuels sector one of the

largest animal feed processing segments in the U.S. This shows that the benefits of ethanol

production go beyond the usage of ethanol as fuel. Figure 2.2 also illustrates how U.S. exports of

distillers’ grain were at record levels in 2014, which is in line with the widespread acceptance

that distillers’ grains volumes have grown in the international markets.

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Wet Milling Process

Figure 2.3

Figure 2.3 (RFA) displays the steps of the wet milling process. Unlike dry milling, where

the grain is grinded into flour, in wet milling, the grain is soaked for 24 to 48 hours in water and

dilute sulfurous acid to help separate the grain into its components. Then, the corn germ is

separated from the slurry after going through several grinders. As the corn oil is extracted from

the germ, the remaining components are centrifuged. The concentrated water and fiber

components make up a gluten free livestock feed, and the gluten component also turns into a

corn gluten meal that is used as a feed in the poultry industry. Finally, starch and all the other

remaining components get fermented into ethanol, get sold as cornstarch or get processed into

corn syrup. Even though the fermentation process of wet milling is very similar to that of dry

milling described above, most of the ethanol refineries use the dry milling process to produce

ethanol fuel along with high quality livestock feed products.

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Dry Milling and Wet Milling Comparisons

When comparing the two different ethanol production processes, it is important to note

that wet milling is more capital intensive and costly than dry milling, although it often produces

a wider range of byproducts. Dry milling, on the other hand, can lead to higher ethanol yields

because it is more efficient in retaining the key substance within the ethanol it produces. Hence,

we consider dry milling less capital intensive and less versatile than wet milling because the

process’s focus is on the production of ethanol rather than its byproducts. Therefore, in the U.S.,

most of the existing plants use dry mill technology and most of the future expansion is expected

to use dry mill technology. Dry mill plants produce about 82% of total U.S. ethanol production

and specialize in producing one product, ethanol, from the starch that is processed; whereas wet

mill plants produce the remaining 18 % of U.S. production as they usually have higher

investment costs albeit being more flexible (Eidman).

In the U.S., corn has historically been the feedstock for ethanol production; in other

countries such as Brazil, ethanol is more commonly made from starch, sugar or cellulosic

feedstocks. Although corn-based ethanol production technology has become increasingly

effective over the years, some experts argue that this method has already matured with slight

possibility of further innovation (DiPardo). Experts have argued that substantial cost reductions

may be possible if cellulose-based feedstocks are used instead of corn. This claim will be further

analyzed in the Cost Benefit Analysis Economic Model subsection.

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PART III: Science of Ethanol as Fuel

Introduction to Types of Crops

In order to fully understand the costs and benefits of ethanol as a motor fuel, the scientific

underpinnings of its production and consumption must also be analyzed. To start, the base raw

materials for ethanol are sugar, starch, or cellulosic crops. Sugar crops, such as sugarcane and

sugar beets, are used to produce a sugar-containing solution that can be directly fermented by

yeast because they contain simple glucose molecules. Both starch and cellulosic feedstocks

require additional conversion steps before fermentation can occur. Brazil uses sugarcane for

ethanol and has a more straightforward scientific conversion process relative to the U.S., which

uses complex carbohydrates to produce ethanol.

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Ethanol Production from Starch

We will start this section with a scientific explanation for the production of ethanol from

complex carbohydrates, which is what we see in the U.S. On the other hand, since Brazil uses

simple glucose sugars from sugarcane, the production process would just start with the

conversion of glucose into ethanol as shown in Figure 3.1.

Figure 3.1

Chemically, starch is a long-chain polymer of glucose as shown in Figure 3.1 that must

be broken down into simple glucose units through hydrolysis. During the hydrolysis reaction,

water is mixed into the solution to produce a final mash containing 15-20% starch. Two enzymes

are added as the mash is boiled to result in the final glucose product. Once glucose is retrieved

(either directly or through the intermediate step), yeast is added to form ethanol, carbon dioxide,

and heat as shown in the reaction below in Figure 3.2 below.

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Figure 3.2

From stoichiometry, we expect that the maximum conversion efficiency of glucose to

ethanol is around 51% on a weight basis, in that 1 kg of glucose results in 511 g of ethanol. In

practice, the glucose-to-ethanol conversion rate is only actually 40-48% because of cell mass and

metabolic production constraints.

Distillation is then used to separate ethanol from the rest of the mash based on differences

in boiling point between ethanol (78.1 degrees Celsius) and water (100 degrees Celsius).

Because ethanol and water form an azeotrope (a binary mixture with the same composition in the

liquid and vapor phases that boils at a constant temperature), ethanol can only be concentrated to

95.6% by volume via fractional distillation. Figure 3.3 below shows that at around 351 kelvin,

which is the boiling point of the azeotropic solution, we should have close to pure azeotropic

ethanol in the distillate.

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Figure 3.3

To achieve pure anhydrous ethanol, dehydration is required following distillation. One

method to do this is to add benzene to the ethanol/water mixture to change the boiling

characteristics of the solution to separate the anhydrous ethanol. The more commonly used

method, especially because benzene is carcinogenic, is to use a molecular sieve to run on the

ethanol to gradually distill the 96% ethanol into more pure forms. A molecular sieve works due

to the differences in molecular size between water and ethanol. As shown in Figure 3.4 below,

water is a smaller molecule than ethanol and will be captured by the sieve.

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Figure 3.4

The final ethanol product is a volatile, flammable, colorless liquid with a slight chemical

odor. It also has the following chemical properties in the below table (Figure 3.5).

Figure 3.5

Property Value

Molecular Weight 46.07 g/mol

Density (at 20 degrees Celsius) 0.791 g/cc

Boiling Point 78.5 degrees celsius

Heat of Combustion 1,300 kJ/mol

Heat of Vaporization 9.225 Kcal/mole

Octane Rating 106-108

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Implications for Cars and Engines

Based on the above science discussed, there are some conclusions to draw about the

usage of pure ethanol versus azeotropic ethanol as a fuel in engines. If the ethanol is kept in its

azeotropic form, it can be used in cars with engines that are only fit with accepting ethanol,

which does not include the majority of U.S. cars. If the ethanol is to be purified into a pure form,

then it can be used in normal engines which normally consume gasoline in combinations of up to

20% ethanol (80% gasoline). It may be more cost effective at times to keep ethanol in its

azeotropic form to use as fuel because that eliminates the need for the costly dehydration steps.

However, normal cars will require engine conversions to handle the azeotropic ethanol. Deciding

whether to use azeotropic or pure ethanol as a fuel becomes a question of the cost of the engine

conversion versus that of dehydration.

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Ethanol Production from Cellulose

Cellulosic ethanol production has a lot of potential as a source of biofuels because it often

makes up approximately half of plant biomass. However, there are production barriers that make

it tougher to extract ethanol from. We can see the structural difference below in Figure 3.6.

Although both starch and cellulose are polymers of the glucose monomer, they are oriented

differently geospatially due to their chemistry. Starch polymers are alpha-glucose whereas

cellulose is beta-glucose. This is an important distinction because enzymes are specific for a

particular type of chemical bond and there are few organisms with enzymes capable of breaking

down cellulose links.

Figure 3.6

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To make matters even more complicated, cellulose molecules are packed in tight crystalline

forms and wrapped around with lignin and hemicellulose, which works to create plant cell walls.

We see the complexity of the structure in Figure 3.7. In the current process, pretreatment, or

disentangling the cellulose from the rest of the structure is the most expensive step in the

process. For future research, there is tremendous potential to harness energy from cellulosic

plants if scientists can separate cellulose effectively as well as find enzymes or organisms to

break down cellulose into its monomeric glucose form.

Figure 3.7

36

As a summary of the different scientific processes, there are three main starting points

from which to create ethanol from plants. In Figure 3.8 below we see ethanol can be formed

from various starting materials, including glucose, starch, and cellulose. It is most efficient to

produce ethanol from simple glucose because it requires the fewest steps in the process. Brazil is

able to capitalize on these efficiencies because it uses sugarcane as the simple glucose form to

make ethanol. In the future, if the U.S. is able to expand large-scale technologies in the

pretreatment and digestion of ethanol, there is significant potential to bring cheaper ethanol to

the market.

Figure 3.8

Source: Great Lakes Bioenergy Research Center

37

Combustion Process of Ethanol vs. Gasoline

Thus far in the science section, we have discussed the production of ethanol from

different starting points. For ethanol to actually translate into energy to move cars, it must be

combusted based on the equation below in Figure 3.9. The heat of combustion for pure ethanol

fuel (E100) is 29.7 kJ/g, which is only about 63% as much energy as the 47.0 kJ/g released from

gasoline. This number is better for E85 (85% ethanol), which has 76% of the fuel mileage

compared to 100% gasoline. As of July 2015, E85 ethanol prices were 48 cents cheaper than

gasoline per gallon ($2.36 vs. $2.82) but this doesn’t fully reflect the value of these two fuels.

Adjusted by the amount of energy, ethanol is actually slightly more expensive than gasoline

($3.07/GGE vs. $2.82/GGE) (U.S. Department of Energy). This is a very telling fact, as in

Overview of the Brazilian Ethanol Industry we mentioned how past research has shown that

Brazilian consumers tend to purchase fuel that is cheaper at the pump. Yet, in reality, ethanol has

less mileage per gallon as shown above. As households become more educated about the

differences in energy content between ethanol and gasoline, policymakers must take the mileage

differences into consideration when coming up with price incentives to promote ethanol usage.

This crucial point will be further studied in the upcoming Household’s Demand for Ethanol

Economic Model.

Figure 3.9

38

Part IV - U.S. and Brazil Economic Analyses

Costs and Benefits of Ethanol for the U.S.

In order to further understand the costs and benefits of utilizing ethanol as a fuel, several

papers on the ethanol industry were examined. One of the main benefits of ethanol discussed for

the U.S. include energy security, where ethanol use reduces U.S. reliance on foreign oil as

discussed in Ethanol and Its Significance. An increase in ethanol use also leads to a decrease in

U.S. consumption of oil, reducing problems that arise due to sudden changes in energy supply

and prices. Additionally, ethanol usage decreases greenhouse gas emissions due to a reduction in

carbon monoxide emissions and air toxic emissions such as benzene, leading to improvements in

local air quality. Ethanol production has also brought on an increase in wages and employment in

many states in the Corn Belt, as the U.S. primarily uses corn-based ethanol. For instance, the

increase in corn prices in the Corn Belt states has bolstered earnings of farmers (Cecot).

Yet, there are also significant costs to ethanol for the U.S. that have to be analyzed. Even

though the biofuel is found to reduce carbon dioxide emissions, it may not decrease the overall

level of greenhouse gas emissions, as ethanol usage increases other emissions like sulfur oxides

and nitrogen oxides. Ethanol production and distribution is also more costly than gasoline due to

the infrastructure needed for the transportation and pumping of the fuel. Since a majority of

ethanol produced in the U.S. is corn-based, specific fertilizers and pesticides are also needed to

ensure that the crops are suitable for the production processes. These fertilizers and pesticides in

return result in excess nitrogen that eventually leaks into the groundwater and rivers, causing

ground level ozone and water contamination. Additionally, although the rise in corn prices may

39

be a benefit for farmers, it is seen as a cost for the average consumer. The increase in corn saved

for ethanol production also leads to a decrease in corn available in the global market, which is

particularly harmful for third world countries that rely on U.S. exports of corn (Cecot). Because

of this, some argue that the U.S. will never be able to produce enough corn-based ethanol

without compromising the food supplies of other developing countries (Cason).

40

Literature Review on Cost-Benefit Analysis for the Ethanol Industry

Due to the different costs and benefits of ethanol, it is important to conduct a cost benefit

analysis to quantify whether or not ethanol brings more benefits or costs to the U.S. To do so, we

examined the papers “Ethanol: Law, Economics and Politics” by Robert Hahn, “The Benefits

and Costs of Ethanol: An Evaluation of the Government’s Analysis” by Caroline Cecot and

Robert Hahn and “A Cost and Benefit, Case Study Analysis of Biofuels Systems” by Matthew

Cason and Rohit Satishchandra.

“Ethanol: Law, Economics and Politics” and “The Benefits and Costs of Ethanol: An

Evaluation of the Government’s Analysis” both come to the same conclusion that the costs of

corn-based ethanol production in the U.S. outweigh the benefits of corn-based ethanol

production and that “policy rationales for [corn-based] ethanol do not justify its widespread

support [since] ethanol made from corn is not likely to boost energy security and its

environmental benefits are uncertain” (Hahn). Both papers start off by presenting two different

scenarios to measure the impact of increased ethanol usage. The first scenario is the Renewable

Fuel Standard (RFS), in which ethanol usage is increased from four billion gallons per year to

seven billion gallons per year. The second scenario is the Energy Information Agency (EIA)

case, in which ethanol production reaches the level of ten billion gallons per year by 2012. The

RFS scenario does not hold if the EIA scenario does.

Both papers then utilize the benefits transfer method, meaning benefits and costs were

monetized based on findings from literature and the Environmental Protection Agency (EPA).

For the benefits, EPA’s regulatory impact analysis provides numbers on oil displacement and air

toxic emission reductions. Data from the Intergovernmental Panel on Climate Change was also

41

used in determining the average value of greenhouse gas emission reductions from increased

ethanol usage. Similarly, for the costs, EPA’s estimates for production costs and increased

emissions from ethanol usage and production were utilized. Most emission increases are a result

of producing and transporting ethanol. Government subsidies were also taken into account,

where a deadweight loss (DWL) was calculated by multiplying government subsidies by a factor

of 0.25 due to economic inefficiency.

Figure 4.1

Figure 4.1 above illustrates that the costs exceeded benefits by US$1.2 billion in the RFS

scenario and US$2.5 billion in the EIA scenario. We tried replicating Figure 4.1 with updated

numbers and updated standards for both the RFS and EIA scenarios, but EPA officials told us

that no updated data is available. Hence, given the lack of more recent figures that may reflect

new advances, we are unable to conclude that the costs of corn-based ethanol outweigh the

42

benefits of corn-based ethanol in the U.S. today and that the policies that promote corn-based

ethanol are of no use today. For instance, technological advances have increased the efficiency of

ethanol production, possibly causing the benefits of corn-based ethanol to outweigh the costs.

In order to address the costs and benefits of corn-based ethanol, we decided to turn to

alternative economic models presented in Household’s Demand for Ethanol Economic Model

and Commodities Pricing Economic Model. Our results eventually led us to conduct a cost and

benefit analysis on cellulosic ethanol, where this will be presented in Cost Benefit Analysis

Economic Model. Lastly, a case study will be conducted between the U.S. and Brazil to

determine if there is anything the U.S. can gain from Brazil’s successful sugarcane based ethanol

program.

43

Literature Review on Cellulosic Ethanol

In addition to the costs and benefits of corn-based ethanol, we also hope to understand the

costs and benefits of cellulosic ethanol. The reason for this is because the U.S. mandated large-

scale consumption of cellulosic biofuel in 2011 based on a 2007 mandate, but the target was not

met. A possible explanation to why the target was not met may be because the high production

costs outweighed the benefits, which may explain why the U.S. reduced its funding for

alternative biofuels during the recession. Therefore, in order to fully understand the U.S. ethanol

program and to give appropriate recommendations, it is important to determine if it is beneficial

for the U.S. to continue implementing policies that encourage usage of cellulosic ethanol or if it

should only focus its time on corn-based ethanol.

Since we hope to further understand the costs and benefits of cellulosic ethanol, the paper

“A Cost and Benefit, Case Study Analysis of Biofuels Systems” by Matthew Cason and Rohit

Satishchandra was further analyzed. The paper speaks of the difference between First Generation

(1G) and Second Generation (2G) Biofuels, where 1G biofuels include those made from energy

crops such as corn, sugarcane and grains, and 2G biofuels include those made from agricultural

residues such as sugarcane bagasse, and forest residues (Cason). The authors argue that

developed countries such as the U.S. should switch to 2G biofuels while continuing to develop

their 1G biofuel programs. On the other hand, developing countries such as Brazil should stick to

1G biofuels due to the cost of infrastructure, input costs, as well as initial setup costs (Cason).

Ultimately, the authors suggest that 2G biofuels are generally profitable and desirable for

developed countries, but will require a large investment to develop the necessary facilities to

support production. The authors view this as a positive investment, as the socioeconomic and

44

environmental sustainability of 1G biofuels have repeatedly been called into question. Therefore,

it is possible that the U.S. should increase its investments and research and development for

alternative forms of ethanol such as cellulosic ethanol, a form of 2G biofuel.

Figure 4.2

Despite the authors conclusions, we believe that there are technological production and

efficiency lessons that the U.S. can learn from Brazil to enhance its own ethanol program,

whether or not it chooses to continue using 1G biofuels or switch to 2G biofuels. For instance, as

seen in Figure 4.2, Brazil generates more 1G revenue in comparison to a developed country such

as Germany. Hence, we believe that a comparative case study between the U.S. and Brazil will

still provide us with additional insights to improve the U.S.’s ethanol program.

45

Literature Review on the Effects of Ethanol Subsidies

In order to better construct a cost and benefit framework for our analysis, we will also

analyze the negative economical and environmental externalities resulting from ethanol subsidies

in this section. The reason for this is that in Literature Review on Cost-Benefit Analysis for the

Ethanol Industry, it is seen that Cecot and Hahn estimated a US$340 million DWL from

government subsidies in the RFS scenario and US$720 million deadweight loss from

government subsidies in the EIA scenario, as government subsidies create inefficiencies in the

market.

Government ethanol production subsidies total over US$3 billion annually, which is

roughly US$0.79 per litre of ethanol produced. The cost of production of ethanol combined with

the subsidy results in the cost of ethanol to be US$1.21 per litre, which is around US$4.58 per

gallon. This total subsidy per litre is 45-times greater than that of gasoline, and virtually all of the

benefits from current ethanol production subsidy policies in the U.S. are captured by the

producers of ethanol rather than the consumers, as the subsidy is funded by higher taxes (Cecil).

46

Figure 4.3

Source: http://www.freeeconhelp.com/2011/12/calculating-deadweight-loss-from.html

The main reason why some view the subsidies to ethanol as negative is because of the

DWL that it creates. From an economic perspective, DWL exists in the economy when total

welfare of the consumers and producers are not maximized. The economy encounters DWL

when there are externalities in the market or government interventions that do not let the markets

move towards equilibrium, or to exhibit perfect competition. According to Figure 4.3, without

any government intervention, the economy will be at Q* where the price of ethanol will be at P*,

hence supply price = demand price. When the government subsidizes the production of ethanol,

the quantity is increased to Qsubsidy, where Qsubsidy > Q*. The increase in quantity supplied causes

the supply curve to shift to the right, resulting in a higher price received by suppliers (Pd), and a

47

lower price paid by consumers (Ps). Often, taxpayers fund the difference in prices between Pd

and Ps. Moreover, the green area in Figure 4.3 represents the DWL as a result of the government

subsidy on the production of ethanol. Again, the reason why DWL arises in this case is that

government intervention causes inefficiency in the markets.

Nevertheless, we argue that despite the DWL in the market due to the subsidy, it is

important to note that consumers are paying a lower price (despite the fact that taxpayers fund

the subsidy), and that producers are receiving a higher price. Since we have learnt that pricing

incentives matter, it is possible that producers will not produce ethanol without this subsidy and

consumers will not purchase ethanol. Additionally, past research from Du and Hayes suggest that

the high cost of these ethanol subsidies are actually cost saving. The authors claim that the

resulting increased ethanol production prevented gasoline price increases that would have

resulted from refineries working at maximum capacity if ethanol had not been produced. Thus, a

large subsidy would actually save money in the range of US$0.29 per gallon - US$0.40 per

gallon. Hence, although many economists argue that the efficiency losses from subsidies far

outweigh the benefits consumers gain as they also lose a significant portion of the benefit to

taxation, we believe that without the pricing incentives from the subsidy, both producers and

consumers will turn to cheaper alternatives, such as fossil fuels, leading to a decline in the

ethanol industry.

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Household’s Demand for Ethanol Economic Model

Given the literature review above, we turn to alternative economic models to analyze the

costs and benefits of corn-based ethanol. One way in which to do so is to understand the costs

and benefits of corn-based ethanol in terms of pricing. In order to further our understanding, we

turn to “The Demand for Ethanol as a Gasoline Substitute” by Soren Anderson. The model

presented is one of household utility, where ethanol and gasoline are linearly combined to

provide the household’s transportation services.

Assumptions of the Model:

1) Each household owns a single flexible-fuel vehicle

2) Utility is quasilinear in transportation services V(.) and other goods

3) V(.) is strictly increasing and strictly concave

4) Ethanol and gasoline are perfect substitutes

Household’s Utility Function:

V(e+rg) + x

e = consumption of ethanol

g = consumption of gasoline

x = consumption of all other goods

r = rate at which household converts gallons of gasoline into the equivalent amount of

ethanol

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If a household only cares about mileage, then r is equal to the ratio of the household’s

mileage when it uses gasoline to the household’s mileage when it uses ethanol. The rate r also

takes into account households who choose to use ethanol because of its environmental benefits.

Because of this, the rate r varies across households and fully takes into account households

preferences for ethanol as a substitute to gasoline.

Household’s Budget Constraint:

y - pee - pgg - x = 0

pe = Price of ethanol

pg = Price of gasoline

y = Household’s Income

Given the household’s utility function and budget constraint, we seek to understand if the

household will choose to use gasoline or ethanol. Since the utility function is linear, a corner

solution exists, where the household will purchase ethanol if pe < pg / r and will purchase

gasoline if pg / r < pe. Since ethanol and gasoline are viewed as perfect substitutes, the household

will choose the fuel at the “lower ethanol-equivalent price”. Alternatively, the household will

choose ethanol when r < pg / pe, where r functions as a “fuel switching price ratio” (Anderson)

and determines the type of fuel the household chooses.

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Household’s Demand:

The household’s demand for the quantity of fuel depends on absolute price levels, where

the household equates the “marginal utility of ethanol equivalent fuel consumption to the

ethanol-equivalent price of [the] fuel it chooses” (Anderson).

If ethanol is chosen, the optimal quantity demanded is:

e* = q(pe)

If gasoline is chosen, the optimal quantity demanded is:

g* = q(pg / r) / r

Aggregate Demand:

Assumptions

1) N households in the market

2) Each household owns a vehicle

3) Fraction φ of the vehicles are flexible-fuel vehicles

4) The fuel switching price ratios r are distributed according to a differentiable cumulative

density function H(r) defined over [0, ∞]

In order to determine the fraction of households that choose ethanol over gasoline, we

can evaluate the cumulative density function at H(pg / pe). We can then figure out the aggregate

demand of households to be the total number of households multiplied by the fraction φ that

owns flexible fuel vehicles. We then multiply this number by the fraction of households that

51

choose ethanol based on H(pg / pe). We then take this number and multiply it by the average

ethanol consumption among households that choose ethanol over gasoline to give the equation:

Qe(pe, pg ) = NφH(pg / pe)*avgq(pe)

Price Elasticities:

To determine the price elasticity of aggregate demand for ethanol, we can take the natural

logarithms of both sides of the equation above: LnQe(pe, pg ) = LnNφ+LnH(pg / pe)+Lnavgq(pe)

We then differentiate by the pg to determine the gasoline-price elasticity of the aggregate demand

of ethanol: ζg = [H’(pg / pe) * pg] / [H(pg / pe)*pe]. This equation tells us that a 1% increase in the

prices of gasoline leads to a ζg% increase in the quantity demand of ethanol. In general, the price

elasticities vary across all households, therefore changing the shapes of the distributions of the

price-switching ratio r. As seen in Figure 4.4, if households are nearly identical, then the fuel-

switching behavior occurs at a single peak or single price ratio. If this behavior holds in the

market, policies that promote ethanol must be targeted towards achieving a huge price difference

that will lead to this fuel switching behavior, potentially causing large distortions in the market.

If households are heterogenous, there is not one single price ratio that can cause households to

substitute from gasoline to ethanol or vice versa. Additionally, price elasticities are much smaller

in magnitude as demand is less sensitive to prices. Because of this, policies that promote ethanol

can induce households to switch to ethanol by causing fewer distortions in the market prices.

52

Figure 4.4

Findings:

In order to conduct the analysis above, Anderson uses a dataset that consists of 5000

monthly observations of corn-based ethanol prices and sales volumes between 1997-2006 at over

200 retail gas stations in Minnesota. Anderson’s findings show that the demand for corn-based

ethanol has an average elasticity of about 2.5-3.5, hence showing that demand for corn-based

ethanol is sensitive to relative prices, and that policies that promote corn-based ethanol usage are

capable of causing huge distortions in the market. Yet, Anderson’s findings also show that fuel

switching behavior occurs throughout a wide range of relative prices, and that “preferences for

[corn-based] ethanol among households are quite diffuse” (Anderson).

53

Based on Anderson’s findings, we must consider the fact that households are not

identical, and that preferences not only depend on the mileage aspect of fuel consumption. Many

households were willing to pay a per-mile premium for corn-based ethanol due to its perceived

environmental benefits and role as a clean form of energy, leading to a wide range of price-

switching ratios. Because of this, it is possible that households that have strong preferences for

corn-based ethanol still choose to use ethanol without any large government price subsidies in

place. This is something to take into consideration given the DWL that results from government

subsidies as discussed in the Literature Review of the Impacts of Ethanol Subsidies. Adding on,

despite the fact that Anderson’s findings are based on corn-based ethanol, it is important for the

U.S. to evaluate the impact pricing and household preferences have on cellulosic ethanol or other

2G biofuels when coming up with policy incentives.

54

Commodities Pricing Economic Model

Based on Anderson’s findings above, it is seen that policies that promote corn-based

ethanol usage are capable of causing huge distortions in the market. One way to analyze possible

distortions in the market is to understand the effect corn-based ethanol has on the pricing and

availability of food products, as a cost previously mentioned is that corn-based ethanol leads to

an increase in food prices. In order to do so, we refer to two NBER papers, “Biofuels, Binding

Constraints And Agricultural Commodity Price Volatility” by Philip Abbott and “Identifying

Supply and Demand Elasticities of Agricultural Commodities: Implications For the US Ethanol

Mandate” by Michael Roberts.

In Abbott’s paper, the share of U.S. corn production used to produce ethanol increased

drastically in the past decade, as seen in Figure 4.5. Even after accounting for return of corn by-

products to the feed market, there is a large and persistent new demand for corn that has changed

price dynamics. Incentives such as the RFS mandates, subsidies to ethanol, regulations on

gasoline chemistry and import tariffs have created more capacity for ethanol production, and to

use corn for fuel rather than food. Abbott discusses researchers who say that the presence and

emergence of biofuels have caused a global food crisis, while others assert that biofuel shocks

should only affect corn prices, as other common factors across commodities are more important

in explaining price increases (Abbott).

55

Figure 4.5

Roberts takes Abbott’s work one step further to try to quantify the price impact due to

corn being used for ethanol rather than for food. To do this, first we must understand the

theoretical model. The equation below represents the theory of competitive storage, in which

consumption can be substituted over time by transferring food from periods of scarcity to periods

with plenty. Here, amount consumed ct is equivalent to total food supply at the beginning of

period, zt, minus how much food is stored. Any food not stored is consumed.

Theoretically, we obtain the Bellman equation for the social maximization equation that

is shown below. To start, the social planner makes two decisions for xt, how much to store for

the next period, and λt, the amount of effort put into new production (such as how many acres to

plan for the following year). The planner maximizes the utility consumed u(zt - xt) minus a

function for the cost of storage ϕ(xt) and a function for the cost of effort g(λt). The last term in

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the maximization is a discounted expected value gained from total food supply in the following

period. The law of motion equation zt+1 = xt + λt ωt+1 just says that the total amount of food in

the following period is a function of the amount λt stored plus your effort multiplied by random

weather shocks ωt+1 in the following period. The weather shocks are unpredictable and

exogenous. The final constraints just show that you cannot store or expend negative units of food

and effort. Lastly, consumption zt - xt must also be positive each period.

Empirically, Roberts takes production and storage data from the Food and Agriculture

Organization (FAO) for the years 1961-2007. He uses the empirical model shown below. In the

supply equation, we have log of supply st, an intercept αs, weather yield shock ωt, time trends in

supply (from technological change, population, income growth) f(t), and an error term ut. The

most important value in the regression is the price term βslog(E[pt|t-1]). The log of expected

prices is an expected value based on the previous period. The βs term is valuable because it

represents the supply elasticity, or the unit change in log supply for each unit increase in log

prices. The demand equation is very similar to the supply except for there is no weather shock

term affecting demand and the price is not an expectation. This is because on the supply end,

farmers make planting decisions before a year’s weather shock whereas consumers face prices in

the present period. βd is the elasticity of demand in the demand equation.

57

In order for the empirical model to work, both equations must be identified. The authors

check to ensure the independent variables are not correlated with the unobserved factors that

could affect supply or demand. More importantly, weather shocks are an exogenous variable

because weather affects farmers’ decisions but not vice versa. Weather is also random at planting

time (for the most part) but does have an obvious causal connection to supply.

From the 2SLS and 3SLS regressions, it is found that the supply elasticity for food varies

between 0.08 and 0.13 while the demand elasticity for food varies between -0.05 and -0.08. The

U.S. ethanol mandates, which are explained further in U.S. Ethanol Regulation and Policy

History, increase global biofuel production by 5% approximately. Using this policy change, the

elasticities translate into a 30% increase in global food prices which will reduce consumer

surplus by 155 billion dollars annually. The change in consumer surplus is calculated based on

the prices in 2007, 7.06 billion total people globally, and that the 30% price increase reduces

consumption by 1.5%.

Although Roberts’ findings show that corn-based ethanol leads to a 30% increase in

global food prices, it is important to consider how much consumers eat corn relative to total

consumption of other foods. It is possible that higher corn prices do not actually lead to a 30%

increase in global food prices, “as the value of corn is only a small proportion of the final

consumer food dollar” (Babcock). Additionally, it is important to note that ethanol production is

not the only factor that influences corn prices as corn prices still move with typical equilibrium

supply and demand. Nevertheless, due to the pricing effects that corn-based ethanol has on

58

global food prices, we will turn our attention to alternative forms of ethanol, such as cellulosic

ethanol, for the rest of the paper. The reason for this is that a major advantage of using 2G

biofuels, such as cellulosic ethanol, is that it does not require additional land to grow, as seen in a

2010 report by the World Bank. Therefore, cellulosic ethanol will not have that great of an

impact on global food prices as corn based ethanol, and will also not compromise the food

supplies of developing countries. Although there are only a few small cellulosic plants that are in

operation or under construction in the U.S. (Gay), we believe that this is an area that should be

further studied based on our understanding of previous literature and our analysis of economic

models.

Moving forward, it would also be interesting to look at producer surplus in order to get an

idea of the total social welfare consequences of corn-based ethanol. Among the producers, we

can think about who benefits from these increases in prices, whether it is the farmers or the large

food manufacturer conglomerates. Further economic analysis and research is needed to answer

these questions.

59

Cost Benefit Analysis Economic Model

In the Literature Review on the Cost Benefit Analysis for the Ethanol Industry subsection, we

found that developed countries like the U.S. should invest in 2G biofuels. To test this hypothesis

quantitatively, we built a simplified NPV model for a cellulosic ethanol production plant. The

following assumptions were made from this model based on data from Wu et. al (2010) and from

the Center for Climate and Energy Solutions (Sperow):

● A ethanol plant producing 50 million gallons of cellulosic ethanol has a life-span of 20

years

● The fixed costs for such a plant is US$265 million, and yearly maintenance/operational

costs of US$27.7 million

● Price and variable cost per gallon of cellulosic ethanol is constant over the life of a plant

● The fixed cost is paid in year 0 and production of ethanol starts in year 1

Figure 4.6 below gives an example of the calculation using the formula:

𝑁𝑃𝑉 = −𝐹𝐶0 + ∑[(𝑃𝑡 − 𝑉𝐶𝑡) × 𝐺𝑎𝑙𝑙𝑜𝑛𝑠𝑡 − 𝑀𝑂𝑡]

(1 + 𝑅)𝑡

20

𝑡=1

60

Figure 4.6

From this simplified model we get a NPV of US$75 million over 20 years when

assuming a 5% interest rate. The 5% was used because it is slightly more conservative than the

interest rate offered by the 20-year average yield of the U.S. Treasury. With a lower interest rate

of around 3%, our NPV estimate would go above US$140 million. Of course, there are many

variables that can change which may alter our analysis. For example, prices of ethanol are

constantly fluctuating and the variable cost per gallon of ethanol is seeing global declines as

there are more investments in technology. However, our estimate is close to the US$68 million –

US$84 million NPV calculated by Wu (2010). To further refine our cost-benefit NPV model, we

would like to include more variables that will affect both the costs and benefits. Taxes and

capital depreciation will increase our costs while usable electricity generation will be an added

benefit. Further, there are also environmental costs like pollution that are hard to quantify but are

important for a complete analysis.

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Although these results suggest that the investment of a cellulosic ethanol producing plant

is beneficial monetarily, we should think about the costs and benefits for different stakeholders

in society. For the normal consumer, they will receive more environmentally friendly fuel

options, see fewer increases in prices of corn-based foods, and will face less pollution (relative to

gasoline), which could have positive health outcomes. The oil companies will face costs due to

competition from these factories arising and government may have to invest money to help

incentivize private companies to start cellulosic ethanol plants. If government subsidizes these

factories, then this could be translated into higher taxes as a cost for taxpayers. From an

economic development standpoint, cellulosic ethanol production can also affect farmers through

prolonging employment past the harvest season which may be able to spur job creation

(Eisentraut, 2010).

62

Costs and Benefits of Ethanol for Brazil Given the results from our cost benefit analysis above as well as studies of the economic

models, the last step we have to take before determining the appropriate recommendations for

the U.S. is to study the ethanol market in Brazil and the ways the U.S. can learn from it.

Some of the benefits of ethanol for Brazil is that its massive sugarcane ethanol fuel

production program allowed the country to avoid large oil price shocks triggered by the OPEC,

which led to financial crises in other nations. Additionally, according to the EPA, the production

and use of sugarcane-based ethanol only generates two-fifths of the carbon emissions of

petroleum and half the carbon emissions of corn-based ethanol for one unit of energy. Beyond

the environmental benefits of sugar-cane based ethanol, economists also estimate that Brazil’s

focus on sugar-cane ethanol production has increased the country’s economic output by 35%

than if it were to rely on offshore oil (Halasz).

Similar to the U.S., the costs of ethanol are also present in Brazil. For instance, dramatic

land use changes have been found in the Northeast and Southeast regions of Brazil, areas of

intensive sugarcane production. These changes are mainly due to Brazil’s Proalcool program

further discussed in Brazil Ethanol Regulation and Policy, which is a government program that

encourages production of alcohol as an alternative energy source. Although only less than 1% of

Brazil’s total territory is needed to reach the production level of 30 billion liters of alcohol per

year, the Northeast and Southeast regions of Brazil have been affected by the effects of having

only one species of crop (sugarcane) grown densely over a large area. The high density requires

an increased use in pesticide, which causes further negative effects by destructing natural

habitats. Further, since most of the land in the Northeast and Southeast regions of Brazil are

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devoted to sugar-cane production, other crops were driven out of these areas, leading to an

increase in their prices as the price of land surrounding land used for sugarcane production has

increased due to high demand (Halsaz).

Yet, despite the costs of ethanol for Brazil, it provides around 40% of transportation fuels

in Brazil, the highest number amongst other nations. Adding on, although Brazil is a developing

country, it is able to efficiently produce ethanol due to its low production costs, favorable climate

and mature infrastructure built up over several decades. The main reason for this success is due

to the favorable policies that Brazil has implemented throughout its history. For instance, the

Brazilian government required that all gasoline sold contains a minimum percentage of ethanol,

with the blending ratio currently set at 20%. The government also provides a tax benefit towards

the purchase of new FFV’s that run on ethanol, where a 14% sales tax is applied instead of the

usual 16% for gasoline-only vehicles (Sandalow). Because of this, it is important to further

analyze the policies and regulations in place for both the U.S. and Brazil, so that we can

effectively draw comparisons and make appropriate recommendations for the U.S.

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PART V - Policy Implications

U.S. Ethanol Regulation and Policy History

Biofuels have existed since the 1930s in the U.S., but it took until the 1970s for the

market to grow, when the government launched tax credits (Gay). Specifically, in 1978, the

government instituted a 40 cents per gallon tax credit for producers, which in 2005 was increased

to 51 cents per gallon, a level it remains at today (Gay).

In 2005, Congress passed the most significant regulation on ethanol, the Energy Policy

Act of 2005, which launched the Renewable Fuel Standard program, known as RFS (EPA). In

2007, the Energy Independence and Security Act of 2007 (EISA) enhanced the scope of RFA.

The program sets an evolving annual fuel requirement (up until 2022) for the production of

cellulosic biofuel (a biofuel produced from wood, grasses, or the inedible parts of plants),

biomass based diesel (made from vegetable oil or animal fats), advanced biofuel (fuels that can

be manufactured from various types of biomass), and total renewable fuel. The volumes by year

in the statute are listed below from the EPA website and is seen in Figure 5.1 below.

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Figure 5.1

The Act also allowed for the EPA to amend the volume mandates in the EISA through a

rulemaking procedure. The EPA’s yearly announcements are closely followed by ethanol and

corn producers. The EPA allows two methods for producers to fulfill specified ethanol volume

requirements: 1) meeting the standard through the production of ethanol or 2) by obtaining

credits called Renewable Identification Numbers, known as RINs (EPA). RINs are obtained

through the production of renewable fuels (ethanol) and can be freely traded. This is why

producers who produce below standard can still meet the requirements by purchasing RINs from

sellers who produce above standard. RINs will get a closer examination in RINS in Depth later in

this paper.

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U.S. Regulation and Production Forecasts

Due to the RFS mandate discussed above, ethanol production is expected to grow at a

rate of 400 thousand barrels a day from 2011 to 2040, according to the U.S. Energy Information

Administration (EIA). Despite the mandate, energy production is expected to grow modestly due

to projected declines in gasoline consumption (EIA). If gasoline consumption declines to the

consensus estimated production level of 8.1 million barrels per day in 2022, biofuels will not

meet the volume standard set forth in the EISA of 2007 (Cason). Thus, ethanol consumption is

expected to decline to 14.9 billion gallons in 2014, but will still be the predominant alternate fuel

source used (Cason).

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RINS in Depth

RINs have a lifecycle of their own and are the currency of the RFS program (EPA).

Figure 5.2 below outlines the cycle of 1 RIN:

Figure 5.2

Source: EPA

The first step in a RIN’s lifecycle is its production. A new RIN is created when new

ethanol is produced. Once a RIN is produced, it can then be traded in the market in two ways.

The first is what the EPA calls “assigned RINs”. This means that ethanol producers can trade the

RIN by trading the production of ethanol it originally came from. Thus in an “assigned RIN”

transaction, a purchaser obtains both the RIN and its associated fuel. RINs can also be decoupled

or separated from the ethanol volume it was associated with. This is the second type of RIN

trade, and is called a “separated RIN” transaction. In this type of transaction, the ethanol volume

stays with the producer, and only the RIN is traded (EPA). This almost always happens when a

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blender mixes ethanol into gasoline or diesel, and has more RINs than needed for compliance

and thus sells it to a party who has less RINs than needed to meet compliance.

Sometimes, production of renewable fuel is greater than mandated (this happened in

2012, for instance). In these cases, producers stock the excess RINs to be able to reduce

production in the next year. The EPA allows producers to use up to 20% of previous year RINs

to meet production for the current year. Thus, separated RIN prices exist to close gaps between

supply and demand due to the existence of mandates.

Figure 5.3

Source: USDA, Economic Research Service, based on Thompson et al., 2009b.

RIN is the delta that bridges supply and demand gap due to imposition of mandate

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Finally, the last part of the RIN lifecycle is when it is retired. This happens when parties

“surrender” their RINs to the EPA to satisfy compliance with the ethanol mandate. The EPA

regulates what parties can participate in RIN transactions. Currently, “obligated parties” (refiners

and importers of gasoline and diesel who use ethanol for blending purposes), ethanol exporters,

ethanol producers, and finally registered RIN market participants, are allowed to trade RINs.

Type of RINs:

A RIN is a 38-digit code that identifies single gallon fuels (gallon-RIN) or multiple

gallons (a batch-RIN) (Christensen). Specifically, a RIN has a unique structure

KYYYYCCCCFFFFFBBBBBRRDSSSSSSSSEEEEEEEE where K=designates if RIN is

separated or assigned; YYYY=Year of production; CCCC=designates associated company

through a Company ID; FFFFF=Designates associated facility through a Facility ID;

BBBBB=Batch number; RR=designates Equivalence Value; SSSSSSSS=Beginning of RIN

block; EEEEEEEE=End of RIN block (Christensen).

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Ethanol Blend Regulations

As discussed earlier, ethanol production is primarily designed as a fuel additive to

enhance the efficacy of fuel by increasing octane and in theory make blending economics more

favorable than pure fuel. Ethanol additives, and gasoline blends used for “highway motor

vehicles” must be registered with the EPA but fuel designed for off-road vehicles or engines has

no registration requirement. There are two broad categories of ethanol blends: higher ethanol

blends and mid-level blends. Higher ethanol blends include E10 (10% ethanol, 90% gas) and the

newly announced E15 standard (15% ethanol, 85% gas). The E10 standard was launched with

the Clean Air Act Amendments of 1990, which required oxygenated fuels in areas with high

levels of carbon monoxide. More than 95% of U.S. gasoline is blended with 10% ethanol or less.

While ethanol, a renewable fuel, is used in E10, the blend itself is not classified as one (DOE).

The E15 standard was sanctioned by the EPA in 2011 for use by car model years 2011 up

until now. E15 is still not commonly used because of limited availability, and is sold primarily in

the Midwestern U.S. (DOE).

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Relationship Between RINs and Gas

Figure 5.4 illustrates of the historical market price of one RIN compared to the price of

gasoline in 2014 up to the beginning of 2015:

Figure 5.4

The difference between the cost of production of 1 RIN and the cost of production of gasoline (in

this case RBOB, which is the price of unleaded gas futures) is a key spread for ethanol producers

because they use it to decide to make more ethanol or obtain RINs through purchase. When

ethanol is significantly cheaper than RBOB gas, producers are motivated to blend more ethanol

into gasoline. There is also one other factor that influences ethanol producers: the prices of

different types of RINs for different variants of ethanol. The market price of the D6 RIN, the

RIN used for corn based ethanol, can change from speculation given it is traded freely. Most of

the time, the D6 RIN has a higher price near EPA announcements of RFS standards or

compliance deadlines. In 2014, and 2015, the D-6 RIN has been relatively high. While gas

prices have continued to be low, the higher D-6 RIN provides a cushion on the spread, what is

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called the “net of RIN cost”. Even in times where spot prices do not favor the production of

ethanol, a high RIN price reduces the cost of blending. For instance, when in December 2014

and January 2015, prices for ethanol increased from US$0.25/gallon to a US$0.30 /gallon, the

D6 ethanol RIN increased by approximately the same amount, from US$0.45/gallon in

November to US$0.71/gallon in mid-January (Hill).

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Brazil Ethanol Regulation and Policy History Now that the regulatory climate in the U.S. has been discussed, let’s examine

governmental policy in Brazil. The first signs of investment in ethanol date back to the formation

of The Instituto do Açúcar e do Álcool (IAA) in the 1930s. For much of the middle portion of the

century, this government agency regulated all aspects of sugar production, existing until the

1980s (Iglesias). The production of sugarcane ethanol, however, remained fairly low until the

1970s, and in particular the first 1973 oil crisis. On November 14, 1975, largely in response to

the realization of their dependence on international oil manifested through a financial crisis

brought on by skyrocketing oil prices, the Brazilian government enacted the National Ethanol

Program, or Proalcool, in order to begin gaining independence from foreign energy.

Besides the rise in oil prices on the international market, another external factor that

made Proalcool appealing was the U.S. embargo on Cuban sugar, which opened space in the

international market for Brazilian sugar (Alonso-Pippo). Internally, several other factors could be

attributed to the creation of Proalcool. These include: (1) The coexistence of a sugar agro-

industry with a national automobile industry, which has a certain degree of experience and

technological development; (2) The existence of an internal automobile market with potential

consumers (about 40 million); (3) Privileged geographical and climatic conditions for sugarcane

growth; (4) The political willingness of generalizing the alcohol production in the sugar industry;

and (5) The presence of well prepared researchers and technicians in numbers enough to

guarantee the change (Alonso-Pippo). Besides acting as a general bailout of Brazil’s struggling

sugar industry, Proalcool had four explicit goals: (1) to increase net exports and net supply of

foreign exchange by decreasing demand for foreign fuel; (2) to reduce income disparity by

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increasing the incomes of the relatively poor agricultural workers in the sugar-producing

Northeast; (3) to increase national income through the expanded use of the underutilized

resources of land and labour; and (4) to increase the demand for capital goods in the agricultural

machinery sector (Hira). To achieve some of these goals, Proalcool made use of large-scale

government interventions such as quotas, marketing orders, price setting, and subsidized interest

rates (Martines-Filho).

By the end of 1978, the goal of replacing gasoline with 20% ethanol was close to being

realized, and the initial goal of 3.5 billion gallons was close to being met. However, 1979 saw

the onset of the second oil crisis. On the same day that OPEC hiked oil prices by 37%, Brazilian

president Figuerido announced the expansion of the annual goal of 790 million gallons/year to

2.8 billion gallons/year by 1985, as well as an additional goal of another $5 billion in

investments in fuel production facilities (Hira). During these years, from 1979-1985, the

Brazilian government also enacted a system of tax exemptions for buyers of ethanol cars and

began pegging the prices of ethanol at the pump to those of gasoline (Martines-Filho).

Beginning in the mid-late 1980s, Brazil began entering a period of uncertainty and

stagnation in the ethanol industry that trended towards a deregulation of the industry (Alonso-

Pippo). In 1986, the global collapse in oil prices caused the government to cut R&D funding and

the purchase price for ethanol was set below its average costs of production (Hira). Come 1987,

Petrobras, the state-owned oil and gasoline company that had previously been required to buy

and distribute all production from the ethanol industry was no longer required to do so

(Martines-Filho). This fact, combined with a global increase in sugar prices and subsequent lack

in consumer confidence of ethanol-powered vehicles, led Brazil to become the largest importer

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of ethanol from 1989-1996 (Hira). The 1990s saw the gradual closure of many of the government

agencies responsible for regulating the ethanol industry, including the aforementioned IAA. By

January 1, 1997, all sugarcane and ethanol prices were determined solely by market prices. The

only significant regulatory attempt during this period of stagnation in the ethanol industry was a

1993 law that required all gasoline produced to be 20-25% blend of ethanol (Martines-Filho). In

general, for the rest of the 1990s, Brazil saw a shift in consumer preferences back towards

gasoline and gasoline-powered cars (Alonso-Pippo).

Beginning with the development of the FFV in the early 2000s, Brazil saw a

revitalization of its ethanol market that led to almost a decade of sustained growth. The new

technology, which, as mentioned earlier, rapidly took over a sizeable portion of the market,

allowed the sugarcane ethanol industry to support itself in the relative absence of government

intervention. Combined with a period of unusually high sugar prices, this period was a perfect

storm for sustained growth in Brazil’s ethanol industry, giving Brazil its status as one of the top

ethanol producers and exporters (Alonso-Pippo). Though at this time the industry remained

unregulated, the tax structure in place could serve as evidence of the Brazilian government’s

commitment to the continued growth of the industry. In 2006, the tax on gasoline at the pump

was 52.12%, which was 58% higher than the tax on pure ethanol, and infinitely higher than the

untaxed “gasohol” mix of 20-25% ethanol with gasoline (Hira).

Though currently about 90% of new vehicles manufactured in Brazil are FFVs, Brazilian

governmental policy caused a period of relative stagnation in the early 2010s ethanol industry.

This is largely due to President Dilma Rousseff’s commitment to keeping gasoline prices at an

artificially low level, which limits the competitiveness of ethanol as consumers practice arbitrage

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at the pump. This was achieved by removing the aforementioned infrastructure tax on gasoline

(Alvarez). By November of 2013, only 23% of FFV owners were regularly purchasing ethanol.

To compare, this is down from 66% of FFV owners four years earlier in 2009 (Phillips). As of

this last year, Brazilian policy has shifted back in favor of the ethanol industry. In the wake of a

high-profile scandal in which the Federal Police uncovered rampant corruption in Petrobras,

policymakers have 1) reinstated the infrastructure tax on gasoline, 2) increased the required ratio

of ethanol in gasoline blends from 25% to 27%, and 3) forced Petrobras to raise gasoline prices

(Alvarez). From a policy perspective, the Brazilian government has demonstrated a renewed

commitment to ensuring a bright future for its country’s ethanol industry.

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U.S. and Brazil Policy Comparison

The ethanol industry in Brazil has created more than 1.8 million jobs and has replaced

over 1.44 billion barrels of oil since 1976. Given the policy sections above, and using Brazil as a

case study, we have determined a few basic characteristics of what makes good energy policy.

1. Government support is key to the rapid expansion of ethanol production capacity as

biofuels in general are more expensive than fossil fuels (Sandalow). Brazil’s history

suggests certain policies, such as credit guarantees and low-interest loans, that the U.S.

should implement to improve its production of corn-based ethanol, or to facilitate its

switch to cellulosic ethanol or other 2G biofuels. For instance, the U.S. can look into a

combination of tax subsidies, volume/blend mandates and incentives for investment.

2. Government regulations have to be consistent (Sandalow). The most important part of

Brazil’s ethanol program over the past three decades is the requirement that ethanol

makes up a certain percentage of fuel supply. Brazil’s government has been consistent

with this regulation and approach, and varies the percentage of ethanol required based on

market conditions.

3. Ethanol programs must anticipate the possibility of commodity price fluctuations

(Sandalow). Demand for ethanol production increases in Brazil when oil prices are high

and sugar-cane prices are low. Although the U.S. primarily uses corn-based ethanol, law

makers must also be aware of the changes in corn-prices. Additionally, since the current

price of oil is slightly above US$40/barrel, the lowest price in years, law-makers must

understand that some consumers may prefer using oil rather than ethanol due to the lower

price. When oil prices eventually rise in the future, this may in return lead to a sudden

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increase in demand for ethanol. Because of this, FFV makers must be ready

for the increase in demand and be able to quickly scale up production to meet the demand

of consumers.

4. Public attitudes towards ethanol change quickly (Sandalow). For instance, in the 1970’s

and 1980’s, enthusiasm for ethanol was high in Brazil, leading to a shortage in supply of

ethanol around the late 1980’s and 1990’s. Law-makers should be flexible and aware of

these public attitudes and changes, and reflect them in their policies. For instance, when

public attitude towards ethanol is high, law-makers may decide to increase the percentage

requirement for ethanol, hence indirectly pushing the growth of the ethanol industry.

5. Finally, ethanol technologies improve steadily with time (Sandalow). Improvements in

technology eventually lead to an increase in efficiency and decrease in costs of ethanol.

This is one of the many reasons why as a group we decided that we could not fully accept

the conclusion from the Cost and Benefit analysis papers written by Cecot and Hahn on

the U.S. ethanol industry as the analysis was conducted in 2008, a time when ethanol

production in the U.S. may not have been as efficient as it currently is now.

Moving on to comparing production, Brazil’s process is more efficient than the U.S’s

because of Brazil’s reliance on sugarcane as its basis for ethanol production instead of corn. The

overview of Brazil’s ethanol industry mentioned that there is a lower opportunity cost measured

in terms of land used to produce sugarcane ethanol versus corn ethanol. In other words,

sugarcane produces 62 more gallons of ethanol per one acre (Luk).

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Another way of quantifying the higher level of production efficiency in Brazil is through

the measure of “net energy balance” - the difference between the energy required for production

and the energy released by consumption. Brazil’s net energy balance is around 9.5, while the

U.S.’s corn based process delivers a net energy balance of 1.3 (Luk). Thus, sugarcane ethanol

has a net energy balance that is 7 times more than the U.S.’s corn ethanol (Luk). In addition,

sugarcane requires a fourth of the energy necessary to turn sugars into ethanol. This is because

only up to half of the starch in corn can be converted to sugar to then be distilled to ethanol. This

intermediary step is not required with sugarcane distillation, and thus costs significantly less -

currently around US$80 less per cubic meter than corn based ethanol (Luk).

So why then, does the U.S. not switch to sugarcane based ethanol? Simply put, there is

nowhere near an adequate supply of sugarcane in the U.S. to supply the country’s ethanol

consumption. Another key difference is the widespread use of FFV’s, discussed at length in an

earlier section. Flex-fuel engines can run on different sources of fuel - pure ethanol, pure

gasoline, and gasoline/ethanol blends. The prevalence of flex-fuel engines beginning in the early

2000s drastically boosted demand and consumption of ethanol in Brazil with little government

intervention. In 2006, the government instituted a discriminatory tax at the pump favoring

ethanol by taxing the source at a lower rate than that of pure gasoline. It is no surprise then that

pure ethanol fuel - E100 - remains a popular choice at the pump, and is ubiquitously available,

along with E85 blends, and the most popular E20-E25 blends. On the other hand, in the U.S.,

E15, a standard significantly below even the lowest of mainstream blends used in Brazil, is only

available in Midwestern states (near the corn belt states), and as a consequence, has low

consumption volume. Thus, the comparison shows how successful the Brazilian flex-fuel

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program has been in capturing the market and how distant the U.S. is in terms of boosting the

amount of ethanol in proportion to gasoline, though steps are being made. Legislation such as the

the Open Fuel Standards Act (OFS) aims to promote ethanol as an alternative fuel by mandating

that a higher percentage of newly-produced motor vehicles have flex-fuel capacity. If it ever

wishes to catch up to Brazil in terms of effective and efficient use of ethanol, the U.S.

government must follow through with this demonstrated commitment to ethanol as an alternative

fuel with more policy initiatives that both incentivize ethanol use (such as Brazil’s

discriminatory taxes) and promote research into more economically sustainable ethanol sources.

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PART VI - Conclusion and Recommendations

Through comparisons of the U.S. and Brazil, we hope to adopt policies that are not

present in the U.S. ethanol market to make it more cost effective. In the Household’s Demand of

Ethanol Economic Model, we concluded that both pricing and the mileage differences between

ethanol and gasoline are factors that affect the consumption of ethanol. For instance, although

government subsidies may cause the price of ethanol at the pump to be lower than the price of

gasoline at the pump, pricing is not the only factor that determines whether households choose

ethanol over gasoline. Households also look at mileage differences, where Combustion Process

of Ethanol vs. Gasoline demonstrates that gasoline has more mileage per gallon. Adding on,

through the Commodities Pricing Economic Model, we were able to see that corn-based ethanol

causes a 30% increase in global food prices, and also causes large distortions in the market.

Because of this, we turned our attention to analyzing the costs and benefits of alternative sources

of ethanol such as cellulosic ethanol in the Cost and Benefit Analysis Economic Model, where

cellulosic ethanol was seen to have a NPV of US$75 million. These factors were all taken into

consideration when determining the appropriate recommendations we have for the U.S.

From the analysis done in our paper, we have a few recommendations for the U.S. on

ways it can improve its ethanol market. First, instead of trying to increase ethanol usage for all

modes of transportation, the U.S. should target specific modes of transportation. For instance,

policies can be implemented to increase the number of FFV’s in the U.S. and to specifically

target increased ethanol usage for household cars. Additionally, the U.S. state governments

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should consider lowering the auto-tax for FFV’s, as they are generally more expensive than

normal vehicles, as this can encourage usage of FFV’s.

Second, the number of gas stations that provide E85 or various ethanol blends should be

increased throughout the U.S., so that they are not only concentrated in the Midwest. This in

return will further promote the usage of ethanol due to easy accessibility. In order to do so, the

U.S. government should look into implementing appropriate pumps at all gas stations throughout

the U.S., as special pumps are needed for higher blends of ethanol.

Third, the U.S. should redirect some of its subsidies and investments away from corn-

based ethanol and towards 2G biofuels such as cellulosic ethanol in order to diversify its inputs

for ethanol, reduce its reliance on corn and to limit adverse effects on global food prices. The

reason why we decide to redirect some subsidies and investments towards 2G rather than all is

because the technology for 2G has not yet been fully developed, and therefore subsidies and

investments are still needed for 1G biofuels so that the ethanol industry continues to grow.

Adding on, the reason why we decided to retain subsidies for ethanol in general is because we

believe the benefits for these subsidies outweigh the DWL as explained in the Literature Review

on the Effects of Ethanol Subsidies.

An example of a 2G biofuel the U.S. could potentially switch to is switch grass, which

may be a more feasible and efficient source to produce ethanol. Switch grass has a net energy

balance of 4, three times that of corn, and can yield around 1,250 gallons of ethanol per acre,

which is higher than corn and even sugarcane. In addition, while corn is used for consumption

purposes beyond ethanol (food), and thus has an opportunity cost in terms of forfeited alternative

forms of consumption, switch grass is not used as a food (Luk).

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The usage of 2G biofuels also brings many benefits, such as potential job creation and

regional income growth. According to a 2010 report published by the International Energy

Agency, existing farm labor can be utilized to create the residue of crops used in 2G biofuels.

Additionally, employment would also be prolonged past the time-frame for regular harvest

seasons. Since 2G biofuels also utilize agricultural residues, this brings added revenue to the

agricultural industry, as the residues are often discarded (Cason).

Lastly, in terms of revenue generation, it is seen that revenue generation from 2G biofuels

are generally higher than revenue generation from 1G biofuels, where this holds true for both the

U.S. and Brazil (Cason). Although the current cost of producing 1G biofuels is generally cheaper

than 2G biofuels due to the familiarity with this field, the long-term benefits of 2G biofuels

exceed those of 1G biofuels. Therefore, we believe that investments and subsidies should be

allocated such that underutilized cellulosic feedstocks gain usage in the U.S. and become more

commonplace in American ethanol production. While we do advocate for continued

subsidization of corn-based ethanol production despite its adverse pricing effects and other costs

discussed, we believe that more focus should be targeted towards 2G biofuels. Although past

targets to produce cellulosic ethanol have not been met, we believe subsidizing new 2G

technologies today will result in large developments given the stronger economy, whereas there

lacked sufficient incentive in the past as the weak economy heightened the perceived risks of

investing in 2G biofuels.

Fourth, the U.S. can implement a staggered surcharge approach to pricing motor fuels,

where the surcharge should account for the mileage differences between ethanol and gasoline.

For instance, in order to promote ethanol usage, the U.S. could place a small surcharge on

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ethanol and a larger surcharge on gasoline, where the differences in surcharge would provide

enough of an incentive for consumers to switch to ethanol (taking into consideration mileage

effects and DWL effects as well). The U.S. government should then direct the differences in

demand price and supply price towards funding the investments in 2G biofuels as well as

implementing appropriate pumps for higher ethanol blends throughout the U.S.

Fifth, the U.S. must take into consideration the impact that policies have on market

dynamics, such as the effects the policies have on international trade. As seen in the Household’s

Demand for Ethanol Economic Model, the demand for ethanol for a U.S. household has an

average elasticity of about 2.5-3.5, showing how demand for ethanol is sensitive to relative

prices. Because of this, policies that promote ethanol usage are capable of causing huge

distortions in the market. We believe that only by fully understanding the implications of ethanol

policies that the U.S. can finally take appropriate steps to improving its ethanol market.

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Glossary

1G Biofuels: The first generation biofuels refer to the fuels that have been derived from sources

like starch, sugar, animal fats and vegetable oil

2G Biofuels: Second generation biofuels, also known as advanced biofuels, are fuels that can be

manufactured from various types of biomass; Biomass is a wide-ranging term meaning any

source of organic carbon that is renewed rapidly as part of the carbon cycle

Anhydrous: Containing no water

Azeotropic: A mixture of two or more liquids whose contents cannot be altered by distillation

Biodiesel: A domestically produced renewable fuel used in diesel vehicles that can be

manufactured from products such as vegetable oils and animal fats; It is a cleaner burning

alternative to petroleum diesel

Cellulosic Biofuels: A biofuel produced from wood, grasses, or the inedible parts of plants

Conversion Efficiency: The ratio between energy output and input into an energy converting

machine

Corn Belt: A region of the Midwestern U.S. where corn (maize) has, since the 1850s, been the

predominant crop, replacing the native tall grasses

Cumulative Density Function: Function that maps out the probability that a variable takes a value

less than or equal to x

Distillation: Separating a liquid into its component parts through evaporation and condensation

E10: 10% ethanol, 90% gasoline blend E15: 15% ethanol, 85% gasoline blend E85: 85% ethanol, 15% gasoline blend E100: pure ethanol

EIA: Energy Information Administration

Energy Policy Act of 2005: Congressional act that created the Renewable Fuel Standard Program

Energy Independence and Security Act of 2007: Enhanced the scope of RFA by setting an

evolving annual fuel requirement

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FFV (Flex Fuel Vehicle): Any vehicle capable of running on ethanol-gas blend, or pure ethanol

or gas

Fossil Fuels: Non-renewable energy sources made of plant and animal matter; The 3 main fossil

fuels are oil (petroleum), natural gas and coal

GGE: Gasoline gallon equivalent

Hydrolysis: A chemical reaction in which molecular bonds are broken down by water

Instituto do Açúcar e do Álcool (IAA): First Brazilian governmental agency responsible for

regulation of sugarcane ethanol

Marginal Utility: The gain from an increase (or loss from a decrease) in consumption of a

product; Positive marginal utility is a good thing

Net Energy Balance: The difference between the energy required for production and the energy

released by consumption

Nitrogen Oxides: Generic term for various nitrogen oxides that are produced during combustion;

They are believed to cause harmful effects to the environment as well as react with oxygen in the

air to produce ozone

Octane Rating: Designates the amount of compression a fuel can take before igniting

Ozone: A molecule with the chemical formula O3; It has a pungent smell and takes the form of a

pale blue gas

RBOB Gas: Price of unleaded gas futures

RFS: Renewable Fuel Standard

RIN (Renewable Identification Number): The number given to each batch of biofuel, used for

tracking each batch

Petrobras: Multinational, Brazil-based energy company that was the legal monopolist of Brazil’s

oil industry until 1997

Proalcool: The Brazilian National Fuel Alcohol Program

Price Elasticity of Demand: Measures how sensitive demand is to changes in prices; If demand is

inelastic, it is not sensitive to changes in prices; If demand is elastic, it is highly sensitive to

changes in prices

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Sulfur Oxides: Compounds of sulfur and oxide molecules that can have adverse effects on

human health or the environment even in its untransformed state; Typically, Sulfur Oxide

transforms to Sulfur Dioxide, a toxic gas with a pungent and irritating smell

Switch Grass: Native warm-season grass that is found in the U.S.

88

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Pictures Cited

Title Picture: http://www.lagaceta.com.ar/nota/515952/rural/etanol-maiz-integra-energia-

alimentos.html Figure 1.1: http://www.afdc.energy.gov/fuels/ethanol_feedstocks.html Figure 1.2 – unkown

Figure 1.3 - http://www.afdc.energy.gov Figure 1.4 - http://www.fas.usda.gov/sites/default/files/2015-04/04-2015_ethanol_iatr.pdf Figure 1.5 - http://www.afdc.energy.gov Figure 1.6 - http://www.oardc.ohio-state.edu/s1041/images/S1041_Eggeman.pdf Figure 1.7 - http://www.nrel.gov/biomass/data_resources.html Figure 1.8 - https://www.google.com/url?q=http://sugarcane.org/the-brazilian-

experience/brazilian-transportation-

fleet&sa=D&ust=1448947395122000&usg=AFQjCNHU2j597LUrBF-bkHDFeJ2_QaPzeg Figure 1.9 - http://www.bain.com/publications/articles/biofuels-from-boom-to-bust.aspx Figure 1.10 -

http://gain.fas.usda.gov/Recent%20GAIN%20Publications/Biofuels%20Annual_Sao%20Paulo%

20ATO_Brazil_7-25-2014.pdf

Figure 2.1 - http://www.ethanolrfa.org/how-ethanol-is-made/ Figure 2.2 - http://www.ethanolrfa.org/resources/industry/co-products/

Figure 2.3 - http://www.ethanolrfa.org/how-ethanol-is-made/

Figure 3.1 - http://www.biotek.com/assets/tech_resources/Cellulosic_App_Note_Part_II.pdf

Figure 3.2 - http://www.appropedia.org/images/thumb/e/e5/Ethanol_UEFXA2.gif/600px-

Ethanol_UEFXA2.gif

Figure 3.3 - http://arxiv.org/ftp/arxiv/papers/1302/1302.3767.pdf

Figure 3.4 - http://www.wintek-corp.com/dehydration/molecular-sieve-dehydration-units-

msdu.html

Figure 3.6 - http://hyperphysics.phy-astr.gsu.edu/hbase/organic/carb.html

Figure 3.7 -

https://www.glbrc.org/sites/default/files/Why%20is%20it%20so%20difficult%20to%20make%2

0cellulosic%20ethanol%3F.pdf

Figure 3.8 – Great Lakes Bioenergy Research Center

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Figure 5.1 – EPA

Figure 5.2 – EPA

Figure 5.3 - USDA, Economic Research Service, based on Thompson et al., 2009b.

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