Effects of Increased Biofuels on the U.S. Economy in 2022
by Mark Gehlhar, Ashley R Winston, and Agapi Somwaru
Economic Research Report No. (ERR-102) 36 pp, October 2010
Diversifying the Nation's energy supply is one of the primary
means for providing long-term energy security. A diverse energy
portfolio can also have far-reaching economic impacts by reducing
dependence on foreign oil. The Energy Independence and Security Act
of 2007 (EISA) mandates a Renewable Fuel Standard (RFS-2) under
which the United States will annually produce 36 billion gallons of
biofuel, primarily ethanol, by 2022. Transitioning away from
nonrenewable fossil fuels (such as petroleum oil) without placing
additional burden on the U.S. economy is a long-term challenge.
Although experts and policymakers generally agree on the importance
of energy security, how best to achieve this goal and at what cost
is subject to debate.
What Is the Issue?
Reducing dependence on foreign energy by expanding domestic
renewable fuels can have impacts for the overall U.S. economy
because of energy's importance in consumption, production, and
trade. In the past, increasing energy independence would generally
be expected to place a greater burden on the U.S. economy because
of the higher domestic costs of producing alternative energy to
replace relatively inexpensive foreign petroleum. However,
according to the U.S. Department of Energy, petroleum prices are
more likely to continue rising in the long term relative to the
cost of producing domestic biofuels. Although the exact timing is
uncertain, cost-reducing technology in biofuel production is
expected to be a key factor in expanding production and making
biofuels competitive with petroleum. However, without policies that
provide incentives to deploy renewable energy technology, biofuel
producers likely will shy away from investing in new technology
because of market uncertainty. The RFS-2 mandate is accompanied by
incentives in the form of tax credits to ethanol blenders. Tax
credits, however, could add to taxpayers' costs and place greater
burden on the economy. This study examines the potential effects of
the RFS-2 on the U.S. economy as measured by gross domestic product
(GDP), household income and consumption, price and quantity of
energy fuels, and agricultural production and trade. We compare the
U.S. economy in 2022 with and without the RFS-2.
What Did the Study Find?
If biofuel production technology advances and petroleum prices
continue to rise as projected, the RFS-2 could benefit the U.S.
economy. U.S. household consumption would rise because of higher
real wages, increased household income, and lower import prices. By
substituting domestic biofuels for imported petroleum, the United
States would pay less for imports overall and receive higher prices
for exports, providing a gain for the economy from favorable terms
of trade. Improved technology and increased investment would
enhance the ability of the U.S. economy to expand.
Gross Domestic Product
Changes in GDP and the magnitude of benefits (or costs) are
highly dependent upon assumptions about alternative biofuel support
policies and the future price of oil. The greater the value of
displaced petroleum for each dollar of biofuel produced and the
lower the tax credits, the greater the benefit to the U.S. economy.
Cost-reducing technology would not only reduce the costs of
producing biofuels but also contribute to national GDP because
production would rise as efficiency improves.
Household consumption would increase regardless of whether or not
tax credits were retained, with the gains primarily due to
increased real income, favorable terms of trade with relatively
lower import prices, and hence, greater purchasing power to the
household. Consumption would increase by about $13-$28 billion,
depending largely on oil prices. The RFS-2 would raise real wages
and household disposable income as returns to labor and capital
increase. Replacing imported oil with domestic biofuels would lower
the cost of motor fuels. Thus, households would spend less on, but
consume more, motor fuels. In addition, lower prices for imports
and fuel would encourage greater consumption of other goods and
Energy and Trade
Expansion of domestic biofuel production would reduce petroleum
demand, thereby reducing the quantity of imported crude petroleum.
Crude oil, which is a major input for gasoline, would be displaced
by ethanol. U.S. imports of crude oil would fall by 16-17 percent
in 2022. The United States is the largest importer of crude oil,
with imports accounting for about two-thirds of total U.S. supply.
Reduced U.S. demand for petroleum would lower the price of crude
oil. As a result of lower demand and a decline in the import price,
the U.S. import bill for crude oil would decline by $61-$68
billion. With a smaller import bill, the U.S. dollar would
appreciate. A stronger dollar would reduce the cost of importing
other goods, including agricultural commodities, and reduce export
volume because of increased prices in foreign markets for U.S.
products. In addition, with greater demand for land to use for both
energy crop production and all other agricultural activities,
meeting the RFS-2 would reduce U.S. agricultural commodity exports
and increase the demand for agricultural imports as crops must
compete for limited land.
This study does not predict the future but addresses the question
of what would be the likely impacts on the U.S. economy should the
RFS-2 mandate be met under different price/policy scenarios. The
study acknowledges the uncertainty in meeting the mandate in 2022.
The exact timing of the commercialization of new technologies to
produce biofuels cannot be determined because of a myriad of
uncertain factors. Future developments will also depend on new
investments in infrastructure needed to support a transportation
and distribution network for biofuels. Determining when such
developments would take place is beyond the scope of this study.
Long-term impacts on the U.S. economy from meeting the RFS-2 will
depend partly on future petroleum prices. This study adopts a price
projection from the U.S. Department of Energy that assumes that
satisfying the growing world demand for petroleum will require
accessing higher cost supplies of oil. Under these conditions,
petroleum prices are likely to be higher in 2022 than current
prices. Unlike previous decades, petroleum prices are likely to
rise relative to the cost of producing biofuels.
How Was the Study Conducted?
The study used a detailed computable general equilibrium model
for the United States-the U.S. Applied General Equilibrium (USAGE)
model-comprising 534 industries. The model is a multipurpose
framework for addressing a broad set of questions, including
domestic and trade policy as well as macroeconomic links to trade.
The model was modified to include additional sectors and industries
involved in biofuel production, including conventional ethanol
(corn-starch) produced from dry-milling and second-generation
ethanol made from crop residues, dedicated energy crops, and other
advanced biofuels. Other modifications include explicit treatment
of U.S. agricultural land and regional land allocation for the
production of biomass (organic material) and all other agricultural
activities. A base, or reference, scenario without the RFS-2 was
conducted for the year 2022 using the U.S. Department of Energy's
projections. The effects of RFS-2 were determined as alternative
scenarios using scenario analysis. Volumes of all types of ethanol
were based on those established by EISA.