USDA Long-Term Projections: U.S. Biofuel Overview

The Energy Policy Act of 2005 mandates that renewable fuel use in gasoline (with credits for biodiesel) reach 7.5 billion gallons by calendar year 2012. However, high oil prices combined with blender tax credits and import tariffs (see box, page 24, on tax credits and tariffs), elimination of methyl tertiary butyl ether (MTBE) as an additive in gasoline blending, State programs, and other factors have provided economic incentives for a biofuel expansion that exceeds the Act’s mandate.

Most of the ongoing and projected biofuel expansion in the United States is for ethanol. Ethanol production is assumed to expand sharply through 2009/10, reflecting ongoing plant construction in response to strong profit incentives. Although more moderate growth is assumed in subsequent years, over 12 billion gallons of ethanol are produced annually by the end of the projection period.

Most of this expansion is dry mill production which primarily uses corn as the feedstock.  Consequently, more than 30 percent of the corn crop is used to produce ethanol by 2009/10. Nonetheless, even by the end of the projection period, ethanol production (by volume) represents less than 8 percent of annual gasoline use in the United States.

Biodiesel production capacity and output have increased rapidly in the past 2 years and are projected to rise rapidly again in 2007/08. Slower growth is then projected for several years, with biodiesel output leveling off beyond 2010/11 as higher soybean oil prices reduce profitability. At its projected high of 700 million gallons, biodiesel uses about 23 percent of soybean oil production, but accounts for less than 2 percent of highway diesel fuel use in the United States. Cellulosic-based production of renewable fuels is assumed to meet the minimum specified in the Energy Policy Act of 2005 of 250 million gallons in 2013 and subsequent years.

New dry mill ethanol plants are assumed in the projections to have a production yield of 2.80 gallons of ethanol from a bushel of corn, raising the industry average to 2.76 gallons per bushel at the end of the projection period. It takes slightly more than a pound of refined soybean oil to produce a pound of biodiesel, close to a one-to-one physical conversion factor. This implies that about 7.35 pounds of soybean oil are used to produce 1 gallon of biodiesel.

Strong demand for ethanol production results in higher corn prices and provides incentives to increase corn acreage. Much of this increase occurs by adjusting crop rotations between corn and soybeans, causing a decline in soybean plantings. Other sources of land for increased corn plantings include cropland used as pasture, reduced fallow, acreage returning to production from expiring CRP contracts, and shifts from other crops such as cotton.

As the ethanol industry absorbs a larger share of the corn crop, higher prices will affect both domestic uses and exports, providing for more intense competition between and among the domestic industries and foreign buyers in the demand for feed grains. U.S. feed use of corn typically accounts for 50-60 percent of total corn use and the United States typically accounts for 60-70 percent of world corn exports. Market adjustments to higher prices result in a reduced share of corn used directly for domestic livestock feeding and a lower U.S. share of global corn trade. Corn used for animal feeding declines and represents 40-50 percent of total use in the projections, while the U.S. share of global corn trade falls to 55-60 percent.

Increased demand for corn to produce ethanol leads to higher prices for corn and other crops, which, in turn, results in smaller government outlays under current farm commodity programs. For example, with the prices projected in this report, program costs for price-sensitive marketing loan benefits and countercyclical payments for feed grains are minimal, even with stochastic considerations included. In contrast, higher market prices result in increases in CRP rental rates and overall costs for the CRP. Government costs for crop insurance also increase because of higher market prices for several of the major insured commodities. Additionally, government tax revenues are reduced due to higher total blender tax credits for biofuels.

Ethanol demand is very inelastic (unresponsive to price changes) in the range of prices projected in this report. Although the projections assume no shocks to commodity markets from production shortfalls due to weather, pests, or other factors, an important issue is how agricultural markets might respond should a production shortfall occur. With inelastic demands representing a greater share of the market and smaller levels of stocks projected, increased price variability and market volatility are likely.