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The United States is currently attempting to develop energy policy instruments to deal with issues related to energy use. The reasons for developing energy policy are many and varied, and can include social, economic, environmental, and security considerations. Policy instruments can be designed to shift a larger potion of the social costs (e.g., environmental impacts) to users and producers. Other tools are designed to reduce the risk of developing new technologies, particularly to private sector investors. Energy policy can be developed to affect the demand for, and/or supply of energy. Demand side policies are designed to affect the demand for fuel and include energy taxes to encourage consumers to use less fuels or buy more efficient vehicles. On the supply side, numerous approaches are being taken including subsidies, fuel standards, or guarantees (i.e., for loans, purchase quantities, purchase prices, etc.).   Subsidies to encourage the domestic production of fuels can be generic (i.e., a stipulated amount per Btu of energy) or be specified at rates not linked to energy value. Capital subsidies involve support for a portion of the capital cost of building production and/or distribution facilities and infrastructure. Renewable (or alternative) fuel standards (or mandates) are intended to increase domestic production and use of alternative fuels, and can be implemented with or without subsidies. Loan guarantees are used to cover the added risk of developing new technologies and products. Purchase guarantees are used to increase the use of domestically-produced alternative fuels when their cost of production is likely to exceed conventional fuels. A price guarantee can function in a manner similar to a purchase guarantee or it can function more like a variable subsidy.   Interventions can be specific to a particular technology, source, or use, or they can be generic–applying to all energy sources or uses. The different policy instruments work in different ways and consequently affect consumers and producers differently. Following is a discussion of the mechanisms and differential impacts of selected biofuels policy instruments.

Flat versus variable tax credits
Currently, ethanol production is federally subsidized via a flat tax credit of $0.51/gallon of ethanol blended with gasoline. The subsidy is paid per gallon of ethanol regardless of ethanol prices, input and production costs, energy value, or other market factors and is constant regardless of the price of ethanol or its profitability. Flat subsidies provide large profits to ethanol producers when oil prices are high, but may be insufficient to maintain production when oil prices are low. Additionally, a flat subsidy leads to increasing corn demand as long as oil prices remain high, which causes corn prices to increase substantially.   An alternative to a flat rate subsidy is a variable subsidy that varies as a function of the crude oil price. A variable rate subsidy can reduce the cost to the federal government while still providing a safety net for ethanol producers. The design of a variable subsidy depends on two key parameters--the price of crude oil at which the subsidy begins, and the rate of change of the subsidy as crude oil price falls.   The relationships between crude oil price and break-even corn prices under the two policies can be illustrated by the following example. For a flat tax subsidy (figure 1) and assuming the current federal ethanol blending subsidy of $0.51/gallon, an ethanol energy value of 70% that of oil, and a value of ethanol as a gasoline additive of $0.35/gallon, at crude oil prices of $60/barrel, the break-even corn price is $4.72/bu for a new plant (with a 12 percent return on equity and 8 percent interest on debt), and $5.50/bu for existing plants that have already recovered their capital investment. Under the same assumptions, but now assuming a variable subsidy (figure 2) with the trigger price being $60/barrel for crude oil (e.g., no ethanol subsidies when crude oil prices are greater than $60/bbl), and increases in the subsidy of $0.025/gallon of ethanol for each dollar that crude oil prices fall below $60/barrel, then at crude oil prices of $60/barrel, the break even price for corn is $3.12/bu for a new facility. At a crude oil price of $70/bbl, the corn breakeven price is $3.65/bushel and there is no ethanol subsidy. At crude oil prices of less than $60/bbl, the ethanol subsidy is in effect and in this example, is equal to $0.25/gallon and $0.50/gallon for crude oil prices of $40 and $50/bbl respectively. Under these conditions, the ethanol subsidy is roughly the same as the current fixed subsidy of $0.51/gallon.   With the fixed subsidy, ethanol plant investment decisions continue to be heavily influenced by the government subsidy even at crude oil prices that render ethanol production profitable in the absence of a subsidy. A variable subsidy, if properly designed, provides less incentive to invest in ethanol production based on non-market factors, induces less pressure on corn prices, reduces the cost to the federal government, and still maintain a safety net when crude oil prices are low.

Renewable fuels standard
The Energy Policy Act of 2005 includes a Renewable Fuel Standard (RFS) which mandates a minimum amount of renewable fuel that must be used in U.S. automobile fuel consumption. It is estimated that the RFS will reduce petroleum use by 2.3 to 3.9 billion gallons per year, decrease carbon dioxide emissions by 1.3 to 3.6 percent, and cut greenhouse gas emissions by 9 to 14 million tons per year.   Under fuel standards, changes in cost are typically passed on to the consumer through changes in fuel prices. This differs from subsidies which are paid through the government budget funded by taxes. The extent to which changes in fuel prices are passed on to consumers depends in part on the demand elasticity for fuel (i.e., percent change in fuel quantity demanded for a one percent change in the price of the fuel), with a higher percent of the price change passed on to consumers when demand elasticity is low which is the current situation.   The functioning of a alternative (renewable) fuel standard is illustrated in figure 3. Each line represents a cost for alternative fuels. The bottom line is the U.S. Department of Energy target for cellulose ethanol ($47/bbl crude oil equivalent), and the top line represents the estimated DOE costs of producing cellulose ethanol today ($102/bbl crude oil equivalent). The horizontal axis is the price of crude oil and the vertical axis represents the percent change in consumer fuel prices relative to the prices that would occur in the absence of a fuel standard. Under conditions of low alternative fuel prices and/or high crude oil prices, consumers see little or no change in fuel price. With high alternative fuel prices (current state of technology), or low crude oil prices, changes in consumer fuel prices are significantly higher.                   One option to limit the consumer exposure to large fuel price increases is to combine a variable subsidy with a fuel standard (figure 4) (Tyner, 2007). In this example, the horizontal axis is crude oil price and the curve is based on an alternative fuel cost of $60. A subsidy is provided only when crude oil prices fall below some predetermined level, say $45/bbl, which is illustrated by the line to the left side of the curve. The variable subsidy limits the price increase consumers see at the pump. This option is a form of risk sharing in that in the event of very low oil prices, the government budget and consumers share the increase in fuel prices.