Antonio M. Bento and Joel R. Landry Environmental Economics and Energy Policy Program

1. On the Trade-Offs of Regulating Multiple Unpriced Externalities with a Single Instrument:Evidence from the Renewable Fuel Standard Antonio M. Bento and Joel R. Landry Environmental Economics and Energy Policy Program Dyson School of Applied Economics and Management Cornell University

2. Motivation • Tinbergen (1952): In order to restore economic efficiency when multiple market failures are present we require a separate policy instrument to address each market failure. • Despite this, policymakers frequently use a single policy instrument to address multiple unpriced externalities. • The Energy Independence and Security Act of 2007 (EISA) was passed to address two objectives: • Reduce energy dependence • Reduce GHG emissions • Our knowledge of the potential trade-offs between these two objectives is limited.

3. Overview of the Renewable Fuel Standard (Energy Independence and Security Act, 2007) 36 billion gallons of total bio-fuels, 21 billion gallons advanced, by 2022 Billions of gallons

4. Key Questions • What are the economy-wide costs and benefits of the Renewable Fuel Standard (RFS) for conventional biofuels? • What are the trade-offs between the environmental and oil dependency related external benefits of the RFS? • What would policymakers implied value of oil dependency have to be in order for the RFS to pass a benefit-cost test?

5. Key Features of the Model

6. Overview of the Model • The domestic agents in the model are: • Households • Producers of Agricultural Crops • Producers of Ethanol • Refiners of Regular Gasoline • Suppliers of Blended Fuel • Producers of Food • Government • Trade with the Rest Of the World: • Crude Oil Imports • Crop Exports

7. Welfare Formula • Change in welfare due to RFS is given by: • Consists of six components: • Primary Costs, dWPC • Subsidy Interaction Effect, dWE • Blended Fuel Output Effect, dWF • Oil Premium Effect, dWP • CRP Interaction Effect, dWN • Change in Trade Balance, dWB

8. Data Sources

9. Model Dynamics • Yields, domestic income and ROW demand for crops are allowed to adjust following the USDA’s Long-Term Projections for 2009. • Crude oil and energy prices follow the central price path of the EIA’s Annual Energy Outlook 2010. • Corn and energy requirements for ethanol follow RFS2 assumptions. • Fuel economy adjusts per National Research Council’s 2002 report. • CRP rental rates increase by 2% a year.

10. Monte Carlo • Use Monte Carlo methods to quantify uncertainty with respect to our welfare analysis. • For each category of external benefits (GHG emissions, oil dependency related, CRP benefits, local air pollution, accidents, and congestion), we fit separate independent gamma distributions to match: • The a mean of our central parameter estimate, • The 10th percentile to equal our lower bound parameter estimate, and • The 90th percentile to equal our upper bound parameter estimate.

11. External Cost Parameters

12. Numerical Results

13. Baseline and Mandated Ethanol Quantities (Billion Gallons)

14. Effect of the RFS on Land-Use Change

15. Effect of the RFS on Import and Export Markets

16. Effect of the RFS on Fuel and VMT Markets

17. Net Costs of the RFS

18. Does the RFS Pass a Benefit-Cost Test?

19. How Do Environmental Benefits Trade-off with Oil Dependency Benefits?

20. Policymakers Implied Value of Oil Dependency

21. Implications if Policymakers Intended to Replace VEETC with RFS

22. Implications if Policymakers Intended to Replace VEETC with RFS

23. Conclusions • Excluding the change in the trade balance, the RFS for conventional biofuels fails a benefit-cost test with costs exceeding benefits by 3:1. • Result is robust, with passage of benefit-cost test occurring only 0.01% of the time. • Net costs per EGG of ethanol added by RFS is $0.64-$0.79. • With respect to the change in trade balance, if only a quarter of the welfare gain from the change in terms of trade is realized then the RFS will pass a benefit-cost test.

24. Conclusions • Policymakers trade-off oil dependency benefits from the RFS with additional environmental costs almost dollar for dollar. • In order for RFS to pass a benefit-cost test, policymakers would have to have external costs of oil-dependency that are 3 to 5 times greater than our central value of the external costs of oil dependency.

25. Conclusions • When RFS replaces VEETC, • The ratio of benefits to costs improves to 0.9 and net costs per EGG fall to $0.36 to $0.19. • Instead of a trade-off, we have instead a simultaneous welfare improvement in environmental benefits and oil dependency, with each dollar benefit in oil dependency complemented with a $1-2 gain in environmental benefits. • The implied value of oil dependency needed for RFS to pass a benefit-cost test would still have to be1.5-2 times greater than our central parameter estimate.

26. Acknowledgements • ( • Cornell University Agricultural Experiment Station • Cornell Center for a Sustainable Future Cornell Institute for Computational Sustainability