Complement or substitute: Ethanol's uncertain relationship with gasoline under alternative petroleum price and policy scenarios

Abstract

Ethanol demand depends on the crude oil price and domestic biofuel mandate, but the aggregate effect on consumer fuel choices and export demand is uncertain. The relationship between crude oil and ethanol price is complex, and the presence of policy driven domestic biofuel use (mandate) make the modeling of the world ethanol market challenging. A structural economic multi-market multi-region partial equilibrium model considering the complementary and substituting effects between gasoline and ethanol demand is developed. In this study, a kinked ethanol demand curve that reflects those relationships is used to depict ethanol demand. We further simulate two forward-looking alternative crude oil price scenarios to identify how the crude oil price interacts with ethanol use mandates and trace the consequences on the U.S. Renewable Identification Number (RIN) market. The study finds that, under high crude oil prices, the substitution effect might trigger a large increase in ethanol demand by the rest of the world and the U.S. and Brazil will be the key ethanol exporting countries. In the U.S., the overall biofuel mandate might become non-binding.