The development of first-generation biofuels has strengthened the linkage between agricultural
commodity markets and energy markets. This chapter analyzes the implications of U.S. domestic and trade
policies for ethanol in the face of year-to-year fluctuations in the domestic supply of feedstock (corn) and
petroleum prices. The current U.S. policy mix involves a prohibitive tariff on imported ethanol, a fixed subsidy
for blending ethanol with gasoline, and a blending or consumption mandate. We find that as the likelihood that
the mandate is binding increases, the variability of ethanol use declines; the impact of corn supply variations on
corn prices is increased due to greater inelasticity in demand, but the impact of oil price variations on corn prices
is reduced. Tariffs could be reduced to allow ethanol imports, given a modification of the subsidy mechanism,
which would reduce the impact of corn supply fluctuations on corn prices. But, if the minimum supply-inducing
price for imported ethanol is sensitive to petroleum prices, corn prices could be affected by petroleum price
fluctuations even when the U.S. mandate is binding. With freer trade, the impact of U.S. domestic and trade
policies for ethanol on the variability of domestic corn prices depends on the relative magnitude of external
shocks as well as on ethanol policies in supplying countries. In addition to examining a reduction in the current
specific tariff, the implications of using an ad valorem tariff or a variable tariff are assessed.
