Ethanol Plant Investment and Government Policy : A Dynamic Structural Econometric Model

Ethanol has attracted considerable policy attention both for its use as a gasoline substitute, and as a way to enhance profits in rural areas. In this paper, we analyze the effects of government policy on the decisions of ethanol-producing firms to invest in building new ethanol plants in the Midwestern United States during the second US ethanol boom. To do so, we develop and estimate a dynamic structural econometric model of the ethanol plant investment timing game, and then use the estimated structural parameters to simulate counterfactual policy scenarios to explore the policy factors driving industry growth and location, and to disentangle the impacts of state and national policies on the timing and location of investment in the industry. According to our results, government policies, the intensity of corn production, and private information shocks all have significant effects on ethanol investment payoffs and decisions. Of the policies analyzed, the policies that led to most of the ethanol plant investment during this time period were the ban on the use of the oxygenate MTBE as a gasoline additive, and the 2007 Renewable Fuel Standard (RFS2)