Our initial analysis examines ethanol production volumes between now and 2040. We consider four different scenarios altering the presence of the EPA RFS 2 man­dates (EPA 2009) and market penetration costs. Figure 2 presents ethanol production

volumes with and without penetration costs under a mandate. When a drop-in type fuel is produced avoiding market penetration costs, we find increased ethanol mar­ket supply. Our second comparison analyzes the impact of penetration barriers when mandates are not present (Fig. 3). There without a mandate, less crop ethanol is pro­duced than with mandates and more cellulosic ethanol is produced after 2020, mainly due to lower processing costs. Furthermore, the removal of market penetration costs has a stronger impact on ethanol volumes reflecting the greater flexibility allowed.

Next, we examine the impact of adding carbon prices. First, we consider the case with no mandates in place, but with market penetration barriers (Fig. 4). There total ethanol production volume increases slightly under increasing car­bon price, and ultimately reaches about a 10 % increase in total production. Simultaneously, cellulosic ethanol replaces crop ethanol production due to its enhanced GHG emission offset efficiency (see McCarl and Sands (2007) for esti­mated offset rates).

We also examine the projections of future ethanol production under “no mandates and no penetration costs in place” scenario for three points of time (Fig. 5). It can be observed that removal of market penetration costs drives ethanol volumes up. In 2020, the amount of total ethanol produced fluctuates between 25 and 30 billion gal­lons per year (depending on the GHG price); in 2030, the amount of total ethanol is in the range of 30 and 35 billion gallons per year; and in 2040, the total etha­nol amount reaches 40 billion gallons per year under GHG price of $50 per ton of CO2e. GHG payments provide additional revenues and increase ethanol volumes. At the same time, we see that only under scenarios with a carbon payment and no penetration costs does the total volume of ethanol produced reach the RFS2 biofuel mandate levels. Thus, it appears that in the absence of carbon trading schemes or a drop-in fuels it is highly unlikely that the EPA RFS2 mandate will be ever met.

Finally, we examine impact of penetration costs removal on the total volume of ethanol produced. At the same time, we assume that scenario with no penetration costs could be a case of all drop-in biofuels which do not require adjustment in infra­structure before their distribution in the market. Some innovative liquid biofuels, like butanol or methanol, are free from corrosive properties and they could be distributed and sold to the end-consumer through the currently existing distribution networks and pumping stations. As one can observe in the Fig. 6, removal of penetration bar­riers raises the total ethanol production by around 5 billion gallons per year unde

Fig. 5 Projection of future crop and cellulosic ethanol production under varying GHG prices (at three points of time) for “no mandates and no penetration costs in place” scenario all considered GHG prices in 2020. In 2030, the situation looks slightly different. Under $0 carbon price and scenario with no penetration costs the amount of ethanol produced is around 6-7 billion gallons higher than under the scenario with penetra­tion costs in place. However, under $100 carbon price this difference between two scenarios amounts to 10 billion gallons per year. Some discrepancies could also be noticed in the projections for 2040. Under $0 carbon price, the total amount of etha­nol under no penetration costs exceeds the total amount of ethanol under scenario with penetration costs by 10 billion gallons per year. However, once the carbon price reaches $100 per ton of CO2e, the gap between both scenarios amounts to almost 15 billion gallons per year. In general, these projections display the pattern which reflects the impact of penetration costs removal on the amount of total ethanol pro­duced. Clearly, removal of penetration barriers enables ethanol to be absorbed by the market and encourages growing consumer ethanol demand. On the other side, exist­ence of penetration barriers and lack of investments aiming at their reduction might hamper further development of the ethanol industry.

As experience has shown, the production of lignocellulosic ethanol in the USA has not been launched on the industrial scale so far. It is believed that more techno­logical progress is needed to lower processing costs of cellulosic ethanol production. Enzymes used for fermentation have to become cheaper and biochemistry of reactions

needs to become more efficient. So far, cellulosic ethanol production is limited to operations in pilot plants; therefore, it is difficult to estimate processing costs of cellu — losic ethanol per gallon. Uncertainty related to potential location of cellulosic ethanol plants makes it challenging to assess feedstock and other materials costs, transporta­tion costs, and capital costs related to cellulosic ethanol production. Until now, one of the available projections is the estimation made by the National Renewable Energy Laboratory (NREL) which presents $3.29 per gallon as a viable unitary process­ing cost (see Fig. 1 for the specific estimation of cost). In our next analysis, we try to analyze the impact of further cellulosic ethanol processing cost reductions to see how much the processing costs have to fall from $3.29 per gallon level for cellulosic ethanol production to become economically profitable. We also look at what level of processing costs the volume of ethanol produced approaches volumes contemplated by the Energy Independence and Security Act and the EPA RFS2 mandates. In this analysis, we hold crop ethanol production costs constant. Figure 7 shows the effect of decreasing processing costs on production volumes for three different points in time.

Decreasing processing costs are found to reduce crop ethanol and increase cel — lulosic ethanol volumes in the absence of mandates. For example, we find that 50 % cost drop in processing costs of cellulosic ethanol causes amount of crop ethanol produced in 2020 to drop to around 5 billion gallons per year and in 2040 to drop to around 1 billion gallon per year (Fig. 7, panel a). These amounts are much smaller compared to current levels of crop ethanol of around 13-14 billion gallons.

At the same time, the 50 % cost drop causes the volume of cellulosic ethanol to increase from 13.3 billion gallons per year to 19 billion gallons per year in 2020. It is also worth mentioning that RFS2 mandate schedule requires cellulosic ethanol to be produced at the level of 16 billion gallons per year by 2022. From the projec­tion of cellulosic ethanol production in 2020 in Fig. 7 (panel a), we observe that this volume is only achievable under 25 % decrease in processing cost. When it comes to the total ethanol volume, the EPA 2022 mandate of 31 billion gallon per year is never achieved, even if the processing costs drop by 60 % (Fig. 7, panel a).

2 Conclusions

We find that ethanol mandates create volumes that are generally higher than would occur in the free market and that market penetration costs and carbon prices are big influences in ethanol market penetration. Namely:

• positive carbon prices, lower infrastructure costs, or some other cost reduction are needed to provide economic incentive for second-generation liquid biofuels production if they are to reach mandated levels;

• technological progress is essential to reduce processing costs and, thus, produc­tion costs of the second-generation biofuels and to make the second-generation biofuels cost competitive.