CIBC Report: US Corn Ethanol Policy Will Fuel Inflation
23 October 2007
|Trend in US ethanol subsidies. Click to enlarge.|
US policy focused on adding more corn ethanol to the nation’s gas tanks in an effort to increase energy self-sufficiency will do little but drive food prices skywards, according to a new report from CIBC World Markets, the the wholesale and corporate banking arm of CIBC.
The report states that to meet the policy goal of significantly increasing US production of ethanol to reduce dependence on imported oil, federal and state governments are extending huge subsidies to ethanol producers to expand capacity and to corn farmers to supply the crops needed to make the fuel. This diversion of an ever-increasing share of the American corn crop from human consumption and livestock feed to energy production is putting steady and unrelenting pressure on food prices, according to the report.
Converting corn from food to fuel has, at best, dubious net energy benefits, but its impact on food prices, already significant, can only grow over time. With food carrying more than twice the weight in the CPI than energy, the policy response to record oil prices may become more inflationary than oil prices themselves.
In the last two years corn prices have jumped by 60%. Soaring corn prices not only pass directly into animal feed costs and corn-based food prices like tortillas, but they are spilling over to other grain prices as farmers scramble to expand corn production at the expense of other crops. Grain prices are the strongest they have been in memory while global inventories continue to shrink to record lows.—Jeff Rubin, Chief Economist and Chief Strategist at CIBC World Markets
Ninety-five percent of the ethanol currently produced in the US is distilled from corn. The Administration has set a target to raise ethanol production from a level of roughly one billion gallons a year in 2000 to 35 billion gallons a year by 2017.
Rubin notes that huge subsidies are needed to achieve these goals as corn-based ethanol production is simply not economically efficient—not even with $100 per barrel oil. The key reason is the huge amount of energy that is required in first growing and harvesting the corn, transporting it to the distiller, distilling the ground cornmeal into ethanol and then transporting it by truck and train to users across the country. These more costly transportation methods are required because ethanol cannot be transported in conventional pipelines.
These subsidies, worth some $8 billion in 2006, have stimulated the sector as ethanol production hit six billion gallons a year in mid-2007. At this rate of growth, CIBC World Markets expects the Administration’s target will be reached by 2012, a full five years early. The report estimates that subsidies will rise to “a staggering level” of more than $25 billion when production reaches the 35 billion gallon target by 2017 or sooner.
However, the bank finds that this rapid conversion of food to fuel will put increased inflationary pressures on food prices.
By the end of next year we predict food inflation will be running well over five per cent. As ethanol production rises to nine billion gallons in 2009, food inflation will approach seven per cent, its highest level in more than 25 years.—Jeff Rubin
While accounting for less than 15% of the consumer price index, food represents one of the least substitutable areas of consumer demand. For low-income Americans, food costs represent nearly 40% of monthly budgets.
Rubin states that compared with the huge investments in subsidies and the impact of soaring food prices, the net energy benefits of a US domestic ethanol policy are marginal.
The report cites recent studies suggesting that corn-based ethanol in the US provides only a 25% net energy benefit and marginal greenhouse gas emissions properties.
Jeff Rubin and Benjamin Tal. “Corn For Ethanol: An Inflation Crop” CIBC World Markets StrategEcon, 22 October 2007, p4.
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