CIBC Report: US Corn Ethanol Policy Will Fuel Inflation
23 October 2007
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| 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.
Resources
Jeff Rubin and Benjamin Tal. “Corn For Ethanol: An Inflation Crop” CIBC World Markets StrategEcon, 22 October 2007, p4.
It's ok though because both food and energy are removed from the CPI numbers, so there's no real inflation right?
Posted by: KS | 23 October 2007 at 02:13 PM
It makes a lot of CO2, hurts poor people when made from consumable food, and distracts from electrics. It promotes energy independence, which is great, but at a high cost.
Nevertheless Ethanol should be continued, but reformed away from food stock and toward a more energy dense plant grown on land not currently used for food crops.
Posted by: Elliot | 23 October 2007 at 02:41 PM
Elliot -- good idea, but there is no Grass lobby. There is a corn lobby, and farmers vote. Fortunately, some politicians are starting to find out is that consumers vote also.
Posted by: JMartin | 23 October 2007 at 02:48 PM
This report just repeats what so many have said: scrap subsidies and ethanol tariffs.
Then we would have a win-win-win situation:
-farmers in the South produce biofuels that are far more efficient and do not need subsidies (sugarcane ethanol csts $0.28-0.35 per liter - beats crude oil and gasoline hands down)
-a major opportunity to break the Doha trade round and help millions of poor get out of poverty
-affordable fuels for us
-lower generalised inflation (ethanol in Brazil has resulted in lowering the inflation)
-an effective carbon reduction strategy (sugarcane does very well)
Why do American consumers choose to stick to a lose-lose-lose situation, when there's such a clear winner?
Posted by: Jonas | 23 October 2007 at 02:55 PM
I suggest you look over the details about "CIBC World Markets" before deciding how credible it report is.
Posted by: DS | 23 October 2007 at 03:06 PM
CIBC's energy practice has a lot of transactions related to Canadian Oil Sands. (See http://www.cibcwm.com/wm/transactions/oil-gas.html).
No surprise that CIBC might not appreciate ethanol. I wonder if a CIBC analyst has written a report cheerleading the benefits of subsidies for oil sands development.
Posted by: RM | 23 October 2007 at 03:59 PM
CIBC may have political agenda but their conclusion is essentially correct. Corn will never be a panacea for U.S. energy needs, unless of course we breakfast on corn flakes and use the resulting energy to ride our bikes to work. U.S. farm policy has always been stupid; U.S. energy policy is almost always stupid; here was a chance for the morons in Congress to combine stupid agricultural policy with stupid energy policy. How could they resist?
Posted by: Mick | 23 October 2007 at 05:49 PM
Excess supply of paper money causes inflation.
Posted by: John Schreiber | 23 October 2007 at 07:56 PM
Couple of months ago number of biggest US banks were fined for fraudulent practice: their investment experts issued negative predictions about some companies and even whole sectors, shares of this companies dropped, and investment funds of same banks bought truckloads of these shares at reduced prices. It is quite popular practice, and my bet it is what is going on with corn ethanol market right now.
Take a look at this:
"On July 20, 2005, the Securities and Exchange Commission “announced a settled administrative proceeding against Canadian Imperial Bank of Commerce's (CIBC) broker-dealer and financing subsidiaries for their role in facilitating deceptive market timing and late trading of mutual funds by certain customers. The Commission ordered the subsidiaries, CIBC World Markets Corp. (World Markets), a New York based broker-dealer, and Canadian Imperial Holdings Inc. (CIHI), to pay $125 million, consisting of $100 million in disgorgement and $25 million in penalties.”
http://en.wikipedia.org/wiki/Mutual-fund_scandal_(2003)
Statements of CIBC “experts” is kinda of OK to see in NY or LA tabloid, but for financial expert of big bank with all information at the click of the button it is inexcusable. Judge for yourself:
Food inflation was around 9% in 1970-1980. In 1982-2006 it is 2.9%.
In last 30 years yearly average price of corn three times exceeded 3$ per bushel; the highest were in 1995 at 3.53, compared with 2006 average 3.05$.
At 3$ per bushel standard pound box of cornflakes contains less then 4 cents worth of corn.
At 3$ per bushel it takes about 16 cents of corn to raise 1 pound of pork (live weight).
In 2007 estimated government subsidies for corn growers dropped to 3 billion, compared to 8.8 billion in 2006.
http://www.ncga.com/news/OurView/pdf/2006/FoodANDFuel.pdf
Corn ethanol substituted about 5% of US gasoline on energy basis, not 1% as claimed by CIBC "expert".
Corn ethanol has a lot of drawbacks and limitations. Food price inflation is not one of them.
Posted by: Andrey | 23 October 2007 at 09:22 PM
Corn ethanol has a lot of drawbacks and limitations. Food price inflation is not one of them.
Your data takes in so many years as to lack any relevancy to the actual proposition in question. With your last link, you used the past tense to refer to the present (and 2.5 months to come), even though the estimates are from an industry group and were published last year.
Posted by: jack | 23 October 2007 at 09:39 PM
Andrey have you LOOKED at the corn prices recently?
Posted by: Ruaraidh | 24 October 2007 at 03:53 AM
Thanks John...
you know what else causes inflation? Subsidies that alter the market demand by covering 80% of the price of ethanol so people produce/consume more and drive the price up (inflation). Especially when ethanol corn now looks more attractive than other grains on a strict revenue basis, the supply drops and prices go up (inflation). If you doubt the increase is substitute grain prices, go buy yourself a 12 pack and ask yourself why it costs $15 instead of $10.
A side note from that report, did anyone else find it to be a bit of a stretch that they claim a 3x increase in land productivity is "no problem"? 300-400 bushels per acre when they are now at 150....riiiight.
Posted by: Kevin | 24 October 2007 at 05:46 AM
"hurts poor people when made from consumable food"
ethanol is made from corn that was destined for animals to begin with.
"scrap subsidies and ethanol tariffs. Then we would have a win-win-win situation"
OK. If you can the subsidies, and the US imports ethanol from Brazil, that's another form of foreign dependence If you want to use sugar cane in the US, you'll need to subsidize the cane growers. These folks are already requesting Congress for subsidies to keep them afloat as the last set of subsidies were invalidated by the WTO.
Posted by: | 24 October 2007 at 08:19 AM
"hurts poor people when made from consumable food"
ethanol is actually made from corn that was destined for animals to begin with.
"scrap subsidies and ethanol tariffs. Then we would have a win-win-win situation"
OK. If you can the subsidies, and the US imports ethanol from Brazil, that's another form of foreign dependence If you want to use sugar cane in the US, you'll need to subsidize the cane growers. These folks are already requesting Congress for subsidies to keep them afloat as the last set of subsidies were invalidated by the WTO.
"U.S. energy policy is almost always stupid".
Precisely.
Posted by: Jim G. | 24 October 2007 at 08:21 AM
"ethanol is actually made from corn that was destined for animals to begin with."
I'm sure the MExicans might disagree with you on that point! Viz the Tortilla protests last year directly linked to the price of corn, inflated by subsidy and ethanol demand.
Posted by: Ruaraidh | 24 October 2007 at 08:35 AM
John, You wrote "Excess supply of paper money causes inflation" which is true. Other sources of inflation are when you have same amount of paper money chasing fewer goods, e.g., bad weather in Iowa leads to less corn being produced. A third source of inflation is a shift in the demand curve (which can occur even if the amount of paper money and amount of corn remains static). This third source of inflation is what the authors are talking about, i.e, when the U.S. tries to produce enough corn-based ethanol to make a dent in total energy needs, the demand curve for corn will shift to the right, causing inflation.
Posted by: Mick | 24 October 2007 at 08:43 AM
The US should be encouraging other less developed nations to grow ethanol feed crops instead of trying to compete where they can't match the lower labor costs. Anything else will be eventually doomed to failure when someone takes advantage of the lower labor costs elsewhere. Energy self sufficiency for the US on ethanol alone is a pipe dream. It's going to take all the options.
Increases in food commodity prices are more than likely due to an increase in demand from countries like China who can increasingly afford to import more of world food production. Pricing pressure from ethanol production is likely a red-herring.
Posted by: KS | 24 October 2007 at 10:16 AM
Since many current gas guzzlers can consume up to 33 times the energy required to feed a single human being, agrofuels could eventually, not only compete with food crops, but use such huge quantities (to feed up to 2 billion vehicles) that food price would certainly jump and even get scarce in many countries.
A better solution is a massive fuel consumption reduction. This can be done with accellerated electrification of our ground transport vehicles.
We can do it and reduce GHG at the same time. There's a lot of clean Sun, Waves, Wind, Hydro, Geothermal and even Nuclear energy potential around.
Posted by: Harvey D | 24 October 2007 at 10:25 AM
And again, tortillas are made from different corn. There's a lot of inaccurate and misleading information being floated by media pundits at the moment that read straight out of oil refiners talking points papers, because the issue is up in Congress right now.
Posted by: Jim G. | 24 October 2007 at 11:00 AM
And again, tortillas are made from different corn. There's a lot of inaccurate and misleading information being floated by media pundits...
And by you. A jump in feed corn price soon translates into more expensive sweet corn because farmers move acreage into the more profitable crop. The idea that ethanol demand only affects feed corn prices is silly.
Posted by: doggydogworld | 24 October 2007 at 11:20 AM
And this year there's a record corn crop being planted. The US is a country that pays farmers not to plant. This is way too early for a food/fuel problem to have developed. As of now we've just barely begun using biofuels.
Posted by: Jim G. | 24 October 2007 at 11:25 AM
“Andrey have you LOOKED at the corn prices recently?”
Around 3.60 dollar per bushel, or 6.5 cents per pound (bushel of corn contains 56 pound of corn). It takes 2 pound of corn to raise 1 pound of chicken (13 cents), 3.5 pound of corn to raise 1 pound of pork (23 cents), and 5 pound to raise 1 pound of beef (33 cents), all live weight. Dressed meat is about half of live weight.
Now, have you LOOKED at the meat prices recently in your supermarket?
Posted by: Andrey | 24 October 2007 at 12:46 PM
Now, have you LOOKED at the meat prices recently in your supermarket?
I have.
Since Bush's first year, the core CPI (ie, not incl food and energy) has gone up 15%.
Beef is up 35%.
Lettuce is up 26%.
Bread is up 23%.
Apples are up 46%.
Oranges are up 136%.
Gasoline is up 86%.
Electricity is up 29%.
Natural gas is up 45%.
Fuel oil is up 111%.
Thanks for asking.
Posted by: jack | 24 October 2007 at 02:25 PM
How much corn is used to produce lettuce, bread,apples, oranges, gasoline, electricity, natural gas, or fuel oil?
Posted by: Andrey | 24 October 2007 at 02:49 PM
How much corn is used to produce lettuce, bread,apples, oranges, gasoline, electricity, natural gas, or fuel oil?
You brought up beef, and now you're running away from it. The other figures are there for reference, just so we know where things stand.
Posted by: jack | 24 October 2007 at 04:00 PM