|An analysis by Texas A&M concluded that a waiver in the RFS would likely have only a small impact on the price of corn. (See below.) Click to enlarge.|
Texas Governor Rick Perry has requested that the US Environmental Protection Agency grant a national 50% waiver from the federal renewable fuel standard (RFS) mandate for ethanol produced from grain because of rising grain costs. The RFS currently requires 9.0 billion gallons of renewable fuel in 2008.
In his letter, the Governor states that the “artificial demand for grain-derived ethanol is devastating the livestock industry in Texas and needlessly creating a negative impact on our state’s otherwise strong economy while driving up food prices around the world.”
While many other factors affect the price of corn, I need only to look at skyrocketing grocery prices to know that granting a waiver of RFS levels is the right thing to do. As I noted to fellow governors at a recent Republican Governors Association meeting, “If you think it’s bad for foreign countries to control our fuel, image what it would be like if they control our food supplies.”—Letter to EPA Administrator Stephen Johnson
In 2007, 25% of the US corn crop was diverted to produce ethanol, according to the United States Department of Agriculture, which projects that 30 to 35% will be diverted in 2008.
The Texas Cattle Feeders Association immediately supported the Governor’s request, stating that it recognized that the federal government’s ethanol policy is not the only thing driving up grain prices, but “it is certainly a major factor.”
One need only to look at the price increases for corn since the federal government began its big push for ethanol to see the correlation: More corn being diverted to ethanol has meant much higher prices for livestock feed.—Texas Cattle Feeders Association
The Renewable Fuels Association (RFA) shot back, saying that while the reduction would not appreciably reduce grain prices for livestock producers and food processors in Texas, it would increase gasoline and diesel prices even more by eliminating 4.5 billion gallons of fuel from the marketplace. “While this may benefit Texas oil companies, it will certainly hurt consumers in Texas and the rest of the country,” the RFA said.
Economists at the University of Wisconsin-Madison recently published an analysis of the impact of ethanol production on the price of corn in the US. After considering how supply and demand factors, including feed, seed and exports, affected corn prices, T. Randall Fortenbery and Hwanil Park concluded that while rising ethanol production has a “significant impact” on increased corn prices, it is not the sole cause of the higher prices.
...a 1% increase in ethanol production causes a 0.16% increase in the corn price in the short run, ceteris paribus...Since ethanol production capacity essentially doubled between the first two quarters of the last and current marketing years, the model results above suggest that ethanol’s contribution to the price rise was about 41 cents per bushel, ceteris paribus. This would have resulted in an average 2007/2008 first quarter price of $2.95 per bushel had nothing else changed. While this is a significant year over year increase, it is substantially less than the actual price appreciation between the start of 2006/2007 and the start of the 2007/2008 marketing year. As a result, while ethanol production has had a significant and positive impact on corn price, it does not fully explain price level changes in the 2006/2007 marketing year.
...[corn prices in] first quarter 2007/2008 were well above what would be projected, and cannot be explained based simply on ethanol production and associated corn use (as has been the practice in the popular press). This suggests that there may be an outside factor influencing prices beyond those captured in the supply/demand framework estimated here.
Researching more carefully the impact on price discovery resulting from a large increase in the amount of risk capital coming from the speculative side of a market seems justified, and this is the focus of current work. In short, there is no empirical evidence to date to justify a suggestion that prices have exceeded their “fundamental” levels as a result of market structure (i.e., growth in the speculative component), but is also clear that attempting to explain current price levels simply as a function of ethanol production is a bit naïve and inaccurate.—Fortenbery and Park
Separate research by economists Agricultural and Food Policy Center at Texas A&M University concluded that the underlying force driving changes in the agricultural industry, along with the economy as a whole, is overall higher energy costs—e.g., $100+ per barrel oil.
Their report, “The Effects of Ethanol on Texas Food and Feed” also concludes that relaxing the RFS would not result in significantly lower corn prices, due to the ethanol infrastructure already in place and the generally positive economics for the industry.
The ethanol industry has grown in excess of the RFS, indicating that relaxing the standard would not cause a contraction in the industry.—“The Effects of Ethanol on Texas Food and Feed”
The researchers explored three scenarios (full RFS, one-half waiver and one-quarter waiver) and concluded that corn prices would be fairly steady near current levels under all scenarios.
Expected prices across scenarios gradually diverge, with the one-quarter RFS waiver price falling about $0.30 per bushel below the full RFS price a few years hence, and the one-half RFS waiver price falling about $0.50 to $0.60 per bushel below the full RFS expected price.
Other findings of the Texas report include:
Speculative fund activities in futures markets have led to more money in the markets and more volatility. Increased price volatility has encouraged wider trading limits. The end result has been the loss of the ability to use futures markets for price risk management due to the inability to finance margin requirements.
The potential exists for even higher corn prices based on historical yield variability. Fewer corn acres planted in 2008 leave production susceptible to weather risks. Small yield reductions will result in even higher prices.
The livestock industry has borne the costs of higher corn prices. The structure of the industry has made it unable to pass costs on, either up or down the supply chain.
The livestock industry is in the middle of this transition, and prices don’t yet reflect the impact of higher costs.
The net balance to the Texas agricultural economy is negative. While corn and grain sorghum producers benefit from high prices, the livestock industry faces increasing costs. Because the livestock industry is bigger than the crop industry, the net balance is negative.
T. Randall Fortenbery and Hwanil Park (2008) The Effect of Ethanol Production on the US National Corn Price
David P. Anderson et. al. (2008) The Effects of Ethanol on Texas Food and Feed