The oil-funded Energy Policy Research Foundation (EPRINC) released a report on Sep. 14 entitled “Ethanol’s Lost Promise” that advocates repealing the Renewable Fuel Standard (RFS). The paper suggests removing the RFS could reduce the oil refining sector’s ethanol consumption down to 6.1 billion gallons annually (compared to 12.5 billion gallons in 2011). EPRINC suggests the void left by smaller ethanol supplies could be filled with imported gasoline, increased gasoline yields at the expense of diesel/distillate production, expanding U.S. refining capacity, and other infeasible options.
RFA offered a quick response to the EPRINC study on Sep. 18, arguing that the report actually underscored the importance of the RFS by showing the lack of reasonable alternatives to reduced ethanol consumption.
EPRINC responded to the RFA critique on Sep. 21. A number of the incorrect statements in the EPRINC response are deserving of further discussion and reply. EPRINC’s statements are shown in boldface type below, followed by RFA’s response in italics.
ELASTICITY OF ETHANOL DEMAND AND CORN USE FOR ETHANOL
In attempting to refute the fact that ethanol production and use have declined in response to higher corn prices (thus showing that ethanol production and demand is sensitive to price), EPRINC says:
“RFA is confusing production and consumption. Ethanol production has declined substantially but blending has remained relatively constant–this proves our assertion of inelasticity.”
We are well aware of the difference between production and consumption. The truth is, both ethanol production and consumption have fallen significantly since the drought began driving corn prices higher in early June. Weekly production is down ~9% since early June, while consumption is down ~7% (see figure 1). This shows that the ethanol market is not inelastic and that marketplace buffers (i.e., stocks, imports) and the flexibilities built into the RFS program (namely the RIN carry-over provisions) are allowing the markets to react rationally. Indeed refiner/blender consumption of fuel ethanol for the week ending Sep. 7 was the lowest since the first week of February, and 3% below year-ago levels. While EPRINC says in one paragraph that ethanol blending “…has remained relatively constant…”, in the very next paragraph they acknowledge a “…drop in blending during this summer,” which is typically the season when ethanol demand is at its highest.
In any case, the issue of relevance to the current policy debate (i.e., RFS waiver requests) is whether the RFS creates inelastic demand for corn. EPRINC’s response dodges this issue, because clearly the ethanol industry’s corn use has adjusted rapidly and significantly to higher corn prices and tighter supplies. USDA and EIA data show that the ethanol industry has done the lion’s share of corn demand rationing thus far and will continue to do so during the 2012/13 marketing year. In responding to our point that USDA and FAPRI are projecting greater reductions in corn use for ethanol than in corn use for feed, EPRINC says the projections are “…logical given the current high price of corn.”
“The decline in production has largely resulted in lower exports. We addressed this on page 3, The U.S. is a net exporter of ethanol, but imports have declined by 80% since the beginning of the year to 20,000 bbl/d.
“Note the sharp reduction of imports during 2012, coinciding with the production declines shown above.”
EPRINC seems somewhat confused on the response of ethanol imports/exports to current market dynamics. While it is true that lower exports of U.S. ethanol do partly explain reduced ethanol production rates (again, highlighting flexibility and input price sensitivity in the ethanol market), U.S. ethanol imports have NOT declined since the beginning of the year, as suggested by EPRINC in multiple places. Rather, U.S. ethanol imports have risen dramatically (see figure 2) in recent months as U.S. production has decreased in response to higher corn prices. The decline in U.S. ethanol exports, and concomitant surge in ethanol imports, is one more example of the rational response of the market to higher U.S. corn prices and tighter supplies.
RESPONSE OF REFINING SECTOR TO REDUCED ETHANOL SUPPLIES
“…the RFS relies disproportionately on substituting ethanol for gasoline, despite that refiners produce a joint product slate. So refiners responded by producing less gasoline. The post-RFS change in processing would need to be partially reversed to offset the loss of 400,000 bbl/d of ethanol, but would not require any additional crude oil.”
We understand that additional crude oil may not be needed if refiners responded to a reduction in ethanol output by maximizing gasoline yields. Our point was, if refiners try to squeeze more gasoline out of the crude oil they are processing, then they will necessarily be producing less diesel fuel and heating oil. The laws of supply and demand dictate that if the supply of diesel fuel and heating oil is reduced, but demand hasn’t changed, then price will go up. You simply can’t take distillate out the market in favor of producing more gasoline and expect it not to affect diesel and heating oil prices. With heating oil prices at record levels, and diesel prices near record levels, reducing the supplies of these products would further pressure prices.
“Should there be a need for more gasoline or diesel, U.S. refiners could shift yields or incrementally increase crude runs to meet the shortfall.”
EPRINC makes this statement after just suggesting that additional crude oil would not be needed to offset the loss of ethanol supplies in a “post-RFS” world. Congress’ intent with the RFS was to reduce dependence on crude oil and to diversify energy supplies. Not only would increasing crude oil runs undermine this intent, but it would also place new demand on the crude oil markets, thus pressuring oil and gasoline prices.
IMPACT OF DISTILLERS GRAINS (DDGS)
“The price ratio of DDGS to corn declined slightly as RFA points out. But this misses the forest for the trees. The two are largely linked as they always have been.”
It is absolutely true that DDGS prices track corn prices; but this in no way means that there is not an economic benefit to livestock and poultry feeders associated with replacing corn and soybean meal with DDGS. While DDGS prices closely follow changes in corn prices, DDGS is typically 80-85% the price of corn (and 40-60% the price of soybean meal). So, there is an obvious economic advantage to using DDGS to the maximum extent possible. Further, in our initial response, we highlighted USDA research that demonstrates 1 ton of DDGS replaces 1.22 tons of corn and soybean meal in feed rations due to its superior nutritional characteristics; EPRINC does not dispute this.
“But DDGS may only comprise a portion of those animals’ feed mix–it is a supplement to corn and soybean meal. The higher nutritional value is wiped out by the recent high price of DDGS, driven by high corn prices.”
Animal nutrition and least-cost ration formulation clearly are not strong suits for EPRINC. DDGS typically make up 40% of the ration for beef cattle, 20-25% for dairy cattle and swine, and 10-15% for poultry. Thus, these co-products displace substantial amounts of corn, making it available for other uses. If the higher nutritional value of DDGS was being “wiped out” by recent higher DDGS prices, livestock and poultry feeders would stop using it. There is absolutely no indication that feeders are reducing their use of DDGS. Indeed, University of Nebraska research found, “Distillers grains has a feeding value that is 13-40% greater than corn when included at 10-40% of the beef cattle diet.” Thus, cattle feeders likely would be willing to pay 113-140% the price of corn for DDGS. As discussed, DDGS prices have typically been 80-85% the price of corn and are currently at parity.
AGRICULTURE MARKET IMPACTS
EPRINC suggests that with repeal of the RFS, “…far less corn will be needed.”
We agree with EPRINC that relaxing or eliminating the RFS would lead to a reduction in corn production—which is exactly the opposite of what livestock and poultry feeders want. EPRINC’s belief that repeal of the RFS would reduce corn output also runs counter to their earlier implications that more corn would be available for feed use without the RFS. Indeed, if an RFS suspension reduced corn demand, less corn would be produced and no more or less corn would be available for feed.
“The RFS dramatically impacted U.S. crop plantings. Corn and soy plantings have increased while wheat has decreased in recent years.”
EPRINC is not qualified to discuss the impact of the RFS on U.S. cropping patterns. While it is true that corn and soybean plantings have increased, that trend began in early 1990s. Further, total U.S. cropland has been consistent with historically normal levels. In 2012, 324 million acres were planted to major field crops, less than in 2008 (325 m.), and each year from 1996-2003. Further, wheat plantings in 2012 are actually higher than in 2011 and 2010, and cotton plantings this year and last are at their highest levels since 2006. Acreage for sorghum, barley, sunflower, and canola was also up in 2012 versus 2011 levels.
“This has resulted in a net decline in corn and soy available for food uses, even after DDGS is accounted for.”
This statement is blatantly false. When DDGS are added back to the feed supply, more corn and DDGS have been available to livestock and poultry feeders over the last seven years (i.e., since passage of the RFS) than ever before. From 2005/06-2012/13, corn for feed use + DDGS has averaged 6.32 billion bushels. That compares to an average of 6.17 bbu. from 2000/01-2004/05, and an average of 5.50 bbu. from 1994/95-1999/2000.
“USDA has a history of bad forecasting (see this year’s “record” crop forecast). But the results are logical given the current high price of corn.”
We are sure USDA, and the scores of agriculture market participants who rely on USDA reports, would dispute this claim. In fact, USDA has a very good track record at projecting supply and demand for world agricultural products (nearly every USDA statistical report has historical “track record” and error information at the back—EPRINC should take some time to examine this data). Criticizing USDA for projecting a record corn crop in May—before drought conditions hit the Midwest—is truly a low blow. Based on the information available at the time (i.e., acreage planted and yield trends), it was a perfectly logical expectation that a record crop would be produced.
In any case, EPRINC acknowledges that USDA’s projections of corn use for ethanol falling more than corn use for feed in 2012/13 is “logical given the current high price of corn.” This statement, again, runs counter to earlier assertions that the RFS is perfectly inelastic and will lead to fixed levels of corn and ethanol consumption regardless of prices or market conditions.