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The Thin Line Between Academics and Advocacy

November 17, 2010

           

Earlier this week, Iowa State University Professor Bruce Babcock released a policy brief entitled "Impact of Ethanol, Corn, and Livestock from Imminent U.S. Policy Decisions."  Much of this analysis is predicated on anticipated fears about corn supplies.  However, as the RFA noted in October, the sky isn't exactly falling as many would have you believe. Babcock ran the CARD-FAPRI model to examine the likely effects on ethanol production, ethanol imports, ethanol prices, RIN prices, and corn prices of allowing the VEETC and tariff to expire, as well as waiving the 2011 RFS.  Babcock's analysis suggests the corn and ethanol industries would be largely unaffected by removal of the tax credit and tariff. This paper builds on a report funded by UNICA, a lobbying organization representing Brazilian sugar plantations, and published by CARD in July. That paper also suggested the impacts on the ethanol and corn sector of eliminating the VEETC and tariff would be minimal. As with the July paper, Babcock makes several important assumptions that are debatable. RFA's Geoff Cooper sorted through these assumptions and offered some thoughts:   Babcock says with the RFS in place, corn use by the ethanol industry would only be reduced if the tariff is eliminated and Brazilian ethanol imports increased dramatically. However, Babcock maintains that increased imports from Brazil are unlikely. RFA Analysis:  This may be true in the short term, as the Brazilian real has appreciated significantly, domestic ethanol demand is strong, and world sugar prices are high, but it is almost certainly not true in the longer term. Failure to extend the tariff will be clear signal to the Brazilian ethanol sector to expand production as quickly as possible. Brazil has the capacity to significantly expand its sugarcane area and ethanol production over the next several years. There is no mention in the Babcock paper of the likely impacts of eliminating VEETC and tariff beyond 2011. This is a major limitation of the paper. What may amount to "modest" impacts in 2011 could be severe impacts in the longer term.   Babcock discusses the "surprising" strength of ethanol prices given that the U.S. market is essentially saturated. He offers a few possible explanations, including that "blenders want to buy large quantities of ethanol in 2010 because they fear that the tax credit is going to expire. Buying ethanol in 2010 allows them to capture the tax credit and to generate a RIN that they can use in 2011." RFA Analysis:  We agree that this is exactly what is happening; blenders are "stocking up" on ethanol and RINs because they fear elimination of the VEETC will greatly reduce available supplies of ethanol in 2011. Babcock's statement seems to acknowledge this fear, but this acknowledgement is contradictory to his modeling results and conclusions. Another possible explanation he offers is that "...the price could be strong because the mandate is binding and RIN prices are high." This explanation doesn't mesh with reality, as the 2010 RFS is not currently binding (production is on pace for 13 bg and the RFS is for only 12 bg) and RIN prices are very low. One further explanation offered is that ethanol is being blended with a "splash of gasoline" to capture the tax credit and then is being exported. While it is true that exports of unblended ethanol are surging, the tax credit does not apply to those shipments. And there is no evidence, beyond anecdotes and unconfirmed press reports, that ethanol blended with a "splash of gasoline" is being exported in significant quantities.   In the modeling case where the VEETC/tariff are eliminated, ethanol prices drop only $0.13/gallon, production drops only 600 mg, and RINs increase 28 cents/gallon to 40 cents/gallon. RFA Analysis:  There is a strong argument to be made that ethanol prices would immediately drop by the full 45 cent/gallon value of the VEETC if it were eliminated, particularly if ethanol prices continue to trade at a premium to gasoline with the VEETC. In response, production would drop by significantly more than 600 mg and RIN prices would increase. Because there are a substantial amount of banked RINs that will carry into 2011, RIN prices likely won't increase enough to bid ethanol production back online quickly. Under this scenario, a significant number of banked RINs will be used for RFS compliance in 2011. And because 2011 physical production would likely be below 12.6 bg, few (if any) surplus RINs would be generated to carry forward for compliance in 2012. So, 2012 RIN prices would spike through the roof, which might bid up the price of ethanol enough to bring some production back online. Babcock seems to be overlooking the fact that there will be a lot of RINs carried into 2011, which will suppress RIN prices, which in turn will hold ethanol prices relatively lower and keep idled plants from coming back online quickly...   Babcock suggests that in the absence of the RFS, the market would be freer to adjust to corn supply shocks. He suggests the ethanol industry could ramp up and down based on the corn supply and price. RFA Analysis:  This overlooks the fact that ethanol producers can't simply "flip the switch" on and off. Starting up and shutting down can be lengthy and costly processes, and interruptions of continuous production can have severe financial consequences for producers. It seems to me that sporadic ramp-ups and ramp-downs of ethanol capacity based on corn supply would contribute more volatility to the market—not less.   Babcock suggests that the "dramatic increases in the prices of corn and soybean meal that we are currently experiencing are a direct result of our current ethanol policy, which forces demand adjustments in the livestock sector..." RFA Analysis:  This statement ignores the fact that corn prices began to rise long before it was evident the U.S. corn crop would be smaller than anticipated. Without question, the current high prices were set off by the speculation that ensued following the recognition that Russia's wheat crop would be substantially short. A significant portion of the recent increase in corn prices is due to speculation based on the Russian wheat failure. The weak dollar has undoubtedly played a major role in higher corn prices as well (the impact of the rising dollar on corn futures over the last several days is proof of this). Not to mention that livestock feed demand and export demand both increased over year-ago levels. Why is all of the price increase being pinned on ethanol? Aside from Geoff's comments above, there are a few other important point to consider. A number of economists have come to a different result than Prof. Babcock on the issue of ethanol and corn price and their impacts on livestock and food. The corporate livestock and junk food manufacturing opposition to ethanol is based solely out of a desire to buy corn below a farmer's cost of production.  According to Tufts University economists: "Between 1997 and 2005, factory farms saved an estimated $3.9 billion per year because they were able to purchase corn and soybeans – the main components of most feed mixtures – at prices below what it cost to produce the crops, a reduction amounting to 5%-15% of operating costs. Estimated savings to industrial hog, broiler, egg, dairy, and cattle operations totaled nearly $35 billion over the nine-year period." As for the reason corn prices and food prices have spiked, many economists have realized that rampant and irresponsible speculation, energy prices, global demand, and freak weather phenomena have all played a more substantial role. A March 2010 report by the United Kingdom's Department for Environment, Food and Rural Affairs found "Available evidence suggests that biofuels had a relatively small contribution to the 2008 spike in agricultural commodity prices."  Even the World Bank, which in 2008 hastily suggested biofuels was playing a large role in higher food prices, released an analysis in July 2010 that found "...the effect of biofuels on food prices has not been as large as originally thought..." and that "...the use of commodities by financial investors may have been partly responsible for the 2007-08 spike." Before we jump off the deep end to reverse course on energy policy to placate the interests of corporate livestock and junk food manufacturers, we must be certain we are acting on the most accurate facts available and truly thinking about our long term goals.