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Thoughts on New CARD Analysis of Ethanol’s Impact on Corn Prices

April 20, 2011


Grocery manufacturers, industrial meat processors, and other beneficiaries of cheap corn have been busy lately. As grain prices have risen substantially in recent months, the cheap corn coalition has been gearing up for another round of the nonsensical "Food vs. Fuel" campaign. They argue that eliminating the ethanol blender's tax credit and Renewable Fuels Standard (RFS) would magically cure high grain prices and turn back the clock to the glory days of $2/bushel corn. Further, they garishly contend that higher corn prices are a main driver of rising food costs, and that ethanol is the root cause. But a new policy brief published this week by Iowa State University's Center for Agricultural and Rural Development (CARD) dispels these myths and shows that factors other than ethanol are primarily driving corn prices. According to the new report, written by Bruce Babcock and Jacinto Fabiosa, only 8% ($0.14/bushel) of the increase in average corn prices from 2004 to 2006-2009 can be attributed to the existence of the blender's credit, also known as the Volumetric Ethanol Excise Tax Credit (VEETC). Further, the authors write that, "Corn prices without the ethanol subsidies would have averaged only 4% less over this period than what they were." Because VEETC's contribution to corn prices was so small, the impact on food prices was even smaller. The authors write that the relatively small change in corn prices "...necessarily implies that the contribution of ethanol subsidies to food inflation is largely imperceptible in the United States." The paper suggests that market forces (chiefly high oil prices, low corn prices, and the phase-out of MTBE) had far more to do with ethanol expansion from 2005-2009 than the VEETC and RFS. Thus, according to the authors, ethanol market dynamics were responsible for a larger share of the corn price increase during the study period. Still, their modeling revealed that just one-quarter ($0.45) of the average corn price increase from 2006-2009 could be attributed to the market-based expansion of the ethanol sector. Taken together, market-based ethanol expansion and the VEETC accounted for about one-third of the corn price increase, while other factors explained two-thirds of the increase, according to the paper. In certain years, ethanol policy and market-based expansion had an even smaller impact. In 2007, for example, "...almost 80% of the observed rise in corn prices was due to factors other than ethanol." These modeling outcomes led the authors to suggest that "...most of the change in corn prices that we have seen is not due to ethanol expansion but rather is due to other forces at work." The modeling results and analysis led the authors to a central conclusion that "...ethanol production would have expanded quite rapidly even without subsidies." While this conclusion is supported by the modeling results and the discussion in the paper, it begs some important questions about the actual function and role of ethanol policies like VEETC and the RFS. Investors who built ethanol plants in 2003 and 2004 made those investments without the knowledge that a total phase-out of MTBE would occur in 2005 and 2006—but they did know that the VEETC would ensure ethanol was competitively priced against gasoline. Investors who built plants in 2005 and 2006 did so without the knowledge that record high oil prices in 2007 and 2008 would spur strong discretionary blending demand—but they did know that the RFS would provide a demand floor against a backdrop of volatile oil prices. So, the question is: how much of the actual investment in ethanol during the time period in question occurred because of a supportive ethanol policy regime, not in spite of it? Most likely, the investments that enabled ethanol expansion were ultimately made because investors had clear policy signals (VEETC and RFS) from the government that the development of a robust ethanol industry was a national priority and that their investments would be protected against geopolitical and economic volatility. So while market forces may have been encouraging investors to put their toe in the water, policy backstops like the RFS and VEETC likely gave them the confidence to jump in with both feet. And while examining the past can be highly instructive, it isn't always totally relevant for the future. That is, we can't simply assume the next five years will behave like the last five years. The time period examined by CARD for this study featured some market behaviors that may never again be replicated: 1) corn prices and oil prices were decoupled and disparate during much of the study period; 2) the study period included the MTBE phase-out, which could be considered a black swan; 3) the study period saw an unprecedented commodities bubble and subsequent crash; and 4) there was no E10 blend wall constraint. Again, few (if any) of these events could have been predicted by investors who were considering jumping into ethanol in the early part of the last decade. But because of a strong ethanol policy regime that included the VEETC and RFS, investors took the plunge. On a final note, the CARD analysis shows that the VEETC didn't have much impact on ethanol margins or production levels when margins were high and oil prices were high relative to corn prices. However, the analysis shows that the VEETC was much more important when oil prices were low relative to corn. In 2008, for instance, when oil prices crashed to less than $40/barrel, CARD's analysis shows that ethanol profit margins were near $0.20/gallon. If the VEETC had not existed during that period, margins would have been just slightly above break-even. Further, total ethanol production in 2008 would have been some 25% lower (2.5 billion gallons), if the VEETC had not existed, according to the paper. The RFA has long held that domestic ethanol production does have some impact on the price of corn – the industry was developed in part to provide farmers with new markets for their corn. These new local market opportunities were meant to provide a modest boost to corn prices, ensuring that farmers got more of their income from the marketplace and less from government payments. Ethanol's corn price impact, however, is often overblown by critics and is marginal when compared to a litany of other factors, like the price of oil and the effects of unbridled speculation. This CARD report provides a basis for moving forward with the thoughtful transformation of current ethanol policies that RFA has been advocating.  Rather than crying wolf, we hope ethanol critics will reexamine their antipathy toward America's most successful renewable fuel and work with the industry to transition current policy to reflect a growing and evolving industry.