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Fowl Policy: Why Corn Stocks-to-Use Ratio Doesn’t Work as RFS Policy Foundation

October 5, 2011

           

Reps. Bob Goodlatte (R-VA) and Jim Costa (D-CA) are pushing legislation that would require the EPA to waive a portion of the annual Renewable Fuel Standard (RFS) when the corn stocks-to-use ratio falls below 10 percent. The ratio is a simple measure of ending stocks (corn left over after all demands are met) divided by total demand. The stocks-to-use ratio has been used by participants in the marketplace as rough gauge of prevailing supply-demand conditions. But history shows the ratio is, at best, a crude and highly volatile indicator of market conditions that is not fit to serve as a mechanism for important public policy decision-making. Under the Goodlatte/Costa proposal, the amount of the waivered volume would depend on the stocks-to-use ratio at the time EPA sets RFS standards for the following year. If the ratio is above 10 percent, no waiver is required; a ratio of 7.5-10 percent would result in lowering the RFS for renewable fuel by 10 percent; a ratio of 6.0-7.49 percent would trigger a 15 percent waiver; a ratio of 5.0-5.99 would trigger a 25 percent waiver; and a ratio of less than 5.0 percent would result in a 50 percent waiver. This type of approach to waiving the RFS is dangerous and misguided for a number of reasons, but a primary concern is the fact that a decision with annual implications would be made based on a highly volatile and imprecise ratio that can change dramatically from month as supply-demand conditions change. Further, USDA has a history of underestimating new crop ending stocks with early estimates. USDA's first estimate of stocks-to-use has been significantly lower than final estimate in each of last three complete crop years (2007/08-2009/10). As an example of the month-to-month volatility of the estimate, the 2007/08 ending stocks estimate fluctuated by more than 1 billion bushels in just five months. And the 2009/10 ending stocks estimate fluctuated by 460 million bu. in just one month. Such fluctuations beg a very simple yet serious question:  How can estimates with such variability be relied upon for a policy decision with year-long implications? The only answer is they can't.  The stocks-to-use ratio provides a snapshot in time – nothing more or nothing less.  Changes in this ratio, as we have seen, can be quite large from month to month and can lead to gross misrepresentations of actual market dynamics. University of Illinois economist Darrell Good cautions that stocks-to-use ratio should only be considered as "a starting point (for estimating potential price impacts) since very different supply and demand conditions in individual years can lead to similar ratios of stocks-to-use but very different prices."[1] Because of this, Good writes, "...the relationship between stocks-to-use and price is not consistent over time." Such a crude indicator of potential market conditions should not be used as the basis for policy. Put simply, the stocks-to-use ratio from a single month is not an appropriate metric for an annual policy decision with very real implications for the American fuels market.  Congress should ignore this bill for no other reason than it is based on an idea that has no real world supporting data.
[1] Good, D. July 2004. Corn: Large Crop, Strong Demand. University of Illinois/Purdue University Grain Price Outlook: 2004—No. 5.