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Intense drought and high corn prices continue as ethanol waiver requests pick up

Purdue University study considers what might happen to corn prices if ethanol production mandate waiver is granted. Study: waiver won’t be a quick fix for rising corn prices. Arkansas Gov. Mike Beebe requests waiver from EPA.

 As cries continue for an EPA waiver of the government’s ethanol production mandate, a new study out of Purdue University considers what might happen to corn prices if a waiver is granted. Among the takeaways: a waiver won’t be a quick fix for rising corn prices.

The analysis comes as the governors of drought-hit Arkansas and North Carolina – joining those from Maryland and Delaware – made formal requests to waive the Renewable Fuel Standard (RFS).

Asking for a “full or partial waiver,” Arkansas Gov. Mike Beebe – who, at the same time, made $2 million in disaster funds available to assist livestock producers in the state (see more here) -- was not shy in linking the passage of the RFS to higher feed costs. The RFS, he wrote in a letter to the EPA, has “resulted in a long-term shortage in grain in our nation, especially corn, potentially forcing reduced production and job loss and increasing food prices for consumers worldwide…

“Because of this policy, ethanol production now consumes approximately 40 percent of the U.S. corn crop and the cost of corn for use in food production has increased by 193 percent since 2005.”

Read Beebe’s full letter here.

The Purdue study – titled “Potential Impacts of a Partial Waiver of the Ethanol Blending Rules” -- was the topic of a Thursday (August 16) webinar (archived here) sponsored by Farm Foundation NFP. It says that corn prices could drop with a waiver but study authors cautioned the many variables involved mean a complicated picture.

More ethanol waiver coverage here.

How complicated? Consider that in 2012, the RFS mandates 13.2 billion gallons of ethanol must be blended with gasoline. That total jumps to 13.8 billion gallons in 2013.

However, in recent years, the blends have exceeded the mandated amounts by 2.6 billion gallons. Those 2.6 billion gallons can be considered blending “credits” -- renewable identification numbers, or RINs — allowing them to count toward blending totals in the future.

“It is very clear” that the livestock producers must make the most adjustments in the face of the drought “if there is no flexibility in the ethanol use of corn,” said Wally Tyner, Purdue economist and co-author of the study. “But that is, perhaps, a big if.”

He cautioned to tread carefully with assumptions that an EPA waiver will solve the issues caused by the drought. “The economic harm has been done by the drought. The corn price is substantially higher. The losses amount to tens of billions of dollars.”

An EPA waiver “can’t change that. They can’t change the loss. They can only redistribute it among the affected parties.”

If refiners and blenders don’t have, or choose not to use, ethanol blending flexibility “a waiver has very limited impact,” continued Tyner. However, the use of prior RINS could reduce the corn price an estimated “67 cents per bushel. For a small waiver it could be around 47 cents. For a larger waiver it could be up to $1.30 per bushel.”

What would be the effect of a partial waiver on gasoline prices?

“If there’s a partial that results in less corn being used in ethanol that would put downward pressure on the corn price and downward pressure on the ethanol price,” said Tyner. “That’s ten percent of gasoline so it (wouldn’t be) a huge impact.”

Any timeline for EPA action on a potential waiver of the RFS?

“No,” said Tyner. “The EPA isn’t obliged to respond quickly but now that four governors have petitioned, they do have to respond.

“Normally, they’d make their decisions for obligated parties in late October/early November. If they’re going to issue a partial that would be a good time to do it in terms of communicating information to the market in a timely manner. But they’re not obliged to do that.”

If blenders use the RINs in 2012/2013 how might that affect future options?

“Part of it comes back to how long it takes refiners and blenders to change the current system,” said Tyner.

“In the process of preparing this paper, some of the people connected to the oil industry told us that we’re so locked into the current system that it would take a bit of time to change. (They) implied that we’d have to perceive that a longer-term change in the structure of the industry would be useful before making the change.

“Others said, ‘No, we can change on a dime. The minute it’s economically attractive we’ll make the change.’”

Over the past five or six years, the demand for corn “has simply outpaced the ability to increase the supply,” said Christopher Hurt, Purdue agricultural economist and study co-author. With the RFS, “we’re already in a period where the rate of growth in the mandate has really slowed down. The year-to-year increase has slowed down. In the next several years, as we approach 2015, we’ll be flat-lining on the RFS for conventional ethanol from corn. We’ve seen a massive response from corn growers to meet this demand.

“The point is that our stock, our inventory, will get down to virtually nothing at the end of the year. There’s no reserve for some of these uncertainties.

“In 2014 – and we’re looking at, perhaps, 100 million acres of corn planted in 2013 – if we could get back to normal production, we’d have the possibility of increasing stock levels. If we have an extra, say, 500 million bushels of corn that’s more flexibility built into our marketing system.”

Livestock, unintended consequences, importing ethanol

What are the long-term implications for the livestock sector?

Not very positive, said Steve Meyer, president of Paragon Economics. “We are catching up to some degree with corn demand by increasing yields every year. But the chances of having severe shortfalls in corn production – three out of five years, or something like that – are pretty small. We have seen it happen, though: in 1983, 1988 and 1993 we had a flood. Mother Nature isn’t real picky on how she screws things up for us. We have to account for that.

“We’re going to reduce these herds. I don’t see any way we won’t reduce herds across the board…

“We’re reducing our ability to produce meat, milk and eggs for U.S. and world consumers.”

What about unintended consequences of a partial waiver?

Hurt said there could be “a lot instability and huge volatility, dropping from the highest price ever seen for a U.S. average price for the 2012 crop. The decrease could be the largest seen for the 2013 crop. Anything that tends to moderate prices a bit for the 2012 crop probably support later on.

“I don’t think that’s an advocacy position but is something that’s an unintended consequence.”

With a “fixed demand like the RFS, it’s inflexible, inelastic,” said Tyner. “When you have a severe shock that means other sectors have to do most of the adjustment.

“The design of the system – having to carry forward RINs – will be a really good feature moving forward. The possibility of a partial waiver could be good if, and only if, we determine that there’s refining and blending flexibility.”

Arguments in favor of an RFS waiver assume there will be an automatic reduction in the demand for corn. That isn’t a given, said Tyner. What if a waiver “becomes a party nobody attends” because the ethanol industry “either cannot or chooses not to for legitimate economic (reasons) not to adjust? We’ll have created expectations that adjustment will occur and it doesn’t happen – that could be disruptive.”

Tyner also worried about setting precedent while the fledgling cellulosic biofuel remains on shaky legs. “It’s very difficult to get investment today for cellulosic biofuels because of a wide range of uncertainties.” Adding the uncertainty of such waivers “makes it even more precarious.”

What about importing ethanol?  

Another option open to the EPA is to waive the RFS for “other advanced biofuels,” which includes sugarcane-based ethanol. That amounts to 750 million gallons (equivalent to some 275 million bushels of corn) in 2013.

“If that were waived,” said Tyner, “then all the sugarcane ethanol would, in essence, substitute for corn ethanol. It would bring about, through market forces, a likely reduction in corn ethanol.”

The impact of an RFS waiver on dried distiller’s grains (DDG) and soybean meal prices?

Hurt said from a bushel of corn that goes to ethanol, roughly a third, (about 18 pounds of a 56-pounds bushel) is left for feed.

“We see a very strong relationship between the corn price and (DDG) prices,” said Hurt. “I think if … a waiver reduced the amount of corn that went to ethanol, we’d see a lowering of the corn price and a lowering of the (DDG) price.”

Potential impacts on food prices at the grocery store?

The drought, said Hurt, “has caused the economic losses. The distribution of that loss is going to essentially be passed to consumers of food and fuel products, not only in this country … but to the world.”

The USDA predicts “something between 3 and 3.5 percent food inflation this year and a 3 to 4 percent increase for next year. There have been three years in a row with food price inflation rate higher than the general inflation also. (It is also) higher than the incomes of producers.”

While wealthier countries can better absorb rising food prices, there has been a run of years “where we’ve seen concerns about world food supplies. Of course, it isn’t just availability but for (those with the) lowest incomes food price increases perhaps push more of those populations into poverty.”

For more on world food prices, see here.

Hurt also warned that, no matter what actions are taken, the consequences of the current drought won’t be over quickly. “There will be implications on the beef side, as an example, right through 2015. The extension of this drought and how it affects our food supply will be with us for several years to come.”

Pointing to the Purdue study and another done by Iowa State University, Bob Dinneen, Renewable Fuels Association President and CEO, said the analyses, “compellingly show that waiving the RFS is unnecessary and would be ineffective in meaningfully reducing corn prices. Congress and EPA built sufficient flexibilities into the RFS to ensure compliance is achievable even under the most abnormal and extreme circumstances, such as this summer’s drought. These studies recognize the impact of that built-in flexibility and show that a waiver would not significantly contribute any additional further relief from drought-induced high corn prices.”

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