Here is a quiz: Raise your hand if you think subsidies are responsible for high ethanol prices and that ethanol is responsible for high corn prices. OK. Now, raise your hand if you think there is no correlation among subsidies, ethanol prices and corn prices. All right. Now remember your answer and follow along with the latest research about subsidies, corn prices and ethanol prices and whether or not they are linked.

You may or may not be surprised at the answer, which comes from an in-depth study at the economics of corn, ethanol and governmental subsidies, which comes from the Iowa State University Center for Agriculture and Rural Development and economists Bruce Babcock and Jacinto Fabiosa. They say the controversy about ethanol subsidies spills over into the price of food, and critics of ethanol contend its subsidization has resulted in higher food prices. And they add that all of the issues have linkage because higher corn prices can result in higher food prices, particularly for meats. Ethanol prices have been a function of blending mandates by the federal government, the phase out of MTBE – which caused ethanol to be the sole supplier of oxygen in motor fuel – and the fact that oil prices are high. Additionally, the demand for feed drives corn prices, and that demand can be traced backwards to population, the economy and other dynamics. The challenge for the economists is separating all of the dynamics to determine their impact on the value of corn and ethanol.

To determine the price of corn they evaluated the market fundamentals affecting corn prices in 2008, which had an average of $4.06/bu. Going backward, they determined the price of corn from 2005 to 2009 without the ethanol blender tax credit and if Congress had capped ethanol production at 2004 levels. Those indicate the proportion of ethanol production in response to the mandates and the role that non-ethanol economic forces had on corn prices.

What all was happening in the corn market beginning with the 2006 crop year? The economists say that was the point at which construction of ethanol plants expanded substantially, corn acreage and yields were lower than expected and global grain prices rose from shortfalls in production. Investors in ethanol plants before 2008 were seeing a return on investment that covered construction costs in the first year of operation. That was a result of inexpensive corn and expensive ethanol along with higher oil prices and a continuation of the ethanol subsidies. When oil prices dropped in late 2008, both corn prices and refining margins declined. Corn prices kept pace with the volume of corn ethanol was consuming through 2009, even as corn yields increased and total corn supply increased.

Price without subsidies

If the ethanol subsidies had not been in place, ethanol processing margins would have been lower, and lower margins would have reduced the incentive to invest in construction of ethanol plants. That would have held back ethanol production and the demand for corn. The economists say, “The fact that ethanol production would have expanded even without subsidies means that corn prices and corn acreage would have also increased. Corn prices without the ethanol subsidies would have averaged only 4% less over this period than what they were. Part of the reason why corn prices would not have seen a more significant decrease is that corn acreage would have been lower without the subsidies.”

Economists Babcock and Fabiosa say ethanol subsidies have contributed to higher corn prices and higher food prices. However, they say, “The largest difference in corn prices, in 2007, would have been 30¢/bu., or about 7%. This relatively small change in corn prices necessarily implies that the contribution of ethanol subsidies to food inflation is largely imperceptible in the U.S.” But they add that that does not mean the contribution of ethanol to food inflation is imperceptible.

Regarding corn prices, they contend, “The general pattern of corn prices would have been the same as in the historical period without ethanol subsidies or without expansion of ethanol, rising from 2005 to 2007 and then declining to 2009. Corn prices would have still risen dramatically in 2007, to $3.75/bu. … These results show 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 economists looked back at the $2.06 corn price in 2004 and the ethanol subsidy impact added only 30¢ of the $2.14 price increase to 2007 and another 14¢/bu. was added because of the market based expansion of ethanol. From 2006 to 2009, ethanol subsidies added 8% to the price of corn, with ethanol demand adding 45¢, for a total contribution of 36% of the price increase. And they conclude by saying, “…while there is no doubt that expansion of ethanol increases corn prices, it is wrong to attribute all of the increase in corn prices we have seen since 2004 or 2005 to ethanol.” And that the pattern of pricing for corn from 2006 to 2009 would still have occurred whether there was a subsidized ethanol demand or not.

How did you score on the quiz?

Summary

Conventional wisdom holds that ethanol subsidies inflate corn prices and that causes higher food price inflation. Researchers have separated the dynamics affecting corn prices and ethanol pricing to find the extent of any impact of ethanol subsidies on corn prices. They report that a relatively small portion of the increase in corn prices from 2006 to 2009 was due to ethanol subsidies and a slightly larger portion due to the demand for corn by ethanol plants.

(Orignially published by the University of Illinois farmgate blog.)