Drought’s Impacts on Crop Prices and Biofuel Production

July 27, 2012 04:09 AM

Iowa State University's Bruce Babcock recently completed a study of how this year's drought might impact crop prices and ethanol production, including potential impacts on ethanol prices and corn used for ethanol. The study, conducted through the Center for Agriculture and Rural Development (CARD), also looks at three different scenarios under the Renewable Fuel Standard, ranging from no change in mandated corn-based ethanol consumption to erasing the ethanol-use mandate completely. Not surprisingly, the impact on corn price (at the same yield and the same gasoline price) is not very significant. That's because incentive for blenders to purchase ethanol quickly returns, holding up ethanol prices and encouraging ethanol production.

Below are the conclusions of Babcock's study. The full study can be accessed at this link.

A short corn crop promises to heighten concern about food prices, fuel prices, and the ability of livestock farmers and biofuel producers to stay in business. Results from a market simulation model provide some preliminary insight into the economic effects of the short crop in 2012. Two findings stand out. The first is that the flexibility built into the Renewable Fuels Standard allowing obligated parties to carry over blending credits (RINs) from previous years significantly lowers the economic impacts of a short crop, because it introduces flexibility into the mandate. The 2.4 billion gallon amount of flexibility assumed in this study lowers the corn price impact of the ethanol mandate in this drought year from $1.19 per bushel to $0.28 per bushel. This means that relaxing the mandate further would have modest impacts on corn prices. Of course, this result is conditional on the distribution of corn yields used in this study. If corn yields turn out to be much lower than assumed here, then the impact of the mandate would be far greater.

To illustrate this point, the average corn-price impact of relaxing the mandate across the lowest 20 percent of the 500 yield draws used in this study is $0.44 per gallon. The average yield across the lowest 20 percent of yields is 130.5 bushels per acre. If corn yields turn out to be greater than assumed here then the impacts of relaxing the mandate would be even lower.

The second finding is that if the current price of ethanol relative to gasoline accurately reflects the value of ethanol to blenders, then the price of ethanol will be supported at quite an attractive level as long as ethanol quantities are not pushing up against the blend wall. This implies that ethanol plants will be a strong competitor for corn even without a mandate. In the no mandate scenario simulated here, ethanol production drops by only 600 million gallons when the mandate is waived. This 600 million gallon drop in supply is enough to raise the value of ethanol in the marketplace to support 12.3 billion gallons of production and continue high corn prices. The desire by livestock groups to see additional flexibility in ethanol mandates may not result in as large a drop in feed costs as hoped.

Of course, this high value of ethanol is only high relative to the price of gasoline. If gasoline prices drop, then a waiver of the mandate would have a larger impact. Across the lowest 20 percent of wholesale gasoline prices used in this study, granting a waiver of the corn ethanol mandate would lower corn prices by an average of $1.13 per bushel from $5.88 to $4.75 per bushel. The average price of gasoline in this 20 percent of draws is $1.87 per gallon.

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