Study: Ethanol Mandate Creates 10% Chance of a Corn Price Spike

Bad Weather + Biofuel Demand Could Rapidly Double Prices

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The prices of corn and other foods sit on the edge of a knife. Thanks to federally mandated ethanol standards, food prices could spike dramatically if drought or bad weather shrinks the U.S. corn yield this year, and the country lacks a good policy mechanism to handle such an event.

A report from two economists at the University of Illinois found that if the corn belt sees bad weather of the sort that has about a 10 percent chance of happening in any given year, the price of a bushel of corn could rise to $7 from about $3.50 today. The reverberations of such an event would be felt throughout food markets in the country, and, if history repeats itself, around the world.

“We have gone through over a decade of very good weather in the U.S. corn belt, and that explains why we’ve had a tendency to have such good yields,” said Scott Irwin, one of the authors of the report. “It is not that technology has overcome the problem of drought for corn production.”

Irwin said many farmers claim that technological advances in farming practices have produced about 15 years of generally good and rising crop yields, but this does not account enough for simple luck.

“There is still a significant yield risk if we have a corn belt-wide drought. “We don’t believe in the ‘bulletproof hypothesis.’”

Corn Production and Ethanol

Corn production for ethanol has increased dramatically over the last five years, from about 1.6 billion bushels in 2005-2006 to almost 3.7 billion bushels in 2008-2009. The percentage of corn used for ethanol rose in that period from 9.5 percent of the total yield to a projected 22 percent in 2009-2010.

The 2007 Renewable Fuels Standards Program calls for more. It requires 12.95 billion gallons of renewable fuel production for 2010, rising to 13.95 billion gallons in 2011; small portions of that are required to fall under the categories of advanced biofuels, but most will come in the form of ethanol. In order to meet those marks, Irwin and his colleague Darrel Good estimate the industry will need 4.4 billion bushels of corn.

“Given normal weather, that trade-off is not that sharp, or that notable, between biofuel and food,” Irwin said. “Where it really pinches would be if we get bad weather.” The modeling done in the report is based on a drought that has about a one in 10 chance of happening; if that does occur, the total corn yield will likely be about 10.9 billion bushels—down more than 2.1 billion bushels from the previous year—meaning that those required 4.4 billion bushels for ethanol would represent more than 40 percent of the total yield.

Irwin stressed that it is hard—if not impossible—to predict if such a weather event will occur in a given year, but “we’ve gone through about a 15-year period of fantastic weather in July and August for the corn belt, and we think that has lulled people a bit to sleep about this kind of scenario actually occurring.”

Historical Precedent

The potential doubling in the price of corn highlights the ongoing issue of food crop competition with biofuel production.

“That’s part of the reason why biofuels is a big boondoggle,” said Kate McMahon, energy policy campaigner at the non-profit Friends of the Earth. “Back in 2008 we saw huge problems with this. Our corn production shifted a lot toward fuel, and when that happened we saw prices of grain all around the world skyrocket. Whether it be from market distortions and policies like the renewable fuel standards, or from droughts, it’s the same problem.”

The spike in 2008 came as a result of poor weather in some corn states, and flooding in the northern Midwest lessened crop yields. Then, too, a bushel of corn peaked above $7.50, and food prices around the world rose, as well. Texas Gov. Rick Perry even petitioned the Environmental Protection Agency for a 50 percent waiver on the ethanol production mandate in the Renewable Fuel Standard.

“The hard part, though, is that that process takes a long time,” said McMahon. “So if there is an immediate issue, like we saw in 2008, we weren’t able to deal with it immediately. By the time EPA got around to looking at it, the problem wasn’t that bad, so they said, well, we don’t have to do anything.” In August of that year, the EPA denied Perry’s petition.

Safety Valve Needed

In their report, Irwin and Good stress that some sort of fallback mechanism that works quickly could ease the potential of price spikes in the event of bad weather. If crop yields drop to a certain point, perhaps, then the biofuel mandates could automatically be dropped to allow more corn to be used for food (field corn, the type used for biofuel, can also be used for corn-based foods such as corn meal and corn flakes).

There are situations, though, where even that wouldn’t solve the problem.

“What if you get bad weather in the Corn Belt and you get $100 crude oil?” Irwin asked; that was basically the scenario that occurred in 2008. If such a situation occurs again, there would be no financial incentive for corn growers to use their crops for food rather than the more lucrative ethanol production.

“Then you have to go to some very harsh potential measures,” Irwin said. “You would have to have direct government intervention into our markets to say, ‘No, you can’t use it for this, you have to use it for food.’ That’s kind of the nightmare scenario, in my opinion, and it would be very hard to deal with.”

McMahon agreed, though, that putting in some sort of safety valve into renewable fuels legislation would at least provide some way out of potential price disasters.

“I’d like to see something like that, but no one is really talking about it yet,” she said. “But the RFS is a flawed policy. It doesn’t have any ways to deal with the ramifications of its impacts. So I could imagine there would be interest in that at some point, but politically I don’t see it happening in the near future.”


See also:

Developing World Sees Wealth in Biofuel Production

EPA Recalculates Land Use Changes, Gives Corn Ethanol Thumbs Up

Subsidies Worth Billions at Stake in Battle Over Biofuel Rules

(Graph: EIA Energy Outlook 2010)