Ethanol and food prices, again

Last week I served on a panel for the RTEC and gave my usual spiel about ethanol and food prices.

In a nutshell:

1) Both supply and demand of staple grains are highly inelasitic. This means it doesn't take much of a shift in supply or demand to cause a big change in price.

2) The U.S. is hugely important in world grain markets.  With the largest share of world production and a much larger share of world exports, we drive international prices for staple grains.

3) Ethanol uses about 1/3 of the U.S. corn crop, or about 5 percent of the calories produced, worldwide, of corn soybeans, wheat and rice--the key grains that feed the world.  That's even with a bigger corn crop (and smaller soybean crop) that has been brought about by ethanol subsidies and mandates.

4) When prices go up, we in rich countries don't eat much less, since commodities are a trivial share of our food expenditures.  Those consuming less are most plausibly the world's poorest.  If not, who do you think is eating less due to the huge diversion from ethanol?

5) Yes, there are other and possibly larger factors affecting food prices: growth in China and other parts of the world, particularly growth in demand for meat, and bad weather.  These factors accentuate the effects of ethanol; they don't diminish it.  A big problem with all this stuff coming online at the same time is that it has drawn down inventories, making markets far more susceptible to other shocks.

I was challenged by the usual armchair reasoning that doesn't hold up under inspection.  Yes, some of the grain used in ethanol production goes back to farmers in the form of distillers grains. But it cannot be used for all animals.  It's 1/3 the calories, maybe less.  The wet stuff is economical but very expensive to transport.

In the real world there are tradeoffs.  You can't have your cake and eat it too.

One anecdote I wish I mentioned but didn't:  In October, the USDA revised its crop forecast for corn downward by about 5% from the September forecast.  This is a nice thing to look at because it provides something of a natural experiment--a large, clear, measurable unexpected shock to the market.  This supply shock caused prices to go up nearly 10% on the same day.

Consider how large this small adjustment on quantity had on price.  Now consider that this production shock was likely due to late season weather, a temporary phenomenon.  Now consider that ethanol is a permanent shock that is about six times the size on an annual basis.

If you say you don't think ethanol is affecting prices for staple grains and soybeans, you are a fool or a knave looking to mislead.

Comments

  1. stuart staniford has beeen doing running research on that; recently:

    http://earlywarn.blogspot.com/2011/02/us-ethanol-production.html

    http://earlywarn.blogspot.com/2011/03/global-biofuel-production.html

    http://earlywarn.blogspot.com/2011/02/what-we-use-crop-land-for.html

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  2. Apropos rjs's comment, figures that Stuart found on the Biofuels Association's website show that the growth in ethanol production has been quite impressive. From 1997 to 2010 the trend growth was over 20% compounding per year (18.8% instantaneous). The corn crop can only grow at about 3 percent maximum on a sustained basis.

    In 2010 about 36% of the corn crop was used for ethanol. If the trend continues, in 2011 that will be about 42%, in 2012 about 50%, 2013 59%, ...

    The problem is not just that ethanol is taking a significant share of the world's food calories. It's also, and mainly, that its share is getting bigger with each passing year.

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  3. rjs and Greg,

    Yes, growth of ethanol has been fast. That's because of a huge mandate and subsidy that came online around 2005.

    But it probably won't grow much more. There is a limit of 10% ethanol that can be blended with our gasoline, and we're basically at that limit right now.

    There is a push to increase it 15%, but that won't be good for older cars (pre-2007). A 15% blend may happen in a few years if oil prices stay high. That would get us up to half the US corn crop.

    We'll need to change the fleet of cars to go up to E85. I just don't see that happening on a large scale. But who knows...

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  4. michael, i was under the impression that we were going to 15%, which irritated me as all my cars are pre-2000...

    here's what i get from search:

    http://gas2.org/2010/10/14/epa-approves-15-blend-of-ethanol-in-gasoline/
    http://www.scientificamerican.com/article.cfm?id=epa-edges-into-15-percent
    http://www.bizjournals.com/wichita/print-edition/2010/12/24/protest-of-e15-blend-by-auto-and.html

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  5. rjs: It was only approved for cars post 2007. It's not clear how to make that work since we all buy gas at the same places. I just don't see it happening without EPA expanding its approval. I'd be a little surprised if they do that soon. Maybe in 5 or 10 years. It could damage a lot of not-so-old cars out there and EPA would be on the hook for that.

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