Federal law that helped jump-start the ethanol industry in the U.S. also is shifting normal supply-and-demand forces within commodities markets, says Wally Tyner, a Purdue University agricultural economist.
Not quite four years after Congress passed the Energy Independence and Security Act in 2007, markets are struggling to meet both the law's renewable fuels standard and grain demands from the livestock, food and export sectors, says Tyner, an energy policy specialist. About 27% of the nation's corn crop must be devoted to ethanol this year to meet the federal mandate, leaving other corn users to compete for the remaining 73%.
"The Renewable Fuels Standard requires 15 billion gallons of ethanol be consumed per year by 2015, regardless of what the price of corn is and regardless of what the price of crude oil is," Tyner says. "Corn could be $2/bu. or $10, crude could be $50/barrel or $100 and that 15 billion gallons has to be there. That means ethanol production is totally unresponsive to price. There's no flexibility."
This "inelasticity" has led to market volatility and wild swings in corn prices, which have topped $7/bu. in recent months.
When markets are more inelastic, supply disruptions – known in economics as "shocks" – often push prices higher than they might be in a typical supply/demand system, he says.
A combination of shocks is placing greater pressure on corn supplies and raising questions about both the ethanol production mandate and the federal subsidy for ethanol, which stands at 45¢/gal. Those shocks include:
"Then we can look at land availability," Tyner says. "In the U.S. we're about maxed out. There's little new land to grow corn. In 2008 when we needed more land for corn we got it from soybean acreage. When we needed more land for soybeans we got it from cotton acreage, and some from wheat. But now cotton prices are high, sugar is high, rice is high, corn is high, soybeans are high – everything's high. So there's no place to go within the U.S. for more land."
Since 2006 globally, 66 million new acres of land have come into production for major agricultural crops, Tyner says. Another 27 million acres have shifted from other crops to corn, soybeans and rapeseed.
"Even with these added acres, prices are high because global demand from all sources, including ethanol, has grown faster," he says.
While the livestock industry has managed to pass along higher corn prices so far, some in the industry have called on Washington to temporarily waive the ethanol production mandate before prices climb even higher.
With pork prices up 13% since 2008 and beef prices up 11% since then, producers can afford to pay more for corn now than they could in 2008-2009, says Tyner.
"The administrator of the Environmental Protection Agency has the right to waive the mandate if it is perceived that significant economic harm is occurring because of it," he says. "The mandate has led to a capacity to produce ethanol that exceeds 14 billion gallons today. Are ethanol producers going to let their plants sit idle?
"As long as oil prices are high and it's profitable to produce ethanol, we're going to keep doing it with or without the mandate, at least in the near term," Tyner says.