The Role of Demand for Biofuel in the Agricultural Commodity Price Spikes of 2007/08

April 06, 2010

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by Simone Pfuderer, Grant Davies, Ian Mitchell (Food and Farming Analysis, Defra) This paper is part of a larger body of work that aims to shed more light on what led to the high agricultural commodity prices in 2008. The paper first looks at of some of the specifics of agricultural markets and the changes over the last few years in those markets due to biofuels (bioethanol and biodiesel).

It goes on to give a brief overview of biofuel policies in the main producer countries. It examines the links between agricultural and energy markets, including economic modelling of the medium-term relationship between the two, and it evaluates the economic viability of biofuel production in the US, taking a case study approach to a specific commodity, namely sugar.

The second part of the paper looks at the 2008 price spike including a literature review of biofuel’s impact on the recent agricultural price increases and draws conclusions based on the arguments surrounding biofuel’s contribution to the price spike in 2008.

Specifically this paper sets out to address the following question:

To what extent did the use of grains/oilseeds for biofuel production (policy driven or not) play a role in the price spikes of 2008?

But will also cover the following:

What has been driving biofuel production in recent years, policy or changing energy prices?
What are the implications of any new links between energy and agricultural markets through biofuels for the level and volatility of agricultural prices in the medium term?

Executive Summary

Demand for feedstocks used directly in biofuel production has dramatically increased over the last decade. For example, the proportion of maize used for bioethanol increased from 4% in 2001/02 to 12% in 2007/08. Still, in terms of global commodity markets, food and feed uses dominate.
This surge in biofuel demand has likely been primarily driven by government policies rather than by ‘organic’ demand from rising crude oil prices during the past few years. Indeed, higher oil prices alone do not drive commercial incentives to produce biofuels; rather, it is the ratio of the oil price to feedstock prices which matters. In the US maize market, the viability of maize-ethanol production has been mostly uneconomic in recent years, even during the large rise seen in the oil price during 2007/08. Were it not for public policy, biofuel demand is very unlikely to have increased as it did.
The primary impact of high oil prices on agricultural commodities seems still to be through the supply-side, via increased costs of production, rather than the emerging demand-side channel of biofuels. Fuel and fertiliser account for over half of operating costs of crop farms but many commentators have ignored oil’s ongoing importance as an input into agricultural production.
Medium-term economic models agree that biofuel demand has and will put upward pressure on prices for those agricultural commodities used in biofuels production.
However, available evidence suggests that biofuels had a relatively small contribution to the 2008 spike in agricultural commodity prices where its impact was largely limited to the maize market with some knock-on effects on soybean prices. By way of contrast, the price of wheat increased before maize and to a higher peak, moving the ratio of wheat to maize prices higher than the recent past and suggesting that incentives for any demand-side substitution were actually away from wheat.
Studies which have found a large biofuel impact across agricultural commodities have often considered too few variables, relied on statistical associations or made unrealistic or inconsistent assumptions.
A significant feedstock for biofuel use, sugar, did not see a large rise in price during the spike period but increased significantly in 2009 when other commodity prices had fallen back from their peaks.
Whilst commodity prices have fallen steeply from their peaks in 2008 biofuel demand has remained steady – indicating that the causal link from biofuel demand to short-term crop prices is still relatively weak. Download Study READ MORE