Updated Assessment of the Drought's Impacts on Crop Prices and Biofuel Production

by Bruce Babcock (Center for Agricultural and Rural Development) ...The sharply lowered production estimates suggest the preliminary assessment of the impact of the drought on crop prices and biofuel production that I conducted last month needs to be updated. ¹In the preliminary July assessment, I estimated that a waiver of the conventional ethanol mandate would reduce corn prices by an average of 4.8 percent across the 500 model outcomes considered. The now lower estimates of corn production imply that this estimated impact of a mandate waiver is too low. However, corn and soybean production are not the only economic variables that have changed in the past month. The average gasoline price used in the July assessment was $2.50 per gallon, which was the average futures price for reformulated gasoline. The average price of the futures contracts from September 2012 to August 2013 is now $2.78 per gallon—up 11 percent. Higher gasoline prices imply greater market demand for ethanol, which reduces a mandate waiver’s impact on corn prices. The net effect of higher gasoline prices and lower crop size on crop prices, and the impact of the mandate waiver, can only be determined by re-running the model used in my July assessment. The results from these updated model runs are presented here.
...Three mandate scenarios were run through the stochastic simulation model. The first scenario acts as if there is no flexibility in the mandates so that they must be met in full. The second scenario assumes that the effective conventional biofuels mandate that is met by corn ethanol is reduced by 2.4 billion carryover RINs. The biodiesel mandate and the other advanced biofuel mandate are not reduced because there is no evidence of carryover RINs for these two fuels. The third scenario does away with all mandates. The focus of this analysis is on the ethanol market and mandate, because ethanol will have a larger impact on fuel and feed prices.
...Results from a market simulation model provide 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 $2.49 per bushel to $0.58 per bushel. This means that waiving would lower corn prices by about 7.4 percent.
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 high levels 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 500 million gallons when the mandate is waived. This 500 million gallon drop in supply is enough to raise the value of ethanol in the marketplace to support 11.5 billion gallons of production and continue high corn prices. The desire by livestock groups to see additional flexibility on ethanol mandates may not result in as large a drop in feed costs as they hope. READ MORE and MORE (Biofuels Digest) and MORE (Renewable Fuels Association) and MORE (Equities.com) and MORE (Omaha.com) and MORE (New York Times) and MORE (Bloomberg BusinessWeek) Access CARD Study Access Purdue Study and MORE (Washington Post) and MORE (National Geographic News)