Impact of Biofuels on Corn and Soybean Prices

AgMRC Renewable Energy Newsletter
September 2008

   Robert Wisner
   Professor of Economics and Energy Economist
   Ag Marketing Resources Center
   Iowa State University
   rwwisner@iastate.edu

No one knows precisely what impact the rapid growth in the production of biofuels has had on corn and soybean prices, but the evidence below suggests it has been substantial.  To show the impact, we have created corn and soybean supply/usage balance sheets assuming the biofuels expansion had not occurred, and compared them to the actual balance sheets with the biofuels expansion.

The balance sheet for corn is shown in Table 1.  Corn usage, carryover and prices with the current corn for ethanol expansion to 4.1 billion bushels (2008/09) is shown in the top half of the table.  The estimated corn usage, carryover and prices if ethanol is held at its 2004/05 level of 1.32 billion bushels are shown at the bottom.

Table 1. Ethanol Usage Projections & Corn Balance Sheet (mil. bu.)

In the “non-expansion” scenario, we assume U.S. corn plantings dropped back to 82 million acres, near the level before the ethanol expansion.  We also adjusted post-2004 U.S. corn yields up by two bushels per acre.  That’s to reflect the yield decline from increased corn-after-corn acres that would not have occurred without the ethanol expansion level and lower-yielding acres that would not have been cropped.  We have adjusted livestock feeding and exports upward to reflect expansion incentives in these industries through lower corn prices.  Projections of these scenarios with low, trend, and above-trend yields are also available.

Impact on Carryover Stocks and Government Program Costs

Figure 1 shows corn carryover stocks under these scenarios.  The red bars on the right show the historic, recent and anticipated future stocks.  The blue bars show carryover stocks under the non-expansion conditions.  Non-expansion carryover stocks with a trend yield in 2009-10 would be approaching the early 1980s level, but would be below the mid-1980s when two-thirds of a year’s use was in carryover.  Much of the carryover at that time was isolated from the market by government storage programs that have since been eliminated.

In the mid-to-late 1980s, aggressive acreage set-aside programs were used to reduce excess production capacity.  Without the rapid expansion in corn ethanol processing, the U.S. crop sector likely would have faced similar excess production capacity in the 2000’s.  With current government farm programs, we would have expected low corn prices to trigger large counter cyclical and loan deficiency payments, and sharply increased government farm program costs.

The Relationship Between Carryover Stocks and Price

There is a close inverse relationship between carryover stocks and price.  If stocks decline, price goes up, and vice versa.  A scatter diagram of corn prices and carryover stocks (weeks of supply) is shown in Figure 2. Our recent projections put the carryover at 3.9 weeks’ supply and the U.S. season average farm price at $5.40 per bushel.  When we insert our non-expansion stocks levels from the balance sheet into Figure 2, we get prices responses as shown. Under the non-ethanol expansion scenario, carryover stocks rise.  So, the market places downward pressure on prices to encourage increased domestic livestock feeding and exports.  With current farm programs, we would expect corn prices under the non-ethanol expansion scenario of about $1.40 to $1.60 per bushel, as shown in Figure 2.  These correspond to the prices shown in Table 1.

Price Impact at the Margin

Note the concave shape of the curve in Figure 2.  This means that a reduction in supply when stocks are small will have a much larger impact on price than a reduction when supplies are large.  For example, the impact on corn prices when supplies are reduced from 20 to 15 weeks will have a much smaller impact than when reduced from 8 to 3 weeks.  So, when carryover stocks are small, a modest increase in usage can have a profound impact on price.  This is what we refer to as the price impact at the “margin”.

World Market Reinforces Ethanol Price Impact

The world corn supply-demand balance has a big impact on the U.S. corn market and vice versa.  At the world level, the amount of the world’s corn crop being used for ethanol is growing rapidly.  For the year ahead, about 115 million metric tons of corn are expected to be used for ethanol.  That’s about 14% of the world total corn use.  Four years ago, ethanol accounted for approximately 5% of world corn use.  The U.S. is the by far the largest processor of corn into ethanol.  Other countries with very small corn-based ethanol industries include China, Canada, and some EU countries.  This growth in corn for ethanol is significant, but would it account for the dramatic increase in western Corn Belt cash corn prices rising from $1.60 per bushel in the fall of 2004 to an all-time record high of $7.00 to 7.25 per bushel in late June for fall 2008 delivery and recent prices in the $5.00 to $5.30 range?  To answer that question, one needs to look at the global corn import demand and exportable supplies, crop acreage needed for the extra corn, and changes in the U.S. corn supply-demand balance resulting from the explosive growth in corn for ethanol and soybean oil for bio-diesel.  The U.S. is by far the world’s largest producer and exporter of corn, accounting for about 62% of world corn exports.

The global corn import market can be viewed as the excess demand or demand deficit in the importing countries.  That demand can be filled by:

   1. increasing domestic corn production, if that is possible,
   2. reducing domestic consumption, or
   3. imports.

If prices rise sharply in importing countries due to a demand surge somewhere in the world, a signal is transmitted to corn exporting countries that importers are willing to pay more for corn rather than reduce use.  An example would be late 1994 to early 1996, when China temporarily needed to import corn because of adverse weather and ineffective government production-incentive policies.  That produced a surge in demand for U.S. corn.

The short-term corn supply is inelastic.  This means that large price increases are needed to shift the available acres out of other crops and into corn.  In most countries, the corn demand also is highly inelastic.  This means that large price increases are needed to bring small reductions in use.  In a few months in the mid-1990s, corn prices more than doubled because the available corn supply could not be expanded quickly to respond to a global demand surge. Today, the markets are being driven by a demand surge from very high crude petroleum prices that make corn and soybeans viable energy crops.  Because of a weak dollar, export demand has been less responsive to price increases than domestic livestock feeding.

Major U.S. Corn Export Markets

The major import markets for U.S. corn are Japan, Mexico, Taiwan, the Republic of Korea, Canada, Egypt, and Columbia.  These countries account for 76 to 78 percent of U.S. corn exports.  They are not in a position to easily increase corn production because of climate or limited availability of land.  Their consumers are not easily persuaded to change food consumption patterns, so their corn demand is highly inelastic. Demand for food use of soybean oil plus soybean meal for livestock and production of animal-based food products also are inelastic.

A Global Perspective on the U.S. Biofuels Expansion

The U.S. biofuels expansion has created a new block of inelastic demand that is approaching 70% of global corn and other feed grain exports (see Figure 3). That’s after deducting the corn feed demand replaced by feeding distillers grain and solubles (DGS). With U.S. plants under construction, net ethanol use likely will soon match world corn exports. This demand growth is much greater than the surge stemming from Chinese corn imports in the mid-1990s.  Including this current marketing year, U.S. ethanol demand growth since 2004 has created a need for about 14 million more corn acres than were in production in 2004 or a reduction in other uses of corn.  That’s with a normal U.S. average corn yield. To maintain other uses and supply ethanol plants under construction, more corn land will be needed next year. The corn industry last year attracted 12.7 million more acres into production than in 2004.  A high price was needed to attract those acres into corn and away from other crops.

As with corn, soybean carryover stocks would have been ample, and likely would have kept soybean prices in the neighborhood of $5.00 per bushel. The red bars in Figure 4 show our projected U.S. soybean carryover stocks under this scenario.  Blue bars show historic and anticipated stocks.  The blue bars show carryover stocks under the non-expansion scenario.  A more detailed balance sheet with recent projections and non-biofuels expansion is also available.

Conclusions

While it is impossible to identify the precise contribution of the ethanol expansion to the sharp increase in corn prices since 2004-05, it clearly has had a major impact.  Use of soybean oil for biodiesel fuel also has had a positive impact on the demand for U.S. crops, although the ethanol-growth impact has been much larger.

Without the rapid growth in biofuels demand, the crop sector of U.S. agriculture likely would have re-entered an extended period of surplus production capacity, low prices and large government farm program costs.

American agriculture has had a long history of surplus production capacity and low prices that dates back to at least the 1930s.  Previous excess capacity has been interrupted briefly at times by adverse weather and sharply reduced yields, or by a surge in export demand, with lower prices following within a few years.  Whether the explosive growth in corn and soybean use for biofuels will be followed by a similar pattern depends heavily on the longer-term price of crude petroleum, as well as government policies.  Government policies are much more complex than in the past, due in part to efforts to monitor and control greenhouse gas production.

Sources

All data for 2004-05 and earlier are from the USDA, World Agricultural Outlook Board and USDA, Economic Research Service.  Hypothetical projections are by Robert Wisner.