Revisiting the Impact of Biofuels on Agriculture
AgMRC Renewable Fuels Monthly Report
Retired Agricultural Extension Economist
In the June, 2008 issue of the Renewable Energy Report I wrote an article listing ten ways in which I believed the emerging biofuels industry would impact production agriculture. The article was written six months after the passage of the Energy Independence and Security Act which contained the Renewable Fuel Standard. Now, over seven years later, let’s look at how things played-out. For each of the ten points I will briefly summarize my comments from 2008 and then provide a 2015 response. Before we get to the ten points, let’s look at how I introduced the topic.
June 2008 -- U.S. agriculture is going through one of the biggest changes in the last 100 years. Essentially, it is changing from a “surplus” production capacity industry to a “deficit” production capacity industry. A primary driver of this change is the entrance of the agricultural into the energy industry. Corn ethanol (and to a lesser extent biodiesel) is the first phase of agriculture’s entrance into the energy industry. Other linkages between agriculture and energy will follow.
October, 2015 – Biofuels over the last decade have been a major driver in turning agricultural crop production from surplus to deficit and creating periods of high profitability. However, the slow pace at which the biofuels industry is evolving and growing brings uncertainty to its future impact on production agriculture.
1) Commodity Business
June 2008 -- Corn ethanol production (as with other biofuels) is a commodity business requiring the purchase of commodity corn and the sale of commodity ethanol. A characteristic of commodity industries is that production capacity is expanded until profits are driven to a minimum. Ethanol production capacity will continue to expand until either the price of ethanol is driven down, the price of corn is driven up, or both.
October, 2015 – As shown in Figure 1, after a period of ethanol production capacity expansion from 2005 through 2007, the price of corn was bid up to the ethanol breakeven corn purchase price (ethanol revenue less all production costs except corn) and stayed at that level until 2014 and 2015 when corn supplies began to exceed corn demand.
The Renewable Fuels Standard (RFS) which requires a certain minimum amount of ethanol usage and subsequently a certain amount of ethanol production and corn usage creates results that are somewhat different than those of a free ethanol market. Even so, high corn prices limited ethanol profits during much of the past decade.
Source: Iowa State University
2) A Rising Tide Lifts All Boats
June 2008 -- “A rising tide lifts all boats” is often used in economic circles to indicate that a growing economy benefits all people. Stating the same concept somewhat differently, “a rising corn price lifts all grain prices.” This rise occurs because high corn prices are not caused by a limited supply of corn acres. Corn acreage can expand easily. Rather, high corn prices, over the long term, are caused by a limited number of total cropland acres. If we have more acres of corn, it means fewer acres for other crops, and fewer of acres for other crops will drive up the prices of those crops.
October, 2015 – When there are not enough total cropland acres to meet the production needed to meet the aggregate demand from all crops, crops begin to compete against each other for acres. This competition drives crop prices higher.
As shown in Figure 2, the additional demand for corn for ethanol production had a positive impact on the prices of corn, soybeans and wheat. A positive price impact also occurred for minor grains and oilseed. This price impact continued until the last couple of years when production once again began to exceed usage for corn, soybeans and wheat, resulting in declining price levels.
Source: Iowa State University, USDA
As shown in Figure 3, corn acreage expanded due to the demand for corn for ethanol production. However, other factors were also at work. Oilseed acreage (primarily soybeans) expanded even more than corn acreage due to increased export demand for soybeans (primarily China). World-wide crop problems and a major U.S. drought impacted harvested acreage levels. The acreage of other grains including wheat declined slightly. Most of the increased corn and soybean acres eventually came from hay and other minor crops. Although other factors were also involved in the changing acreages of individual crops, corn for ethanol was a major driver of these changes and the subsequent increase in crop prices.
3) Crop Price Volatility
June 2008 -- In this new environment, crop prices will be influenced by both food and energy demand factors. The demand from the food sector is relatively stable. By contrast, the energy industry is going through a period of monumental change, leading to uncertainty and rapid changes in supply and demand conditions. These conditions will lead to volatile energy prices which in turn will lead to volatile crop prices.
October, 2015 – Although crude oil prices have been volatile, especially with the recent major price decline, the ethanol production requirements of the RFS have the ability to offset some of the corn price volatility. So corn price volatility has not been as great as it could be under free market conditions. However, non-energy supply and demand changes also cause price volatility and the fixed demand of the RFS may actually increase this volatility. In addition, when grain supplies are limited relative to demand, small changes in supply or demand can have a substantial impact on price volatility.
4) Impacts on the Livestock Industry
June 2008 -- Higher feed prices are putting intense pressure on livestock profits. Economic theory tells us that the industry will adjust as higher feed prices will eventually be translated into higher meat prices as supply is reduced.
October, 2015 – The corn price increases resulting from the demand for corn for ethanol production had a negative impact on livestock profitability. As examples, Figure 4 shows the number of monthly losses for Iowa farrow-to-finish and finishing steer calves livestock enterprises. Although many other factors impact livestock profitability, during 2008, 2009 and 2011 through 2013, when corn demand for ethanol production had pushed up corn prices, were years of numerous monthly losses.
Source: Iowa State University
It should be remembered that distillers grain is a feed by-product of corn ethanol production. This byproduct goes back into the livestock feed supply and offsets a portion (about one-third) of the corn that is channeled from livestock feed to ethanol production.
5) Farmland, the Limiting Resource
June 2008 -- Higher grain prices are assumed to be beneficial for grain farmers. However, profits accrue to the limited resource which in agriculture is farmland. Farmers bid profits into higher farmland rents and market values. Many farmers own land so they receive the returns from both operations and ownership. However, most cropland in Iowa is owned by someone other than the operator.
October, 2015 – Figures 5 and 6 show the trends in Iowa cropland rental rates and farmland market values during the last ten years. As expected, both rental rates and sale values increased rapidly during this period of high crop prices. Market values were helped along by unusually low interest rates. If crop margins remain low (as currently exist) and interest rates rise, rental rates will need to be reduced and sale values will drop of their own accord.
Source: Iowa State University
Source: Iowa State University
Somewhat unexpected during this period of large crop profit margins was the substantial increase in the price of some production inputs as shown in Figure 7. Examples are the prices of seed and diesel fuel.
Source: Iowa State University
6) Meeting the Demand
June 2008 -- Can we increase U.S. crop production capacity to meet the expanding demand posed by biofuels while still meeting the needs of the food industry? There is little doubt that we can meet the challenge of increasing crop output over the coming years.
October, 2015 – As indicated by the current low prices, we are probably meeting the food, feed and energy needs better than expected. Figure 7 shows that even with the increased usage of corn for ethanol production, the amount of corn used for other uses (mainly feed and exports) is about the same this year as it was ten years ago.
Note in Figure 8 that the amount of corn used for ethanol has been adjusted by removing the amount of corn used for producing the distillers grains byproduct. Also note that only a small amount of the corn usage adjustment due to reduced corn production of the 2012 drought year occurred in ethanol production, forcing much of the adjustment to come from other corn uses and thereby increasing corn price volatility.
Figure 9 shows the U.S. corn yield trend over recent decades. Although not as spectacular, many other crops have similar yield trend increases. If these yield increases continue as they have in the past, and if the biofuels industry is slow to evolve and grow, the question may not be “can agriculture meet the demands of both food and fuel”, but “will agriculture exceed the demands of food and fuel”. A wild card affecting crop yield increases in the future is how climate change will impact yields.
7) Industry in its Infancy
June 2008 -- The biofuels industry is a new player on the business landscape. Typical of industries in their infancy, the biofuels industry will evolve rapidly in coming years. Corn ethanol is the first phase of the biofuels evolution. Other phases will follow. Technology and innovation will create a cascade of changes and improvements.
The biofuels industry has not evolved as rapidly as expected. Ten years ago there was much anticipation that corn ethanol was only the first phase. That it would be followed by an array of other feedstocks for ethanol and biodiesel production and a number of other biofuels would emerge in addition to ethanol and biodiesel.
After much fanfare, cellulosic ethanol has been slow in meeting its promise as a major biofuel. Technological breakthroughs to produce ethanol from crop residues, grasses and other biomass sources have been slow to emerge.
Also, the development of other biofuels has been slower than expected. Biobutanol, considered to be superior to ethanol and produced from the same feedstocks as ethanol, has not emerged as a serious player. Renewable hydrocarbon biofuels, similar to petroleum gasoline, diesel and jet fuel, can be made from biomass. These fuels, sometimes called “drop-in” or “green hydrocarbons” can be used in vehicles with no engine modification and utilize existing distribution systems. But they have not emerged as a serous players either.
8) A New Set of Players
June 2008 -- The emergence of biofuels is attracting a new set of players to the agriculture sector. These players, including finance, technology, venture capital and others, will be competing with us for a piece of the action.
October, 2015 – Because the biofuels industry has been slower to evolve than expected, the agriculture industry players are not significantly different than a decade ago.
9) Climate Change and Carbon Emissions
June 2008 -- A powerful new factor has entered the economic calculus of the supply and demand for renewable fuels including biofuels. Over the past years the dangers of greenhouse gas emissions have been confirmed. So biofuels are being called upon to achieve a reduction in the carbon footprint of transportation fuels.
October, 2015 – There were three powerful forces behind the RFS, 1) the need to improve the profitability of the farm sector 2) the need to reduce our dependence on foreign oil, and 3) the need to reduce greenhouse gas emissions.
There is little doubt that biofuels have improved the profitability of the farm sector over the short-term. However, for this to last into the long-term, significant major breakthroughs will be needed.
With the development of “fracking”, U.S. oil and gas supplies have increased substantially. So, our dependence on foreign oil has declined substantially. The U.S. may actually become an oil exporter.
During the last decade there has been much controversy over the amount by which corn ethanol has a smaller carbon footprint than gasoline. Regardless of the actual reduction, it pales in comparison to other renewable energy sources such as solar. However, cellulosic ethanol has a much smaller carbon footprint than corn ethanol and is competitive with other types of renewable energy.
10) History of Little Significance
June 2008 -- People often use historic prices and past experiences for making decisions relative to the future viability and profitability of agriculture and the bio-fuels industry. However, by all indications, we have entered a new era in agriculture.
October, 2015 – Will the impact of biofuels on the energy market be minimal in size and brief in duration? This question is not to say that the renewable energy industry will not live up to expectations. The need to reduce carbon emissions will drive the industry. This need will result in advances in renewable energy sources such as solar and wind that are poised to make major contributions in moving the renewable energy sector forward. Will bio-based energy sources such as biofuels be part of this future? The agriculture industry must be diligent in pushing forward in the development of new and improved biofuels.
History may still have a place in predicting the future of agriculture. U.S. production agriculture over the 20th Century was marked by spikes of high prices followed by long periods of low and relatively flat commodity prices and breakeven profit levels. Will this trend persist into the future or will biofuels change this historic trend?
Alternative Fuels Data Center, U.S. Department of Energy
Ag Decision Maker, Iowa State University