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Weekly UpdatesIn the fall of 2006, the world awakened to the astonishing realization that agriculture was undergoing a major structural change. The US farm price of corn, having averaged US$2.00 per bushel in the 2005-2006 crop year, soared in the middle of the 2006 harvest from US$2.09 per bushel in August to US$3.00 in December and to a peak of US$3.50 in June 2007. The crop was about 4 percent smaller than the US Department of Agriculture had forecast in August, but the major reason was a frenetic effort to expand ethanol plants around the country. In September, Bill Tierney, then Executive VP for Research and Marketing for John Stewart and Associates, a financial trading company specializing in commodities and biofuels, reported that the ethanol production of existing plants and those under construction and probable would reach 8.0 billion gallons by August 2007--nearly 17 billion gallons by August 2008 and 19.0 billion gallons by August 2009.
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To put this expansion into perspective, ethanol production in the 2006-2007 crop year was about 6 billion gallons and used 2.1 billion bushels of corn, which was 20 percent of the crop. The 2009 corn crop will likely be about 12.3 billion bushels. Had ethanol production been ramped up to 19 billion gallons, this would have taken 6.8 billion bushels--over half of the projected crop. There is the prospect that ethanol production in the 2009-10 crop year will reach about 12 billion gallons and use almost a third of the corn crop.
Ethanol production in the United States had been expanding gradually from the early 1980s through 2001; it was given a boost by the Clean Air Act of 1990, which mandated oxygenated gasoline fuels in certain cities with unhealthy levels of air pollution. The competing oxygenates were ethanol and methyl tertiary butyl ether (MTBE), a petroleum product. The use of both oxygenates continued to expand until leaking underground storage tanks for MTBE were found to have contaminated water supplies in California and several other states. This led to bans in several states, thus shifting the demand for oxygenates to ethanol. Since MTBE had been approved as an oxygenate in the Clean Air Act of 1990, the petroleum industry wanted a shield from frivolous lawsuits included in the Energy Policy Act of 2005 signed into law on August 8, 2005. However, provisions for this were dropped. Tight supplies of oxygenates in mid 2006 forced the petroleum industry to bid up ethanol prices well over gasoline prices at wholesale. Profit levels for ethanol plants well exceeded US$1.00 per gallon from May to August. This situation contributed to the optimism evident in the ethanol industry heading into the fall of 2006.
The major federal incentive for ethanol production has been a "blenders' tax credit" amounting to about US$0.50 per gallon that was recently dropped to US$0.45. A blenders' tax credit for biodiesel has been added to energy legislation in recent years at US$1.00 per gallon. The Energy Policy Act of 2005 introduced Renewable Fuel Standards (RFSs) or mandates for blending of renewable fuels for a period of 2006 to 2012. These mandates were enlarged in the Energy Independence and Security Act of 2007 which, in essence, allocates RFSs to specific renewable fuels such as ethanol from corn starch, cellulosic sources, and biodiesel. These mandates, which started in 2006, end in 2022 with a total of 36 billion gallons. Of these, 15 billion gallons are for "conventional biofuels" (mostly corn starch and could include biodiesel, which is set at a minimum of 1 billion) and 21 billion for "advanced biofuels," including 16 billion gallons for "cellulosic biofuels."
US Energy Legislation
In a speech before the Brookings Institution on March 13, 2006, US Senator Richard G. Lugar of Indiana expressed a concern that the world will need 50 percent more energy within the next 25 years and that the United States would spend US$320 billion on crude oil imports in 2006 if prices remained at US$60 per barrel. As the then Chair of the US Senate Foreign Relations Committee, he articulated six threats posed by energy to national security: first, oil supplies are vulnerable to natural disasters, wars, and terrorist attacks; second, worldwide reserves of crude oil are diminishing within the context of explosive economic growth in China, India, Brazil, and many other nations; third, oil producing nations use energy as an overt weapon against import dependent nations; fourth, regimes in countries that are rich in energy are avoiding democratic reforms and are able to insulate themselves from international pressures and the aspirations of their own people; fifth, inefficient and unclean use of nonrenewable energy threatens climate change; and sixth, high energy costs counter efforts to stem terrorist activities in the developing world as such costs are more burdensome than in the developed world.
The insights of US Senator Lugar may require some re-examination in light of recent events but were relevant for the longer look ahead. His views reflected the attitude of Congress at that time which was shared across the aisle. Then US Democratic Senator Barack Obama joined him in introducing several bills to enhance biofuels. In addition to the concerns about the energy situation, broad political support emanated from efforts to shore up depressed farm prices and incomes and to generate development in rural areas often cited as economically deprived. The total cost to produce the US$2.00 corn in the 2005-2006 crop year cited in the first paragraph was about US$2.60 per bushel. Fortunately, the average farmer received about US$0.35 per bushel in direct payments from the farm program to help offset the loss. A clear rationale for the biofuel energy acts is to reduce the farm program costs.
The European Union also has a fairly ambitious biofuel program having ruled that at least 10 percent of land-transport energy must come from renewable sources, led by biofuels, in 2020. Possibly, a byproduct of the expansion in farm-based renewable fuels is that the agricultures in the developed world, often tending to surpluses, can be weaned away from government support and become more amenable to trade negotiation under the World Trade Organization (WTO).
The Price Spike of Crop Year 2007-2008
Following corn as a representative of the agricultural commodity market, farm prices retreated seasonally into the fall of 2007 to around US$3.30 per bushel and then climbed month by month without interruption to a peak of US$5.61 per bushel by July of 2008. As commodities most relevant for food prices, farm wheat prices peaked earlier at US$10.50 per bushel in March (compared to averages of US$3.42 and US$4.26 in crop years 2005 and 2006 respectively) and soybean oil, crude at Decatur, Illinois, peaked at 63 cents per pound in June (compared to averages of 23 and 31 in crop years 2005 and 2006 respectively). By early 2009, corn prices had dropped to the US$4.00 level, wheat to below US$6.00 and soybean oil to about 30 cents. These price patterns mirrored energy prices as crude oil prices (refiner acquisition cost for the composite of domestic and imported) increased from about US$70 per barrel in mid 2007 to a peak of US$129 in July 2008 and then retreated to the US$40 level in early 2009.
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During the period from mid 2007 to mid 2008, increasing concerns about the impact of rising commodity prices on food prices were registered in the press. The Economist ran a feature article entitled "The End of Cheap Food" (December 8-14, 2007) and later "The silent tsunami--The food crisis and how to solve it" (April 19-25, 2008). Considerable blame has been levied on the expanding production of biofuels in the US and in other nations as well, particularly the European Union. Some analysts have taken a broader look as was indicated in the US Department of Agriculture's (USDA's) Amber Waves. Multiple factors were cited in addition to biofuels. This included the rapid growth in global agricultural trade spurred primarily by rising incomes in developing countries, the depreciation of the dollar, worldwide production shortfalls in 2006-2007 and declining stocks of grains and oilseeds. Also cited were rising oil prices and the accumulation of petro-dollars and foreign exchange reserves generated by major oil-exporting countries.
Von Braun and Torero of the International Food Policy Research Institute (IFPRI) pointed out that trade policies of individual nations exacerbate the problems attendant to rising commodity prices. As of April 2008, 15 countries imposed export restrictions on agricultural commodities. Some net-food importing developing countries reduced import barriers. IFPRI modeling indicated that these trade restrictions could explain as much as 30 percent of the increase in prices in the first six months of 2008. They also pointed out that speculation contributed significantly to the global rise in commodity prices and proposed an "Independent Emergency Reserve" to counter such activity in the future.
As in the past periods of sharply rising commodity prices such as in the early 1970s, farmers have responded by increasing production. Peaks in commodity prices have been for short periods of time as can be observed for crop year average prices on corn in Figure 1. The peaks in the 1970s and early 1980s resulted in higher levels of carry over of coarse grain (corn, sorghum, barley and oats). Ending stocks as a percent of annual utilization exceeded 50 percent in the mid-1980s causing depressed farm incomes. The change in stock patterns since 1990 reflects a modification in US agricultural policies. For many years, "non-recourse loans" placed a floor under corn and other farm prices. If market prices fell below the loan, participating farmers could deliver the grain to government warehouses in satisfaction of the loan. As a result, in years of large crops or carryovers from previous years, stocks accumulated. Taking the crop off the market propped up prices to the benefit of non-participants and foreign producers as well. This system has been changed to one in which participating farmers receive a cash payment to make up the difference between the loan rate and the market price if it is below the loan rate.
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