Policy Positions: Food vs. Fuel

Driven by the American public’s demand for alternatives to high-priced foreign oil, the production of ethanol in the U.S. has experienced an 800% increase since the start of the decade. Despite the well-documented economic and environmental benefits of expanded biofuels production, some critics have alleged increased ethanol production is diverting grain from food and feed markets and leading to higher retail food prices. Critics have suggested that crop-based biofuels simply can’t provide significant volumes of energy for transportation without starving the world’s poor. This emotionally-charged “food versus fuel” debate has unfairly plagued American ethanol production since its very inception. Of course, these ridiculous claims have been disproven time and time again, and the world’s farmers have repeatedly shown that they are more than capable of meeting the planet’s growing demands for food, feed, fuel, and fiber. Further, biofuels have proven themselves around the globe as essential conduits for rural development and technology transfer – not rural oppression.

Alarmist rhetoric was rampant in the summer of 2008 as corn prices followed oil prices to record highs, but mainstream media and opinion leaders have recently taken a more careful and measured approach to the discussion over current grain market dynamics and the role of biofuels. Stepping back for a holistic view of the global grain market coupled with multiple new analyses has tempered a repeat rush to judgment about the Food vs. Fuel canard. To quote the visionary Yogi Berra again, “You can observe a lot by just watching.”

DRAMATIC INCREASES IN CROP PRODUCTIVITY HAVE ENSURED ADEQUATE SUPPLIES OF CORN ARE AVAILABLE FOR ALL USES

No reasonable advocate for American ethanol will tell you that using corn to produce ethanol has no impact on food prices.  But, to suggest that the driving factor behind the rise in food prices is our effort to develop a domestic renewable ethanol industry is disingenuous.  An historic look at U.S. corn production and demand streams demonstrates that virtually every bushel of corn now turned into fuel and feed by U.S. ethanol producers comes from increases in productivity ­– not by “diverting” supplies from other uses like livestock feed.

Improved farming practices and seed technology advances are responsible for the dramatic increases in corn yields over the past four decades. Corn yields during 1970-1980 averaged 89.8 bushels per acre whereas corn yields during 2000-2010 averaged 145.4 bushels per acre. Average corn yield per acre has more than doubled in the last 40 years, from 72.4 bushels per acre in 1970 to 152.8 bushels per acre in 2010. In 2010, U.S. farmers had the third largest crop and fourth-highest average yield in history. Seed companies such as Monsanto and Pioneer project average corn yield may double, reaching 250 to 300 bushels per acre by 2030.

Annual grain supplies have grown large enough to satisfy increased demand from all end users. The impact of U.S. ethanol production on world grain supplies is minimal for feedstock demand. U.S. ethanol production accounts for just 3% on a net basis of what is projected to be the largest global grain supply in history in 2011. That means 97% of all the grain produced in the world is available for other uses. It’s important to understand that there are different types of corn: sweet corn is consumed by humans and not used in the production of ethanol whereas field corn is used to feed livestock as well as to produce ethanol.

ETHANOL FEED CO-PRODUCTS MAKE AN IMPORTANT CONTRIBUTION TO THE GLOBAL FEED AND FOOD SUPPLY

Discussions of ethanol’s impact on world grain markets often neglect the important contribution of distillers grains, corn gluten feed and corn gluten meal, the primary animal feed co-products resulting from the grain ethanol process. Every 56-pound bushel of corn entering the ethanol process produces about 2.8 gallons of ethanol and 17 pounds of high nutrient livestock and poultry feed. Thus, of the 4.7 billion bushels of corn projected to be used for ethanol in 2010/11, approximately 1.4 billion bushels (more than 35 million metric tons) are more accurately characterized as being used for animal feed production. In addition to feeding U.S. beef and dairy cattle, swine, and poultry, ethanol feed co-products are increasingly satisfying foreign demand for protein and energy feeds to the tune of approximately 9 million metric tons. That’s the equivalent of 350 million bushels of corn. Put into context, the livestock feed production of American ethanol producers is enough to produce 50 billion quarter pounders a year – that’s 7 hamburgers for every person on the planet. 

FARMERS RESPOND QUICKLY TO PRICE SIGNALS FROM THE MARKETPLACE

Higher world prices for corn resulting in part from lower-than-expected 2011 production in the U.S. and elsewhere will lead farmers in other parts of the world to plant more corn instead of other less profitable crops. Further, U.S. farmers have a history of responding quickly to market signals by adjusting acreage and switching crops to best capitalize on current and expected prices. As an example, a short corn crop in 1995 caused prices to spike and left ending stocks at just 426 million bushels. Farmers responded the next year by increasing corn acres by 11% and boosting total production by 25%. More recently, farmers increased corn acreage by some 15 million acres in 2007 in response to demand and price signals. The 19% increase in corn acreage and 24% increase in production in 2007 clearly demonstrate the ability of farmers to react swiftly to changes in the marketplace.

THE ROLE OF SPECULATION IN COMMODITY MARKETS

July 2010 World Bank research found “…the use of commodities by financial investors (the so-called ‘financialization of commodities’) may have been partly responsible for the 2007/08 spike.” A November 10, 2010 Wall Street Journal article echoed those results, noting the major factors driving up corn prices are U.S. monetary policy, speculation by Wall Street hedge funds, and surging demand from emerging markets. This goes for all commodities from grains to precious metals. Demand for ethanol production, by comparison, plays a relatively minor role.

The recent run-up in grain prices likely will prove to be grossly exaggerated, due to the unprecedented influx of speculative investment in grain futures. By early September 2010, there was more speculative investment in the corn futures market than ever before­–even more than at the height of the 2008 bubble. Non-commercial investors (e.g., hedge funds) and “index traders” together control roughly 4.3 billion bushels of corn – nearly equivalent to the amount of corn the ethanol industry used in 2010. As we saw in 2008, these investors can have perverse impacts on the market—and they can exit the market just as quickly as they entered, resulting in the collapse of prices.

An April 2008 study by Texas A& University found that, “Speculative fund activities in futures markets have led to more money in the markets and more volatility. Increased price volatility has encouraged wider trading limits. The end result has been the loss of the ability to use futures markets for price risk management due to the inability to finance margin requirements.”

BIOFUELS POLICY AND FOOD PRICES

An April 2011 report by Iowa State University suggests that market forces (chiefly high oil prices, low corn prices, and the phase-out of MTBE) had far more to do with ethanol expansion from 2005-2009 than the Volumetric Ethanol Excise Tax Credit (VEETC) and Renewable Fuel Standard (RFS). Thus, according to the authors, ethanol market dynamics were responsible for a larger share of the corn price increase during the study period. Still, their modeling revealed that just one-quarter ($0.45) of the average corn price increase from 2006-2009 could be attributed to the market-based expansion of the ethanol sector. Taken together, market-based ethanol expansion and the VEETC accounted for about one-third of the corn price increase, while other factors explained two-thirds of the increase, according to the paper. In certain years, ethanol policy and market-based expansion had an even smaller impact. In 2007, for example, “…almost 80% of the observed rise in corn prices was due to factors other than ethanol.” These modeling outcomes led the authors to suggest that “…most of the change in corn prices that we have seen is not due to ethanol expansion but rather is due to other forces at work.”

This Iowa State research found that only 8% ($0.14/bushel) of the increase in average corn prices from 2004 to 2006-2009 can be attributed to the existence of the blender’s credit (VEETC). Further, the authors write that, “Corn prices without the ethanol subsidies would have averaged only 4% less over this period than what they were.” Because VEETC’s contribution to corn prices was so small, the impact on food prices was even smaller. The authors write that the relatively small change in corn prices “…necessarily implies that the contribution of ethanol subsidies to food inflation is largely imperceptible in the United States.”

FARM SHARE OF FOOD DOLLAR & THE FOOD CPI

The U.S. Department of Agriculture Economic Research Service (ERS) generated a report in February 2011 that found that just 11.6 cents of every dollar spent on food makes its way back to the farm. That share can be broken down further to approximate the contribution of individual commodities. Corn typically represents about 15% of the total farm value of all U.S. agricultural food and feed products. Thus, it could be argued that corn’s share of the food dollar is just 1.7 percent (15% of 11.6%). Admittedly, the math is rough, but it shows the almost negligible impact of corn on retail food prices.

According to a comprehensive study by Informa Economics, “the statistical evidence does not support a conclusion that there is a strict ‘food-versus-fuel’ tradeoff that is automatically driving consumer food prices higher.” The analysis further found that “…there has historically been very little relationship between annual changes in corn prices and consumer food prices. The corn price would be considered a statistically insignificant variable in determining what drives the food [consumer price index].” Rather, the report concludes that retail food prices are determined by a complex set of inter-related factors, including supply chain costs for energy, labor, transportation, packaging, and other marketing-related expenses.

Informa Economics found that the “farm value” of commodity raw materials used in retail foods accounts for just 16% of total U.S. food costs, a proportion that has declined significantly from 37% in 1973. For food products where corn is only one of several farm-produced inputs, the proportion of the total product cost attributable to the cost of corn is even less than 16%. The remaining portion of total retail food costs is known as the marketing bill. The costs of other components in the marketing bill (e.g., labor, packaging, transportation, energy, profits, advertising, depreciation, rent, interest, repairs, and business taxes) have also been increasing and general inflationary pressures have also impacted food prices. Increases in these marketing bill components are contributing to food price increases, as reflected in the growing farm-to-retail price spread for many food categories.

The Informa Economics study shows that historical price relationships between corn prices and livestock, poultry, egg, and milk prices show relatively weak correlations. With these low correlations, it is statistically unsupported to suggest that high and/or rising corn prices are the only or even the main reason behind high and rising retail meat, egg and milk product prices. Ethanol has not been the only factor influencing corn prices; other supply and demand factors have also been at play. Weather events, a decline in the U.S. dollar, strong export demand, and steady feed demand are among the supply/demand factors that have pressured corn prices in recent years.

THE ROLE OF ENERGY PRICES ON FOOD PRICES

So, if the farm value of each food dollar is actually decreasing, and corn demand and price are even smaller factors in food price determination than previously thought, what is driving American food bills higher? The simple answer is and has been energy. Researchers at Texas A&M concluded, “The underlying force driving changes in the agricultural industry, along with the economy as a whole, is overall higher energy costs, evidenced by $100 per barrel oil.” According to ERS, energy-intensive sectors are the second largest contributor to food prices – only trailing labor costs.  And, as labor costs tend to be more stable and predictable, the volatility in energy prices is driving the sticker shock Americans may be feeling at the checkout counter.  Totaling up the percentages for food processing, packaging, transportation – all energy intensive activities – and actual energy costs, nearly 33% of each food dollar is spent in these energy intensive areas.  If you frequently eat away from home, labor and energy costs gobble up even more of your food dollar and leave just 3.4% for those involved in agriculture. Informa Economics underlined the important role of energy prices in determining consumer food prices and the ability of ethanol to reduce gasoline prices. “Within the overall marketing bill, the costs of energy and transportation have increased considerably over the last several years, with crude oil prices surging from just under $60 per barrel in fall 2006, reaching above $100 per barrel in the first half of 2008, falling back down during the economic recession and again breaking $100 per barrel in 2011, roughly the same periods during which corn prices have increased.”

“There is very clear evidence that oil prices are continuing to have a disproportionate effect on the price of our food,” according to the Global Renewable Fuels Alliance (GRFA). The United Nations Food and Agriculture Organisation’s (UN FAO) Deputy Director, David Hallam confirmed this same finding in early March 2011 by saying that “unexpected oil price spikes could further exacerbate an already precarious situation in food markets.” The International Energy Agency called rising oil prices “dangerous,” warning that high oil prices could threaten the stability of an already fragile recovering global economy. In January 2011, the UN FAO’s global Food Price Index hit an all-time high. According to the GRFA, data going back 30 years shows that the price of oil has driven the price of food and key grains, making prices directly proportional. Also, when shocks to the price of oil occur, the cost of food and key grains has followed suit. When oil prices spiked in the early 1980s, corn and rice also rose to new highs. When oil shot to more than $140 per barrel in 2008, crop prices also spiked to an all-time high, driving the FAO Food Index higher as well.

Biofuels indirectly exert downward pressure on food prices by reducing energy prices. According to Informa Economics research, “…to understand the net impact on consumers’ financial condition, changes in expenditures on not only food but also fuel would have to be considered. Specifically, if more abundant supplies of ethanol were to result in a measurable reduction in retail fuel prices, this would have to be compared to any food price increase in determining the net impact to consumers.”

April 2011 research by Du and Hayes found that the growth in ethanol production reduced U.S. gasoline prices by an average of $0.25, or 16%, over the entire decade of 2000-2010. Similarly, an analysis by Merrill Lynch found that, “Biofuels are making up a huge portion of oil supply growth…” and, “On a global scale, biofuels are now the single largest contributor to world oil supply growth. We estimate that retail gasoline prices would be $21/bbl higher, on average, without the incremental biofuel supply.”

BIOFUELS AND FOOD SECURITY

The UN FAO released information in May 2011 about its new “Bioenergy and Food Security (BEFS) Analytical Framework," which was created to help governments evaluate the potential of bioenergy as well as assess its possible food security impacts. It suggests that robust bioenergy industries can enhance food security in developing nations, stating that, “…investment in bioenergy could spark much-needed investment in agricultural and transport infrastructure in rural areas and, by creating jobs and boosting household incomes, could alleviate poverty and food security.” “FAO has been saying for years that under-investment in agriculture is a problem that seriously handicaps food production in the developing world, and that this, coupled with rural poverty, is a key driver of world hunger," according to BEFS project leader Heiner Thofern. "Done properly and when appropriate, bioenergy development offers a chance to drive investment and jobs into areas that are literally starving for them." FAO studies have shown that small-scale bioenergy projects not targeting export markets can improve food security and help boost rural economies. FAO points out that, as with development of any energy source, there are potential environmental, social, and economic considerations that must be contemplated when evaluating the benefits of a bioenergy project for a particular community or region. FAO says bioenergy likely isn’t a universal “silver bullet” solution that will be appropriate for every community in every case. “That being said, we can't turn our back on the fact that in other cases, bioenergy production holds great potential to revitalize rural economies, reduce poverty, and improve household food security,” Thofern says.

The second major international statement about the rural development and food security benefits of biofuels came in May 2011 as the Global Bioenergy Partnership (GBEP) announced it has agreed on a voluntary framework intended to help countries assess and develop sustainable production and use of bioenergy. GBEP is a group of government officials, organizations and institutions from around the world that was established to implement the commitments made by the G8 in 2005 to support biomass and biofuels deployment, “particularly in developing countries where biomass use is prevalent.” The government officials involved clearly had an eye on the vast potential of bioenergy to improve the quality of life in developing nations. In a GBEP statement, Daniel Clune of the U.S. Department of State said, “Modern bioenergy encompasses many technologies that have the potential to not only promote sustainable development, but also help meet two important needs in the developing world by enhancing food and energy security. The latest research shows that when done rationally and thoughtfully, sustainable modern bioenergy creates a virtuous cycle that improves agricultural productivity and draws investments in to expand associated infrastructures and promote economic and social development.” Indeed, one needs look no further than the American heartland to witness first-hand the tremendous rural economic development benefits of biofuels. What reason do we have to believe the U.S. biofuels model can’t be successfully replicated in developing nations around the globe? It’s encouraging to see influential international organizations and world leaders recognizing that bioenergy is a solution – not a threat – to economic development and food security in developing nations.

BIOFUELS ACQUITTED OF CHARGES OF FOOD PRICE SPIKES AND WORLD HUNGER

A number of new independent studies conducted by governmental agencies, universities, financial analysts, and others on the role of biofuels in the 2007/08 commodities bubble conclusively show that the increasing use of grains like corn for ethanol production played a negligible role in the recent rise in U.S. food prices. These analyses acknowledge that a number of simultaneously occurring factors – including rising energy costs, speculation in commodities markets, currency fluctuations, underinvestment in agricultural technology, changing diets in developing countries, and rising agricultural production costs – all contributed to higher food prices around the world in 2007/08.

A March 2010 report by the United Kingdom’s Department for Environment, Food and Rural Affairs found that, “available evidence suggests that biofuels had a relatively small contribution to the 2008 spike in agricultural commodity prices.” Even the World Bank, which in 2008 suggested biofuels was playing a large role in higher food prices, released an analysis in July 2010 that found “…the effect of biofuels on food prices has not been as large as originally thought…” and that “…the use of commodities by financial investors may have been partly responsible for the 2007-08 spike.”

The findings of a 2009 Congressional Budget Office analysis concluded that “…from April 2007 to April 2008, the rise in the price of corn resulting from expanded production of ethanol contributed between 0.5 and 0.8 percentage points of the 5.1 percent increase in food prices measured by the Consumer Price Index (CPI). Over the same period, certain other factors—for example, higher energy costs—had a greater effect on food prices than did the use of ethanol as a motor fuel.”

A study released in June 2011 by the Geneva-based International Centre for Trade and Sustainable Development (ICTSD) found that “…US ethanol subsidies during this period (2005-2009) had little impact on consumer prices and quite modest impacts on crop prices.” It concluded that the most significant impact of U.S. ethanol policy on retail food prices was a two-cent-per-dozen (1 percent) increase in egg prices in just one of the last five years. Meanwhile, retail prices for beef, pork, and poultry meat were impacted by “much less than 1 percent.” The ICTSD study was authored by Iowa State University professor Bruce Babcock and it builds upon an April 2011 Iowa State University’s Center for Agricultural and Rural Development (CARD) paper. Professor Babcock ran a complex economic model to examine how U.S. ethanol policies influenced prices for agricultural commodities and food products from 2005-2009. For commodities, Babcock found that the impact of ethanol policy on corn prices was “modest.” The largest impact on corn prices occurred in the 2007 marketing year when prices would have been $0.30 per bushel (7.1 percent) lower than they actually were, according to the modeling results. The impact on wheat, rice, and soybean prices “was even smaller,” Babcock wrote.

As for consumer food prices, the ICTSD study found impacts of ethanol policy were negligible. For broilers, the modeling results show that prices wouldn’t have changed by even one penny/pound if there hadn’t been ethanol policies in place. For pork, prices would have been one penny/pound lower (three-tenths of 1 percent) in one year, but identical in the other four years. It’s the same for beef, with prices identical in four years and only one penny (two-tenths of 1 percent) lower in one year. The largest impact was for eggs, where prices would have been two pennies (1 percent) per dozen lower in one year if we hadn’t had ethanol policies in place.

Clearly, based on the ICTSD study results, one can conclude that U.S. ethanol policies have not been a factor in retail food prices in the last five years and have been only a modest driver of commodity prices. In addition, any microscopic impact on food prices that might be attributable to ethanol policy would be overwhelmingly offset by the savings on gasoline prices that results from increased ethanol use.

A study by Mueller et al. found very little support for statements that ethanol was the driving factor in the last quick run up in commodity prices in 2007-2008. “It is not possible to reconcile claims that biofuel production was the major factor driving food price increases in 2007–2008 with the decrease in food prices and increase in biofuel production since mid-2008. The available data suggests that record grain prices in 2008 were not caused by increased biofuel production, but were actually the result of a speculative bubble related to high petroleum prices, a weak US dollar, and increased volatility due to commodity index fund investments.”

Notably, in 2010 the World Bank itself renounced the results of its own 2008 study on biofuels and food prices. The World Bank found “…the effect of biofuels on food prices has not been as large as originally thought, but that the use of commodities by financial investors (the so-called “financialization of commodities”) may have been partly responsible for the 2007/08 spike.”

USDA-ERS confirmed that “Attributing most of the rise in food commodity prices to biofuel production, however, seems unrealistic. Crop prices dropped more than 30 percent during the last half of 2008 even though biofuel production continued to increase. Further, nonagricultural prices rose more than agricultural prices, and the price of corn (an ethanol feedstock) rose less than for rice and wheat (not biofuel feedstocks). Clearly, there were other factors at play.”

For opponents of ethanol and beneficiaries of cheap corn, pointing the finger at biofuels has become the reflexive knee-jerk response any time grain prices start to rise. The fact is that ethanol’s impact on grain and food supplies is marginal. It is clear from the latest research that ethanol is not the primary driver of food prices.

WORKS CITED

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Babcock, Bruce A. The Impact of US Biofuel Policies on Agricultural Price Levels and Volatility. Issue paper no. 35. International Centre for Trade and Sustainable Development (ICTSD) Programme on Agricultural Trade and Sustainable Development, June 2011.

Babcock, Bruce A., and Jacinto F. Fabiosa. The Impact of Ethanol and Ethanol Subsidies on Corn Prices: Revisiting History. CARD policy brief no. 11-PB 5. Iowa State University Center for Agricultural and Rural Development (CARD), April 2011.

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updated October 2011