Federal law that helped jump-start the ethanol industry in the United States also is shifting normal supply-and-demand forces within commodities markets, said a Purdue University agricultural economist.
Not quite four years after Congress passed the Energy Independence and Security Act in 2007, markets are struggling to meet both the law's renewable fuels standard and grain demands from the livestock, food and export sectors, said Wally Tyner, an energy policy specialist. About 27 percent of the nation's corn crop must be devoted to ethanol this year to meet the federal mandate, leaving other corn users to compete for the remaining 73 percent.
"The renewable fuels standard requires 15 billion gallons of ethanol be consumed per year by 2015, regardless of what the price of corn is and regardless of what the price of crude oil is," Tyner said. "Corn could be $2 a bushel or $10 a bushel, crude could be $50 a barrel or $100 a barrel and that 15 billion gallons has to be there. That means ethanol production is totally unresponsive to price. There's no flexibility."
This "inelasticity" has led to market volatility and wild swings in corn prices, which have topped $7 a bushel in recent months.
When markets are more inelastic, supply disruptions - known in economics as "shocks" - often push prices higher than they might be in a typical supply/demand system, he said.
A combination of shocks is placing greater pressure on corn supplies and raising questions about both the ethanol production mandate and the federal subsidy for ethanol, which stands at 45 cents per gallon. Those shocks include:
* An extraordinarily wet spring across much of the Corn Belt, which delayed planting and could lower crop yields this fall.
* A weaker U.S. dollar that is making it less expensive for many foreign buyers to purchase corn and helping maintain high foreign demand.
* Political unrest in Middle East oil-producing nations that sent oil prices surging this spring and made ethanol production more economically viable.
* Grain stocks at dangerously low levels, with the U.S. Department of Agriculture projecting about a three-week supply of U.S. corn by the end of August. Five weeks worth of supply is considered adequate.
"Then we can look at land availability," Tyner said. "In the U.S. we're about maxed out. There's little new land to grow corn. In 2008 when we needed more land for corn we got it from soybean acreage. When we needed more land for soybeans we got it from cotton acreage, and some from wheat. But now cotton prices are high, sugar is high, rice is high, corn is high, soybeans are high - everything's high. So there's no place to go within the U.S. for more land."
Since 2006 globally, 66 million new acres of land have come into production for major agricultural crops, Tyner said. Another 27 million acres have shifted from other crops to corn, soybeans and rapeseed.
"Even with these added acres, prices are high because global demand from all sources, including ethanol, has grown faster," Tyner said.
While the livestock industry has managed to pass along higher corn prices so far, some in the industry have called on Washington to temporarily waive the ethanol production mandate before prices climb even higher.
With pork prices up 13 percent since 2008 and beef prices up 11 percent since then, producers can afford to pay more for corn now than they could in 2008-09, Tyner said.
"The administrator of the Environmental Protection Agency has the right to waive the mandate if it is perceived that significant economic harm is occurring because of it," Tyner said. "The mandate has led to a capacity to produce ethanol that exceeds 14 billion gallons today. Are ethanol producers going to let their plants sit idle?
"As long as oil prices are high and it's profitable to produce ethanol, we're going to keep doing it with or without the mandate, at least in the near term."