The Renewable Fuel Standard (RFS) contained in the Energy Policy Act of 2005 mandated the use of corn-based ethanol in motor fuels. The recently enacted Energy Independence and Security Act accelerated this mandate to 9 billion gallons of ethanol in 2008 and 36 billion gallons in 2022. Recent spikes in food prices, however, have led many to question the wisdom of these mandates and subsidies that encourage the use of corn and other sources of food for use as fuel.
The monthly average price of corn jumped from $2.06 per bushel in January 2006 to more than $6.00 per bushel on the Chicago Board of Trade as of May 1, 2008. Not surprisingly, many observers believe that there is a correlation between the RFS mandate and the skyrocketing prices of corn and foodstuffs. In response, proponents of ethanol mandates and tax subsidies have claimed that food price hikes have nothing to do with the price of corn; that the increase in food prices is due to the higher price of energy. For example, Rick Tolman, chief executive of the National Corn Growers’ Association, deflected criticism of the ethanol mandates by saying, “If you want to know who the real axe murderer is, look at $4-a-gallon gasoline.” Bob Dineen, the president of the Renewable Fuels Association, said, “Rising oil prices have twice the impact [on food prices] of similar increases to corn.”
Although the causes of the increase in food prices are complex, a sober analysis of the data suggests that defenders of biofuel mandates are exaggerating the role energy prices have played in the recent spikes. They also seem to ignore the obvious impact of a policy that requires nearly 20 percent of the corn crop to be diverted for use in motor fuels. In fact, in its 2005 analysis, the Congressional Budget Office projected that the ethanol mandate could reduce farm support payments – due to higher corn prices – by more than $4 billion from 2005-2015.[1]
Perhaps the strongest argument put forth by proponents of the ethanol mandate is a recent study by Texas A&M researchers.[2] The study claims that “[i]mportant food items like bread, eggs, and milk have high prices that are largely unrelated to ethanol or corn prices” (p. 3). This conclusion naturally resonates well with those supporting the RFS mandates and continued subsidies.
However, a close reading of the Texas A&M study argues strongly against the notion that oil prices have driven up the price of food. The authors use an econometric model to gauge the equilibrium price effects of “shocks” to various input prices, in order to fully account for feedback loops in the system. Table 6.2 (p. 25) shows the results. The long run (i.e. after 24 months) impact of a 1 percent crude oil price shock was zero for every single food category in the model-namely eggs, bread, milk, beef, pork, chicken, lettuce, and tomatoes-and also zero for the overall food-at-home CPI; only food-away-from-home CPI was influenced, with a meager 0.007 percent increase. In contrast, a 1 percent shock to corn prices caused egg prices (after 24 months) to rise 0.250 percent, bread prices to rise 0.066 percent, and milk prices to rise 0.100 percent. Overall, the food-at-home CPI increased 0.038 percent for a 1 percent increase in corn prices. As the authors state: “for all retail food prices considered, we cannot find a statistically significant effect of crude oil prices” (p. 25). If ethanol proponents wish to continue pointing to the Texas A&M study, therefore, they will have to drop their rhetoric about oil prices driving up the cost of food.
Setting aside econometric models and employing common sense, rising corn prices surely have to have a major impact on some retail food prices. Feed costs can account for 50 percent of the cost of production for milk, and up to 80 percent for eggs. The price of corn feed is also a significant factor in the cost of raising cattle. For example, a lactating cow can consume 106 bushels of corn per year.[3] In truth there are many factors influencing commodity and food prices;[4] there is no single “smoking gun.”
In addition to the role played by biofuel mandates and energy prices, there is also the strong economic growth in developing countries such as China and India, where their increasing consumption of protein places upward pressure on feed prices for livestock. Another major factor has been the falling dollar, which depreciated a total of almost 20 percent against the euro during 2006 and 2007. A weaker currency not only makes imported items more expensive, but also amplifies foreign demand for American agricultural exports, thus raising their prices even higher. Rather than trying to pick “the” cause of higher food prices, the task is rather to assess the relative importance of the various factors.
It is difficult to measure the full impact on food prices of ethanol mandates and subsidies because of feedbacks in the economy. As farmers devote more land to corn, they must devote fewer acres to other crops, such as soybeans. This reduces the soybean crop, raising soybean prices. Therefore, even food items that have nothing to do directly with corn can see their prices rise because of competition for farmland. As explained in a USDA report:
“By the end of the 2006/07 crop year, over 2 billion bushels of corn (19 percent of the harvested crop) were used to produce ethanol, a 30-percent increase from the previous year. Higher corn prices motivated farmers to increase corn acreage at the expense of other crops, such as soybeans and cotton, raising their prices as well.“[5]
The USDA has assessed the direct impact of the cost of oil on food prices. A 1997 study used three different approaches to model the impact of a doubling of crude oil prices on food prices at home. The two short run models yielded estimates of 0.52 percent and 1.82 percent, while the long run model estimated that a doubling in the price of a barrel of crude oil would only lead to a 0.27 percent increase in the CPI of food at home.[6] We can use these estimates to interpret the recent rises in both food and oil prices. The food-at-home price index in March 2008 was 4.7 percent above the March 2007 level. During the same 12-month interval, the monthly average spot price of crude oil increased from $60.44 to $105.45,[7] a 74 percent increase. Therefore, using the highest estimate of the three USDA models, only 29 percent of the latest March/March rise in food prices can be attributed to rising crude prices, while the other 71 percent of the food-at-home CPI increase must be attributed to other factors. Using the sensitivity estimate from either of the other USDA models with lower estimates, the proportion of food price inflation due to the price of oil would be even less.
There are many factors that contribute to rising food prices including government-induced demand for ethanol, rising oil and gasoline prices, strong economic growth in poorer countries, and a general weakening of the U.S. dollar against other currencies. The price of gasoline is quite obviously not the “real axe murderer” in the rising price of food. Rising oil prices do account for a small portion of the recent spike in food prices. But when 20 percent of U.S. corn production is being diverted from the dinner table to the gas tank, we can confidently say that the ethanol mandate has had – and will continue to have – a lasting impact on the price of food.
Robert P. Murphy is an economist with the Institute for Energy Research (IER). His research focuses on the proper discount rate to be used in cost-benefit analyses and the implications of structural uncertainty for policy solutions.
[1] Congressional Budget Office, July 27, 2005. http://www.cbo.gov/ftpdocs/65xx/doc6581/hr6prelim.pdf
[2] Anderson, David P. et al. (2008) “The Effects of Ethanol on Texas Food and Feed.” Agricultural and Food Policy Center, Texas A&M, April 2008. Available at: http://www.afpc.tamu.edu/pubs/2/515/RR-08-01.pdf.
[3] See http://www.extension.org/faq/25593.
[4] Trostle, Ronald. (2008) “Global Agricultural Supply and Demand: Factors Contributing to the Recent Increase in Food Commodity Prices.” USDA WRS-0801, May 2008. Available at: http://www.ers.usda.gov/Publications/WRS0801/WRS0801.pdf.
[5] Leibtag, Ephraim. (2008) “Corn Prices Near Record High, But What About Food Costs?” AmberWaves February 2008. Available at: http://www.ers.usda.gov/AmberWaves/February08/Features/CornPrices.htm.
[6] Reed, A.J. et al. (1997) “Changing Consumer Food Prices: A User’s Guide to ERS Analyses,” USDA Technical Bulletin No. 1862, page 7, Table 5, available at http://www.ers.usda.gov/publications/TB1862/tb1862.pdf.
[7] See data on West Texas Intermediate crude spot prices, available through the EIA at http://tonto.eia.doe.gov/dnav/pet/hist/rwtcM.htm.
