Oil prices drive ethanol, corn prices — U.N. study

Source: Amanda Peterka, E&E reporter • Posted: Tuesday, December 17, 2013

Oil prices are the long-run drivers of ethanol and corn prices, according to a new study by economists from the U.N. Food and Agriculture Organization.

FAO economists Natalia Merkushev and George Rapsomanikis found that in the long run, ethanol prices move with oil prices — though their relationship is affected by federal policies like the renewable fuel standard. In general, a 10 percent increase in the price of oil will cause a 4.5 percent increase in the price of ethanol in the long term, the study said.

The relationship between ethanol and corn prices is more complex, the economists found. Ethanol and corn prices form a system in which ethanol drives the price of corn and corn drives the price of ethanol. On average, a 10 percent increase in ethanol prices results in a 14.2 percent increase in the long-term price of corn, the study found.

Merkushev and Rapsomanikis presented their preliminary results in April; a final report is available on the Agricultural Market Information System online. The report comes amid a heated debate in the United States over the role of the federal government in spurring ethanol production and the effect of heightened ethanol production on food prices.

“Our working hypothesis was that profit maximization, the US biofuel policies and automotive engine technology give rise to a nonlinear relationship between oil and ethanol prices, and by extension between oil and grains prices,” the researchers said in the study. “We found that oil prices are the long run drivers of ethanol and grains prices.”

The renewable fuel standard, through which U.S. EPA sets yearly targets for ethanol and advanced biofuels, affects the relationship between oil and ethanol prices, according to the study. Because the standard sets a floor for biofuel production each year regardless of market conditions, the prices of oil and ethanol can be unrelated up to the volume set by the standard.

Above the standard, though, the prices of oil and ethanol determine how much ethanol a refiner is willing to blend into petroleum-based fuel.

“Relative costs will determine ethanol demand with blenders substituting an expensive fuel (e.g. petrol) with a cheaper one (e.g. ethanol),” the economists said. “Substitution possibilities link the price of ethanol, and possibly the price of maize and other grains, with the price of oil.”

Ethanol prices adjust to oil prices within four months, the economists said. Corn prices, on the other hand, respond to ethanol prices in about 17 months, while ethanol prices respond to corn prices in about a year.

The finding suggests that ethanol and oil prices have a relatively small impact on corn prices in the short term, the study said.

According to the researchers, the relationship between oil, ethanol and corn prices breaks down at the point the nation hits the 10 percent technically feasible limit to the amount of ethanol that can be blended into gasoline, known as the blend wall.

“Substitution possibilities cease to exist over a certain threshold, called the ‘blend wall,’ as the US automotive fleet is composed, in its greater part, by vehicles which can run on blends that contain up to 10 percent of ethanol,” the study said. “Over this threshold, the link between oil, ethanol and grains prices breaks.”