FarmPolicy

June 27, 2019

Biofuels: Higher Prices & Trade Angles, However, Exports and Doha Still Important Considerations for U.S. Farmers

The September 2007 issue of Amber Waves, a publication from USDA’s Economic Research Service, contained two particularly interesting articles; one discussed ethanol and biofuels, while the other provided a detailed look at agricultural exports and imports.

The ethanol article, “U.S. Ethanol Expansion Driving Changes Throughout the Agricultural Sector”, which was written by Paul C. Westcott, stated that, “The explosive growth of U.S. ethanol production is being felt by nearly every aspect of the field crops sector—domestic demand, exports, prices, and the allocation of acreage among crops—as well as the livestock sector, farm income, government payments, and food prices. Additionally, issues have been raised regarding possible effects on natural resources resulting from the ethanol expansion and changes in farmers’ cropping choices. Adjustments in the agricultural sector to this strong demand are underway and will continue as interest builds in renewable sources of energy to lessen dependence on foreign oil.”

With respect to ethanol production, the article explained that, “With completion of the plants currently under construction, production capacity in the industry will exceed 12 billion gallons within a few years. Ethanol production is expected to be well above the renewable fuel standard mandated in the 2005 Energy Policy Act. Although the ethanol expansion is then expected to slow somewhat, even with the industry operating at less than full capacity, USDA’s 2007 long-term projections show ethanol production growing to more than 12 billion gallons by the middle of the next decade, assuming no changes in policy or technology.” (See this chart from the article, “U.S. ethanol capacity growing rapidly.”)

Noting that corn is currently the most prominent source of ethanol feedstock, the Amber Waves article stated that, “Although cellulosic-based production of renewable fuels holds some longer-term promise, much research is needed to make it commercially economical and expand beyond the 250-million-gallon minimum specified for 2013 in the Energy Policy Act of 2005.”

For a related chart on the estimated cost per barrel of fuel produced by selected biofuel feedstocks that appeared in The Wall Street Journal on August 24, 2007, just click here.

To view recent news articles on alternative feedstock see: Polgreen, Lydia. “Mali’s Farmers Discover a Weed’s Potential Power,” The New York Times. Sept. 9, 2007; Barta, Patrick. “Jatropha Plant Gains Steam In Global Race for Biofuels.” The Wall Street Journal. Aug. 24, 2007- both discuss jatropha.

For more information on switchgrass, see: Fahrenthold, David A. “Cultivating a Crop of Hope.” The Washington Post. Sept. 6, 2007; and for more information on wood chips, see: Heilprin, John. “Forest Chief Touts Ethanol to Power Cars.” The Associated Press. Sept. 7, 2007.

Despite the phenomenal growth rate in ethanol production, the Amber Waves article indicated that, “[B]y the middle of the next decade, ethanol production (by volume) is expected to represent less than 8 percent of annual gasoline use in the United States. Thus, while the growth in corn-based ethanol can contribute to the Nation’s fuel supply, that contribution is relatively small in the gasoline market but can have large effects in the agricultural sector.” (See this chart from the article, “Ethanol’s role increases in gasoline and corn markets.”)

Mr. Westcott then stated that, “The rapid expansion in ethanol production will have far-reaching effects throughout the agricultural sector. The corn market is being affected directly by the increase in ethanol production. As the ethanol industry absorbs a larger share of the corn crop, higher prices will affect domestic use and exports, providing for more intense demand competition between domestic industries and foreign buyers of feed grains.”

In addition, the article noted that, “On balance, increased use of corn to produce ethanol is projected to result in higher corn prices, which will trigger reductions in other uses and increases in supplies to bring the corn market into equilibrium. Nonetheless, stronger ethanol demand will result in lower carryover stocks of corn. At the same time, ethanol demand is very inelastic (unresponsive to price changes) in the range of prices expected over the next decade and relative to other major demands for corn, such as feed use and exports. Thus, overall demand in the corn sector is projected to become more inelastic as ethanol production grows. In combination, these factors will make the corn market more vulnerable to shocks, such as production shortfalls due to weather, pests, or other factors. Low stocks provide limited buffers to shocks. As demand for corn becomes more inelastic, a greater change in market prices would be needed in response to a shock to bring the market to equilibrium. Thus, overall price variability and market volatility in the agricultural sector are likely to increase.”

For additional analysis on the idea of a corn market production shock, see, “2007 U.S. Corn Production Risks: What Does History Tech Us?” (University of Illinois Extension, May 2007), which concluded by saying, “The current situation in the corn market may have other policy implications. Corn prices are expected to remain generally high and extremely volatile for an extended period of time. The combination of a low level of stocks and an increasing portion of corn consumption occurring in the ethanol sector, where demand is relatively price insensitive, suggests that prices will be extremely responsive to small changes in U.S. and world production prospects or changes in demand for corn in any other sector. Prices of other commodities will also be influenced as the market attempts to allocate production resources, primarily land, among the various crops. Provisions of the new ‘farm bill’ are expected to reflect this changing environment of high and volatile crop prices. In addition, careful consideration of potential market impact should be given to policies encouraging additional bio-fuels production.”

At this stage of the debate, however, the House version of the 2007 Farm Bill more closely resembles the 2002 Farm Bill, which was crafted during a time of relatively low commodity market prices and a budget surplus. However, reforms reflecting the notion of increased price volatility at relatively high price levels could possibly still emerge from the Senate.

The Amber Waves article also stated that, “Overall, ethanol expansion will boost net farm income. Higher commodity prices over the next several years, particularly for corn and soybeans, are projected to bring large increases in total farm cash receipts. But to some extent, these gains are expected to be offset by somewhat higher production expenses for inputs such as seed, fertilizer, and livestock feed.

“Higher prices for corn and other crops also mean smaller government payments under current farm commodity programs, particularly price-sensitive marketing loan benefits and counter-cyclical payments. In contrast, with higher crop prices, use of land for production becomes more valuable, so new rental rates for land enrolled in the CRP [Conservation Reserve Program] are likely to rise. As a result, conservation payments and fixed direct payments under the 2002 Farm Act (which do not change with market prices) are projected to account for a larger share of total direct government payments, assuming no changes in policy.

“With lower government payments, the agricultural sector will rely on the market for more of its income, and the share of income provided by government payments is projected to fall.”

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As a side note, the current higher market price environment has also been a factor that some observers have discussed as an issue that could have some impact on the current round of WTO trade talks (Doha), see “Biofuels and the Wide World,” by Ronald Steenblik, which appeared in the August edition of Bridges (page nine)- “US Ambassador to the EU, C. Boyden Gray, has expressed similar sentiments. ‘I am very confident that we are going to get a [Doha Round] deal,’ he told reporters in January. ‘This whole alternative energy revolution is taking hold. This will take the whole issue of agriculture off the table as a sticking point’ between the US and the EU, Gray said.

“The theory that, thanks to biofuels, the end of agricultural subsidies is nigh is appealing but untested. In private discussions with government officials, I have yet to find any who would admit that they have in fact changed their negotiating positions on agriculture in light of the current high prices for crops,” the article said.

Beyond the biofuels impact on Doha, and perhaps more interesting, is the possibility that energy policy, not agricultural policy, could gain increased scrutiny as a leading culprit in market distortions.

For example, note these two paragraphs from a publication issued in October of 2006, “Although some observers of the WTO Doha Development Round Negotiations have put biofuels forward as a possible solution to the Round’s impasse over agricultural reforms, we urge a closer examination of this argument. The new markets and higher prices for agricultural feedstocks brought about by an increasing demand for biofuels are to be welcomed by the world’s farmers and thus could play a role in weaning industrial farmers off of government subsidies to the agricultural sector. However, to the extent that a ‘solution’ to the Doha Round quagmire is seen as a shift of government support from agricultural food production to agricultural energy production, it will only bring about another heavily distorted sector and decrease the potential for trade unless the kinds of acceptable support are carefully limited to measures properly targeted at public goods such as research and development, the creation of infrastructure, and the proper taking into account of environmental externalities.

“Even supposing that future trade in biofuels remains limited, the considerable increase in by-products, whether livestock feed or biobased products, may lead to protectionists pressures, the distortion of world markets, and the need to consider appropriate WTO disciplines.” (“WTO Disciplines and Biofuels: Opportunities and Constraints in the Creation of a Global Marketplace,” October 2006).

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Meanwhile, as the domestic biofuels boom continues to positively impact the market price level of some program crops, some U.S. producers may view the export market with less interest than in previous years. In fact, some corn farmers may be tempted to diminish the importance of the export market as ethanol production takes an increasingly central role in market price determination.

However, a second article from the September Amber Waves issue, “U.S. Trade Growth: A New Beginning or a Repeat of the Past?” (by Erik Dohlman and Mark Gehlhar), stated that, “Fast-rising imports and a stretch of slow export growth reduced the U.S. agricultural trade surplus from a 1996 record of $27.3 billion to less than $5 billion a decade later. But changes in the structure of U.S. trade in recent years have brought renewed export demand and signs of slower import growth, signaling a potential reversal of recent trends. U.S. agricultural exports in fiscal year (FY) 2007 are in the fourth consecutive year of record shipments, buoyed by rising foreign demand, competitive U.S. prices resulting from a weaker dollar, and strong world growth. Despite the weaker dollar, imports are still growing rapidly, but not quite as fast as in some recent years.”

Later, the authors noted that, “So what explains the renewed growth of U.S. exports? In addition to the weakening dollar, a key factor is that demand from emerging markets is having an appreciable impact on both global food demand and U.S. exports. Emerging markets contributed to the growth of global and U.S. food trade throughout the 1990s, but gains since 2000 have been far greater. Global agricultural trade expanded less than 25 percent during the 1990s but has already grown 50 percent in the first part of this decade, spurred by rising incomes in emerging markets. As a result, the share of U.S. exports destined for emerging markets climbed from 30 percent during the early 1990s to 43 percent in 2006. China and Mexico now account for 25 percent of U.S. exports—nearly triple their share in 1990. Exports to China alone are now nearly equal to exports to the EU. Overall, U.S. exports are up from $50.7 billion in FY 2000 to a projected $78 billion in FY 2007.

“Although U.S. exports always have ebbed and flowed, there are a number of reasons to believe that the increased prominence of emerging markets in global food trade could lead to sustained export growth. In the past decade, the emerging market share of global GDP has risen from 43 percent in 1996 to 50 percent in 2006 (as measured by ‘purchasing power parity’ rather than exchange rates), and the emerging market share of global trade has climbed at an even faster pace. Developing regions such as China, Southeast Asia, Mexico, Central America, and India will likely continue to increase their share of global GDP in the coming decades. They will also account for 95 percent of the expected increase of 1 billion persons to the global population by the year 2020. Despite generally higher agricultural commodity prices brought on by the expansion of ethanol production in the U.S., enhanced spending power abroad is projected to substantially raise the value of U.S. agricultural exports over the next decade—from $69 billion in 2006 to $95 billion by 2016, according to USDA projections.”

The article went on to explain that, “Trade agreements, the strength or weakness of different currencies, and unpredictable market developments for particular commodities (e.g., the disruption of U.S. beef exports to Japan following the discovery of bovine spongiform encephalopathy in U.S. cattle) will affect the evolution of U.S. trade flows in individual markets. The differences among countries reflect the contrasting effects of trade liberalization in some markets (NAFTA and China’s World Trade Organization (WTO) accession) and exchange rate rigidities and trade barriers in others. Nevertheless, ERS research indicates a strong connection between foreign economic growth and overall U.S. agricultural exports, and suggests that if economic growth continues at the recent pace in emerging markets it should help sustain U.S. export growth for the foreseeable future.”

Some agricultural observers might note that a successful conclusion to the Doha round of WTO trade talks could enhance this growth and could lead to an even stronger export market.

For more on this, see, “The WTO Trade Negotiations: Why the Emphasis on Development?” (University of Illinois Extension, October 2005), which stated that, “Midwestern producers have a great deal to gain from trade liberalization as demand in low income countries for products in which they have a comparative advantage, particularly corn and soybeans, outstrips those countries’ own productive capacity. It is the acceleration of economic growth in presently low income countries that has the greatest potential benefits for internationally competitive producers.

“All of the growth in consumption of raw agricultural products occurs in the income range from about two to ten dollars per day. The three billion people living on less than two dollars per day and the three billion more yet to be born into this poverty represent a huge potential market – if their home countries experience broad-based economic growth. This potential will remain potential, not realized, growth as long as those countries cannot sell abroad what they can produce relatively more efficiently.

“U.S. farm exports can grow either by increasing our market share or by growing the total size of the market. The former has severe limits and requires dog-eat-dog competition for shrinking markets. Growing the total size of the market has much more potential to increase demand for Midwestern farm products as presently low income people gain the wherewithal to upgrade their diets.”

A variety of factors, possibly including the poor communication of projected benefits of a successful Doha agreement to producers, have prohibited the U.S. from offering more than general “flexibility” since October of 2005.

Keith Good

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