The corn market is ratcheting higher. It's striving to ration demand. A key question is which users will trim corn consumption to make the drought-shortened crop stretch.
Currently, most gasoline sold in the United States contains 10% ethanol. Even though gasoline prices are well off their spring high, fuel remains pricy by long-term standards. Gasoline prices and subsequently ethanol margins are key factors that will determine how much corn ethanol plants use.
In late June, Valero Energy idled ethanol plants at Linden, Ind. and Albion, Neb. Those shut downs might suggest ethanol will bear the brunt of the use adjustment.
An analysis by Bruce Babcock, director of the Center for Agricultural and Rural Development at Iowa State University suggests ethanol may not cut use as much as other users, particularly livestock producers, might hope. He has prepared a briefing paper that presents preliminary estimates of the economic impacts of low U.S. corn and soybeans yields. The impacts are estimated for the 2012–13 crop year that begins on September 1.
"Because we do not know what final yields will be or what future gasoline prices will be, we make the preliminary estimates using a stochastic partial equilibrium model," explains Babcock. "This type of model solves for market-clearing prices for a large number of random 'draws' of yields and gasoline prices. The model is calibrated to information that is available in mid July, including the USDA's supply and demand projections and the level of futures prices for gasoline, corn and ethanol."
Corn yield assumptions. Much uncertainty remains regarding what U.S. corn and soybean national yields will be. On July 9, USDA projected that corn yield per harvested acre at 146 bushels per acre, which surely must be closer to the upper limit on corn yields because of continued hot and dry weather in the primary corn growing regions of Iowa, Illinois, Indiana and western Nebraska.
In the model, Babcock set the maximum corn yield at 148 bushels per acre. Average yield is set at 138 bushels per acre, and 120 bushels per acre is the lowest yield used. The 1988 yield loss, expressed as a percent decline from 1988 trend yield, was 25%. Applying this percent yield loss to the 2012 trend yield gives 122 bushels per acre.
"Combining the average yield, the maximum yield and the minimum yield with an assumed standard deviation of 5 bushels per acre is all that is needed to calculate the four parameters of the beta distribution used in this analysis," says Babcock. "Unfortunately, given the continued deterioration of the crop, we may be too optimistic about the size of this year's crop, but again, no way exists to really know at this time. Thus, interpret the results as being conditional on the assumed distribution of corn yields."
~~~PAGE_BREAK_HERE~~~Conclusions. Two findings stand out. The first is that the flexibility built into the Renewable Fuels Standard allowing obligated parties to carry over blending credits (RINs) from previous years significantly lowers the economic impacts of a short crop, because it introduces flexibility into the mandate.
"The 2.4 billion gallon amount of flexibility assumed in this study lowers the corn price impact of the ethanol mandate in this drought year from $1.19 per bushel to 28 cents per bushel," says Babcock. "This means that relaxing the mandate further would have modest impacts on corn prices."
Of course, this result is conditional on the distribution of corn yields used in the study.
"If corn yields turn out to be much lower than assumed here, then the impact of the mandate would be far greater," notes Babcock. To illustrate this point, the average corn-price impact of relaxing the mandate across the lowest 20% of the 500 yield draws used in this study is 44 cents per bushel. The average yield across the lowest 20% of yields is 130.5 bushels per acre. If corn yields turn out to be greater than assumed here then the impacts of relaxing the mandate would be even lower.
"The second finding is that if the current price of ethanol relative to gasoline accurately reflects the value of ethanol to blenders, then the price of ethanol will be supported at quite an attractive level as long as ethanol quantities are not pushing up against the blend wall," says Babcock. "This implies that ethanol plants will be a strong competitor for corn even without a mandate."
In the no mandate scenario Babcock simulated, ethanol production drops by only 600 million gallons when the mandate is waived. This 600 million gallon drop in supply is enough to raise the value of ethanol in the marketplace to support 12.3 billion gallons of production and continue high corn prices.
"The desire by livestock groups to see additional flexibility in ethanol mandates may not result in as large a drop in feed costs as hoped," he notes.
Of course, this high value of ethanol is only high relative to the price of gasoline.
If gasoline prices drop, then a waiver of the mandate would have a larger impact. Across the lowest 20% of wholesale gasoline prices used in this study, granting a waiver of the corn ethanol mandate would lower corn prices by an average of $1.13 per bushel from $5.88 to $4.75 per bushel. The average price of gasoline in this 20% of draws is $1.87 per gallon.
View the full briefing paper here.