Ethanol Blamed for Record Food Prices

Federal ethanol mandates, which have led to a steady increase in the production of ethanol made from corn, are a major reason why food prices worldwide have reached record levels in the past several months, according to some economists.

Earlier this month, the United Nation’s Food and Agriculture Organization reported that global food prices had risen for eight consecutive months, reaching the highest levels since the agency started tracking prices in 1990. The prices are high in large part because of steadily growing worldwide demand for food, and because of natural disasters that have hurt harvests, but they’re also affected by government policies.

Federal ethanol mandates in the United States have played an important role in the increase in  corn prices, which are approaching $7 a bushel, up from historical norms of $2 to $3. The mandates—called the renewable fuel standard—require fuel distributors to use a certain amount of ethanol each year, with the amount increasing each year. In 2005, when the mandates were first introduced (legislation signed by President Bush in 2007 subsequently expanded the federal mandates), ethanol production accounted for only 5 to 10 percent of the demand for corn in the United States, says C. Ford Runge, professor of applied economics and law at the University of Minnesota. Now it’s up to roughly 40 percent, he says. (The standard calls for 13.95 billion gallons of renewable fuel, almost all of which will come from corn-based ethanol.)

The increased production of ethanol has a large impact on corn prices, not only because it’s a major source of demand, but also because the demand is fixed. In a free market, if the price of corn goes up, demand will go down, moderating corn prices. But the federal mandate requires the same amount of ethanol no matter how expensive corn is.

“In the short run, there’s no doubt that we have more volatile prices for corn because of the renewable fuels standard,” says Wallace Tyner, professor of agricultural economics at Purdue University. In the long term—in two to four years—if prices stay up, more farmers will plant corn, and supply will catch up to demand, he says. But the ethanol mandates will help keep corn prices higher than they have been in the past. The “new normal” will be something like $3 to $4 a bushel, he says.

Runge says that mandates should be more flexible—adapting to corn prices. “What you really want is for corn to be used to make ethanol when corn is cheap,” he says. This will help farmers by ensuring demand for their product. “When corn is expensive,” he says, “you don’t want it to be diverted to ethanol use when it’s in heavy demand for feed and food.”

The exact impact of ethanol demand on food prices is hard to determine, because of the complex interplay of factors such as weather, market speculation, energy prices and so on. After a similar food price spike in 2007 and 2008, the Congressional Budget Office concluded that increased demand for ethanol accounted for between 10 and 15 percent of the food price increase, an estimate that has been echoed in several other studies. Estimates, however, have ranged from biofuels accounting for as much as two-thirds of the price increase, to biofuels having almost no impact. Some experts have suggested that energy prices could have a bigger role than biofuels in increased food prices. The share of corn devoted to ethanol production has increased since the time period these studies analyzed. It was roughly 20 percent of the demand in 2007 (compared to 40 percent now).