FarmEcon LLC

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Comments for Texas Ag Forum

Date: June 9, 2008

The information contained herein has been taken from trade and statistical services and other sources believed to be reliable. FarmEcon LLC makes no warranty, express or implied, that such information is accurate or complete and it should not be relied upon as such.

FarmEcon LLC3825 Constitution Dr.Carmel, IN 46032317-873-9949thomaselam@farmecon.comwww.farmecon.com

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Thomas E. Elam, PhD President

thomaselam@farmecon.com

FarmEcon LLC

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Points to be addressed

Subsidies, taxes and tariffs Policy-induced demand structure of biofuel

feedstocks Effects of commodities on retail food prices Effects of ethanol on energy prices Proposal for an economically healthy and

sustainable biofuels industry

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What do subsidies do?

Subsidy programs do not create added income They do redistribute income Subsidies also shift costs Economists generally agree that subsidies

– Increase the welfare of recipients– Reduce the welfare of everyone else– Welfare losses generally outweigh the gains

Subsidies are engines of redistribution and inefficiency, not creation

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What do tariffs do?

Tariffs drive a wedge between domestic and global prices

Tariffs reduce efficient producer market access Welfare of inefficient domestic producers is

increased Welfare of efficient foreign producers is reduced Welfare of consumers in the country imposing

the tariff is reduced by having to buy from inefficient local producers

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Is ethanol from corn efficient?

At $5.50 per bushel corn is priced at a 40% premium to natural gas per combustible BTU

Only 47% of the combustible BTU content of corn is produced as ethanol

Brazil - 85-90% energy conversion from sugarcane

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systemsPolicy changes demand forbiofuel feedstocks

RFS– Creates a large, price inelastic, feedstock demand– Creates enormous price risk for the market– Likely increases feedstock prices by demand certainty

Tax credits– Make biofuels more affordable for blenders– Increase demand for biofuels vs. market forces

Ethanol tariff– Keeps more efficiently produced ethanol out

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Feed, food, export demand

Price

Quantity Demanded and Supplied

Supply

Demand

APE

QE

Price

Quantity Demanded and Supplied

Supply

Demand

APE

QE

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Biofuel feedstock demand is different

Biofuels account for only a small percent of potential fuel demand– Total world grain supply converted to ethanol is less

than 10% of global petroleum use

Biofuel demand is highly price elastic– Assume biofuels produced for energy, not additives– As production increases, biofuels easily substituted – Therefore, prices not very responsive to supply– Can see short run issues from bottlenecks

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systemsBiofuel demand/supply with additive niches and RFS < Qe, no tax credit

Price

Quantity Demanded and Supplied

Supply

Demand

RFS

A

Add

itive

s M

arke

ts

Petroleum Substitute

P

E

QE

FarmEcon LLC

A source of information on global farming and food

systemsBiofuel demand/supply with additive niches and RFS < Qe, with tax credit

Price

Quantity Demanded and Supplied

Supply

Demand

RFS

A

Add

itive

s M

arke

ts

Petroleum Substitute

PE

QE

B

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Effect on feedstocks markets

Feedstock demand derived from biofuels If no binding RFS price becomes the higher of:

– Combined food, feed, export market value– Or biofuel value if biofuel value>food/feed/export

If RFS is binding upper price limit is increased If biofuel value is high relative to food value

– Biofuel prices are major determinate of feedstock prices– Limited acreage implies prices will never decline from increased

feedstock production alone– Higher prices ration food, feed and exports

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Does ethanol increase corn prices?

“Demand created by ethanol production increases the price a farmer receives for grain.” RFA Website

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Why no rationing to date?

Large corn/soybean stocks of 2006-2007 Long lags in feed use response Weak dollar boosting export demand Price inelastic food demand

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Rationing starts now

Stocks are depleted, or soon will be Reduced 2008 corn crop USDA already forecasts major reductions in corn feeding

and exports based on trend yields Unfavorable May/June weather – yields declining Reductions in soybean yields are likely Wheat acreage expansion limited by corn

– Major reduction in wheat exports– Wheat feeding almost eliminated– Wheat stocks stay at pipeline levels

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Why rationing now? July 09 Corn

12-19-07: House and Senate agree to take4 billion bushels of 2008-crop corn off the market

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Why rationing now? July 09 Beans

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Why rationing now? July 09 Wheat

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Policy benefits and costs

Crop farmers and suppliers benefit from policy– Higher prices = higher incomes

Higher crop prices = higher costs to the system– Corn and soybeans are food inputs, not food– Real food producers see higher costs, lower profits– Food prices increase, but with important lags

Rest of economy sees lower spending/demand Net effect is higher food expenditures, less

spending available for other sectors– April Food CPI = ~$100 billion in discretionary income

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Quotes from RFA Web Site

Ethanol production does not reduce the amount of food available for human consumption.– Ethanol is produced from field corn fed to

livestock, not sweet corn fed to humans. Importantly, ethanol production utilizes only the starch portion of the corn kernel, which is abundant and of low value.

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systemsTypical food producer headlineJune 5, 2008

“Smithfield Foods today reported a significantly lower profit for its fourth quarter due to the increasing cost for grain and falling prices for hogs. The Virginia-based meat producer reported income from continuing operations of $1.8 million compared with $51.8 million from the year prior.”

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Do corn prices matter?

Informa and Texas A&M studies used pre-2008 data. 1985-2007 food commodity prices showed almost no

trend Corn prices could not correlate to upward trending retail

food prices Labor costs did trend up, correlating with food prices This DOES NOT prove that corn and commodity prices

are not important.

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Figure 7 from Informa study

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Food at Home CPI and All Farm Products PPI, 1970-1980

-25%

0%

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125%

150%

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% In

crea

se F

rom

Jan

. 197

0

Consumer Price Index, Food at Home Producer Price Index, All Farm Products

Regression: R2 = 91%, ß=1.148, t=36.46

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Food at Home CPI and All Farm Products PPI, 1981-April 2008

0%

100%

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400%

500%

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-81

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% I

ncr

ea

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rom

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n.

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70

Consumer Price Index, Food at Home Producer Price Index, All Farm Products

You cannot correlate what is not changing with something that is changing.If it is not changing it does not mean it is not important when it does change.

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It’s not just corn!

Corn prices have an effect on a broad range of farm products– Substitution price effects (competing feeds/foods)– Acreage competition effects (all major crops)– Cost effects (downstream foods)

It takes 2-5 years for the effects to move through the food system

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Biofuels policy macroeconomic effects

No net addition to real income or GDP No net gain in jobs Higher spending on biofuels and foods Lower spending on everything else Higher farm production costs

– Variable inputs– Land prices and rents

Increased biofuels prices and costs No net benefit to society

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Effects on energy costs

Increased ethanol production may be depressing gasoline prices

However, gap between gasoline and other petroleum prices has widened to record levels

Evidence suggests, and theory supports, a transfer of cost burden:– From gasoline users (personal transportation)– To other products (goods transport, home heating &

aviation)

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systemsHeating Oil, Diesel and Jet Fuel PricePremiums and (Discounts) to Gasoline

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(20)

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New York Harbor No. 2 Heating Oil Spot Price FOB (Cents per Gallon)

New York Harbor No 2 Diesel Low Sulfur Spot Price FOB (Cents per Gallon)

New York Harbor Kerosene-Type Jet Fuel Spot Price FOB (Cents per Gallon)

Ethanol Production

FarmEcon LLC

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systemsRegression of ethanol production on diesel/gasoline premium

12 MMA, Feb. 1995 to May, 2008 Diesel premium positively related to ethanol

production Each 100,000 bbl of added monthly ethanol

production increases premium by 14.6 cents R2 = 47%, t statistic = 11.8

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Does the Hayes study* refute?

Hayes data were from 1995-2007 Page 8: “Our hypothesis is that this additional (ethanol)

production has had a negative impact on gasoline prices and on the margins of crude oil refiners.”

Page 13: “The results suggest that this reduction in gasoline prices came at the expense of refiners’ profits.”

If margins and profits are depressed, cost recovery will be pushed from gasoline to other product prices

Prior graph shows this is happening in 2007/2008*Xiaodong Du and Dermot J. Hayes. “The Impact of Ethanol Production on U.S. and Regional Gasoline Prices and on the Profitability of the U.S. Oil Refinery Industry”. Iowa State. Working Paper 08-WP 467. April 2008

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Lower gasoline prices are also

Raising the cost of goods transport Increasing cost pressures on the food

system Adding to airline fares Increasing home heating costs No net gain to the economy, possibly a loss

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Rx for a healthy biofuels industry

Eliminate/phase out RFS, tax credits and tariffs Compete for feedstocks on a level playing field,

and based on real economic value Compete with efficient foreign producers Add real value, not artificial cost inflation Continue federal support for basic research