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Ethanol, Mandates, and Drought: Insights from a Stochastic Equilibrium Model of the U.S. Corn Market

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Abstract

The outlook for U.S. corn markets is inextricably linked to what happens to the U.S. ethanol industry, which depends, in turn, on the level of government subsidies and mandates. We develop a stochastic partial equilibrium model to simulate outcomes for the corn market for the 2008/09 marketing year to gain insight into these linkages. The model includes five stochastic variables that are major contributors to corn price volatility: planted acreage, corn yield, export demand, gasoline prices, and capacity of the ethanol industry. Our results indicate that integration of gasoline and corn markets has increased corn price volatility and that the passage of the expanded ethanol mandates in the Energy Independence and Security Act (EISA) has had modest effects on corn prices. Model results indicate an expected average marketing year price of $4.97 per bushel and a price volatility of 17.5% without the 10 billion gallon EISA mandate but with maintenance of the $0.51-per-gallon tax credit. Imposition of the mandate increases the expected price by 7.1% and price volatility by 12.1%. The effects of the mandate are modest, as ethanol production would average 9.5 billion gallons without the mandate because of high gasoline prices. The mandate is binding with a probability of 37.8%, which indicates that an additional tax or subsidy will be needed to ensure that the mandate is met. High corn prices caused by drought can cause the mandate to bind. Fixing 2008 corn yields at extreme drought levels increases expected corn prices to $6.59 per bushel without a mandate and to $7.99 per bushel with the EISA mandate. An average additional subsidy of $0.73 per gallon of ethanol would be needed to ensure that the mandate is met in this drought scenario. Elimination of the current blenders tax credit would result in the mandate not being met in all cases. On average, a subsidy of $0.41 per gallon would ensure that ethanol production is at least 10 billion gallons in the 2008/09 marketing year.

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Bibliographic Info

Paper provided by Center for Agricultural and Rural Development (CARD) at Iowa State University in its series Center for Agricultural and Rural Development (CARD) Publications with number 08-wp464.

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Date of creation: Mar 2008
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Handle: RePEc:ias:cpaper:08-wp464

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Keywords: EISA mandate; ethanol; price volatility of corn; stochastic equilibrium.;

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References

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  1. Lence, Sergio H. & Hayes, Dermot J., 2000. "U.S. Farm Policy And The Variability Of Commodity Prices And Farm Revenues," 2000 Conference, April 17-18 2000, Chicago, Illinois 18937, NCR-134 Conference on Applied Commodity Price Analysis, Forecasting, and Market Risk Management.
  2. Simla Tokgoz & Amani Elobeid & Jacinto F. Fabiosa & Dermot J. Hayes & Bruce A. Babcock & Tun-Hsiang (Edward) Yu & Fengxia Dong & Chad E. Hart & John C. Beghin, 2007. "Emerging Biofuels: Outlook of Effects on U.S. Grain, Oilseed, and Livestock Markets," Food and Agricultural Policy Research Institute (FAPRI) Publications 07-sr101, Food and Agricultural Policy Research Institute (FAPRI) at Iowa State University.
  3. Beghin, John C. & Dong, Fengxia & Elobeid, Amani & Fabiosa, Jacinto F. & Fuller, Frank H. & Hart, Chad E. & Kovarik, Karen P. & Tokgoz, Simla & Yu, Tun-Hsiang & Wailes, Eric J. & Chavez, Edward & Woma, 2007. "FAPRI 2007 U.S. And World Agricultural Outlook," Staff General Research Papers 12805, Iowa State University, Department of Economics.
    • Beghin, John C. & Dong, Fengxia & Elobeid, Amani E. & Fabiosa, Jacinto F. & Fuller, Frank H. & Hart, Chad E. & Kovarik, Karen & Tokgoz, Simla & Yu, Tun-Hsiang (Edward) & Wailes, Eric J. & Chavez, Eddi, 2007. "FAPRI 2007 U.S. and World Agricultural Outlook," Staff Reports 7296, Food and Agricultural Policy Research Institute (FAPRI).
  4. Ray, Daryll E. & Richardson, James W. & Torre Ugarte, Daniel de la & Tiller, Kelly, 1998. "Estimating Price Variability In Agriculture: Implications For Decision Makers," Journal of Agricultural and Applied Economics, Southern Agricultural Economics Association, vol. 30(01), July.
  5. Kevin McNew & Bruce Gardner, 1999. "Income Taxes and Price Variability in Storable Commodity Markets," American Journal of Agricultural Economics, Agricultural and Applied Economics Association, vol. 81(3), pages 544-552.
  6. Babcock, Bruce A., 2008. "Distributional Implications of U.S. Ethanol Policy," Staff General Research Papers 12936, Iowa State University, Department of Economics.
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Cited by:
  1. Qiu, Cheng & Colson, Gregory & Wetzstein, Michael E., 2011. "Considering Macroeconomic Indicators in the Food versus Fuel Issues," 2011 Annual Meeting, July 24-26, 2011, Pittsburgh, Pennsylvania 103689, Agricultural and Applied Economics Association.
  2. Gal Hochman & Scott Kaplan & Deepak Rajagopal & David Zilberman, 2012. "Biofuel and Food-Commodity Prices," Agriculture, MDPI, Open Access Journal, vol. 2(3), pages 272-281, September.
  3. Lihong Lu McPhail & Bruce A. Babcock, 2008. "Short-Run Price and Welfare Impacts of Federal Ethanol Policies," Center for Agricultural and Rural Development (CARD) Publications 08-wp468, Center for Agricultural and Rural Development (CARD) at Iowa State University.
  4. Yano, Yuki & Blandford, David & Surry, Yves R., 2011. "International Variability in Biofuel Trade: An Assessment of U.S. Policies," 2011 International Congress, August 30-September 2, 2011, Zurich, Switzerland 115793, European Association of Agricultural Economists.
  5. Nicole Condon & Heather Klemick & Ann Wolverton, 2013. "Impacts of Ethanol Policy on Corn Prices: A Review and Meta-Analysis of Recent Evidence," NCEE Working Paper Series 201305, National Center for Environmental Economics, U.S. Environmental Protection Agency, revised Oct 2013.

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