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Study finds ethanol demand suppresses crude oil prices

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WILLMAR -- Ethanol is the world's most widely used liquid biofuel in the transportation system with the United States currently the world's largest ethanol producer, providing a 57 percent share of global ethanol production.

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In 2010, about 13 billion gallons of ethanol were blended into the U.S. gasoline supply, accounting for about 9.5 percent of gasoline consumption.

The Renewable Fuel Standard, established by the Energy Independence and Security Act of 2007, mandates annual use of 36 billion gallons of renewable fuel in the U.S. by 2022. If the mandate is reached, ethanol's share of U.S. gasoline consumption could reach 25 percent within the next 10 years.

Despite the growing importance of biofuels, the effect that biofuels are having on fossil fuel markets was not fully understood and therefore became the focus of recent study by the U.S. Department of Agriculture.

Lihong Lu McPhail, a researcher with USDA's Economic Research Service, has developed a joint structural Vector Auto Regression model of the global crude oil, U.S. gasoline, and U.S. ethanol markets to examine whether the U.S. ethanol market has any impact on global oil markets.

In the study, McPhail indicates that ethanol demand in the U.S. is driven mainly by government support in the form of tax credits and blending mandates. Therefore, any sharp impacts to ethanol demand are more likely to reflect changes in government policy than any other factor. However, ethanol supply fluctuations are driven largely by changes in feedstock prices, primarily the price for corn.

A principal finding of the study is that a policy-driven ethanol demand expansion causes a statistically significant decline in real crude oil prices, while an ethanol supply expansion does not have a statistically significant impact.

Based on this finding, McPhail's study would suggest that even though the U.S. ethanol market is small, the influence of U.S. biofuels policy on crude oil market prices is pervasive. The study concluded that a one-time 5 percent increase in U.S. ethanol use will lower the price of crude oil by an estimated 8 cents per barrel over 12 months.

The study also found that abrupt changes in ethanol demand are more important than ethanol supply volatility in explaining the fluctuation of the price of crude oil and U.S. gasoline. Therefore, a policy-driven ethanol demand expansion, such as the expansion mandated by the Renewable Fuel Standard, would cause a decline in both U.S. gasoline and crude oil prices.

Lihong Lu McPhail's study, titled "Assessing the Impact of U.S. Ethanol on Fossil Fuels Markets: A Structural VAR Approach," was published in Energy Economics, April 2011.

USDA analyzes cost savings

of 10-acre

base provision

The 2008 farm bill eliminated direct and counter-cyclical payments to farms with 10 or fewer base acres. An exception to the provision was provided for farms owned by "limited resource" and "socially disadvantaged" farmers.

The intent of the farm bill provision was two-fold -- to reduce farm program payments while also reducing administrative costs for the USDA's Farm Service Agency.

Over the last decade, the number of farms identified by the Farm Service Agency as having 10 or fewer base acres has increased by 4 percent. By 2009, there were 2.2 million farms with base acres, of which nearly 17 percent had 10 or fewer base acres.

A recently released study by USDA's Economic Research Service analyzed the impact that the 10-acre base provision has had on reducing farm program payments and administrative costs for the Farm Service Agency.

In 2009, nearly 371,000 farms became ineligible for payments under the 10-acre base provision, with prohibited payments totaling $29.1 million or about 5 percent of the total direct and counter-cyclical payments. However, many of those farms chose not to participate in the direct and counter-cyclical program in previous years.

Previous to the current farm bill, 60 percent of the nonexempt farms with 10 or fewer base acres declined to participate, likely because the payments were too small relative to the time, paperwork and other responsibilities related to enrolling.

As a result, the annual payment savings associated with the 10-acre base provision is much less than the $29.1 million estimate. Assuming only 40 percent of the 10-acre base farms were affected, the annual payment savings is more likely about $11.7 million.

The study also estimated that the 10-acre base provision has reduced FSA's annual administrative costs by about $1.5 million. Therefore, based on the estimated reductions of $11.7 million in program costs and $1.5 million in administrative costs, the total annual savings from the 10-acre base provision is estimated at $13.2 million.

U.S. farm exports reach record high

Recent data released by the U.S. Department of Agriculture indicate that U.S. farm exports during the 2011 fiscal year reached a record high of $137.4 billion, surpassing the previous high by $22.5 billion.

According to USDA's Foreign Agricultural Service, the U.S. also had an agricultural trade surplus of $42.7 billion during the 2011 fiscal year.

The outlook for U.S. agricultural exports also looks promising, as the recently signed trade agreements with South Korea, Colombia and Panama are expected to provide an additional $2.3 billion in export sales during the 2012 fiscal year.

China was the leading export market for farm products in 2011, buying almost $20 billion of goods that included soybeans, cotton, tree nuts and hides.

Wes Nelson is the executive director of the USDA Farm Service Agency in Kandiyohi County.

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