Let Them Eat Ethanol And Cash

How biofuels and speculation are driving food prices to scary new heights.

Why have global food prices spiked not once, but twice in the last three years, raising the specter of famine and triggering worldwide food riots—including the Arab Spring? Many explanations have been floated, including climate change-related droughts in Australia, volatile oil prices, "food security" export restrictions, and last but not least, feeding China’s strategic pork reserve.

But according to a scientific paper released this morning by the New England Complex Systems Institute, there are only two factors that matter: ethanol and financial speculation.

The former is easier to prove. A drop in the bucket only a decade ago, ethanol will consume a remarkable 40% of the U.S. corn crop this year, comprising 16% of world corn production and 4% percent of total grain production overall. The paper’s authors mapped the rise of ethanol production to the steady climb of the United Nations Food and Agriculture Organization’s Food Price Index since 2004 and found a close fit, much closer than Australia’s droughts (too small), oil price spikes (too late), or China’s craving for pork bellies (big, but not big enough). "Ethanol is much bigger. It’s bigger by a factor of 20," says Yaneer Bar-Yam, one of the paper’s authors and the president of NECSI.

The paper’s second claim is more controversial. While ethanol is responsible for the long-term increase in baseline prices, it can’t explain the bubble-and-bust dynamics of 2007/2008 and 2010/2011. So NECSI’s researchers set out to build an all-purpose mathematical model of speculative bubbles, feeding it price data to see if there was another close fit.

What they found refutes the OECD’s findings and confirms the suspicions of Harpers’ Frederick Kaufman —the repeal of the Commodity Exchange Act of 1936 and the deregulation of commodity futures in 2000 transformed the futures markets from an instrument of liquidity to a place to park one’s money. Instead of being a place where farmers and agricultural businesses set reasonable prices, the markets have become just another place for speculation.

"That regulation had limited the ability of investors to invest beyond a certain amount," says Bar-Yam. "Its repeal enabled the index funds, which in turn opened the door to people who were not in the agricultural investment business to go into the commodities markets of corn, wheat, and so on."

All of that money—commodity index holdings soared from $13 billion in 2003 to $317 billion in 2008—inevitably caused distortions in the market. "If you look at our figures, you’ll see there’s a huge difference between the futures price or the spot price and what should be the equilibrium one," Bar-Yam says.

The authors’ recommendations are straightforward and immediate—to drive down prices for the world’s poor, governments must restore financial regulations (including the Commodity Exchange Act) and begin winding down ethanol production. "There is a moral imperative here," says Bar-Yam. "And from an economic standpoint, efficient allocation and optimality are desirable things," neither of which are currently being served. And if they don’t, as the authors noted last month in a related paper, the turmoil of Arab Spring may go global.

Read more columns like this in our continuing series, The Butterfly Effect

[Image: Flickr user kevindooley]

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7 Comments

  • Yaneer Bar-Yam

    In response to note by John Wagner

    John,

    Take a look at the section in the paper about the role of energy in food prices starting on page 17 (the link is given in the above article with the words "according to a scientific paper") The US Department of Agriculture compiles data about farm costs. The energy costs are explicitly given. They specify both direct and indirect costs due to fertilizer. While an important part of farmers costs, they do not account for the increases in prices of grain sold by those farmers during the peak in 2007-2008. Worldwide, the cost of fertilizer used in the production of wheat was only 5% of the value of wheat in 2007.

    The amount of influence of energy costs on US food prices at the peak might be about 6%. This is about four times the role it played 10 years ago (0.5 -1.8%) beause of a four fold increase in oil prices (see USFDA report: Changing Consumer Food Prices A User’s Guide to ERS Analyses A.J. Reed, Kenneth Hanson, Howard Elitzak, and Gerald Schluter). An influence of 6% cannot account for the 100% (factor of 2) increase in the costs of food in 2007-2008 according to the food price index. (As an aside, note also that the US food prices are much more energy intensive beause of processing and packaging than the food eaten worldwide. The food price index reflects the costs of these basic foods.). 

    The specifics of the wheat prices and oil price peaks are readily available, and the peak in wheat prices occurred in March of 2008, preceding that of oil, which occurred in July of 2008.

    Granger causality tests do not show the extent of an influence, only that an influence exists.

    One of the aspects that is missing from your discussion is the role of speculators in oil prices. Before the repeal of commodity regulations in 2000 oil prices were in the $20-30 range for 15 years. Even at signficantly higher oil prices, ethanol had to be federally subsidized to make it economically viable. Subsidies continue till today. 

    Yaneer  Bar-Yam and Marco Lagi

  • John Wagner

     second attempt at comment one took out all paragraph breaks.  Trying again:

    The 'study' sited is a clear example of selecting data to confirm a desired conclusion.
     Looking at the study, the authors compared oil prices to prices for wheat and make the astounding statement that:
    "The peak in oil prices follows the peak in wheat prices and so does not cause it."
     This contradicts what every farmer knows. In fact, petroleum related costs represent about 6% of the retail price of food. Whereas, corn represents about 1.6% of the retail price of food. I don't know if they will permit urls or links on this site so I can only say Google: "Food Dollar Series: Food Dollar Application" to see USDA's data on this.
     Here's one (among many) studies of the causal relationship of Crude Oil to Food Prices - Google: "The Long Run Relationship Between Petroleum and Cereals Prices" the authors conclude:
    "results of Granger causality tests show that there exist a long run unidirectionalcausality from petroleum price to the three cereals prices, i.e., maize, rice and wheat.The said is not true for the reverse. These results suggest that petroleum price factor isgrowing in significance in the cereal complex. This is a plausible result since modernagriculture depends heavily on the use of fossil fuel in every stage of food production andmarketing. The universal adoption of seed fertilizer technology (SFT) is energy intensive;that is, production of food is heavily dependent on chemical fertilisers, which uses fossilfuel as its primary inputs. The increases in fuel prices have raised the costs of producingcereal crops. For instance, the prices of some fertilizers (e.g. triple super phosphate andmuriate of potash) in US dollar increased by more than 160 percent in the first twomonths of 2008, compared to the same period in 2007. Higher costs for fertilizer, fuel, andseeds could cause farmers without access to credit to produce less than they otherwisewould have, or to shift to crops with fewer inputs requirements. Secondly, gasoline anddiesel fuel are heavily used in ploughing, planting, cultivating and harvesting. Irrigationpumps use diesel fuel, natural gas, and coal-fired electricity. Thirdly, fertilizer production isalso energy intensive as the mining, manufacture, and international transport of phosphatesand potash all depend on oil. Lastly, with freight rates doubling within a one-year periodbeginning in February 2006, the cost of transporting food to importing countries also hasbeen affected."

     While much time has been devoted to how much the demand for corn to make ethanol affects food prices - through corn prices. It's interesting how little space and time (in the general media) has been devoted to how ethanol affectst the price of oil/gasoline. Francisco Blanch was quoted in the Wall Street Journal (May, 2008) saying that ethanol has driven down the price of oil about 15%. A thorough study by economists at Iowa State University concluded ethanol held down the price of oil/gas about 32% in 2010.

     Now since petroleum costs have a much larger impact on the price of food than does corn - (about 3.5 times larger) while ethanol impacts the 1.6% of the retail price of food represented by corn - Ethanol also drives down the petroleum component of food prices (15% to 30%) with the result being that ethanol has very little net impact on the price of food.

  • John Wagner

     in my first comment, somehow the quote I included was repeated twice - making my comment quite confusing (sorry about that).  HERE IS A CLEANED UP version of my first comment:

    The 'study' sited is a clear example of selecting data to confirm a desired conclusion. Looking at the study, the authors compared oil prices to prices for wheat and make the astounding statement that: "The peak in oil prices follows the peak in wheat prices and so does not cause it." This contradicts what every farmer knows. In fact, petroleum related costs represent about 6% of the retail price of food. Whereas, corn represents about 1.6% of the retail price of food. I don't know if they will permit urls or links on this site so I can only say Google: "Food Dollar Series: Food Dollar Application" to see USDA's data on this. Here's one (among many) studies of the causal relationship of Crude Oil to Food Prices - Google: "The Long Run Relationship Between Petroleum and Cereals Prices" the authors conclude: "results of Granger causality tests show that there exist a long run unidirectionalcausality from petroleum price to the three cereals prices, i.e., maize, rice and wheat.The said is not true for the reverse. These results suggest that petroleum price factor isgrowing in significance in the cereal complex. This is a plausible result since modernagriculture depends heavily on the use of fossil fuel in every stage of food production andmarketing. The universal adoption of seed fertilizer technology (SFT) is energy intensive;that is, production of food is heavily dependent on chemical fertilisers, which uses fossilfuel as its primary inputs. The increases in fuel prices have raised the costs of producingcereal crops. For instance, the prices of some fertilizers (e.g. triple super phosphate andmuriate of potash) in US dollar increased by more than 160 percent in the first twomonths of 2008, compared to the same period in 2007. Higher costs for fertilizer, fuel, andseeds could cause farmers without access to credit to produce less than they otherwisewould have, or to shift to crops with fewer inputs requirements. Secondly, gasoline anddiesel fuel are heavily used in ploughing, planting, cultivating and harvesting. Irrigationpumps use diesel fuel, natural gas, and coal-fired electricity. Thirdly, fertilizer production isalso energy intensive as the mining, manufacture, and international transport of phosphatesand potash all depend on oil. Lastly, with freight rates doubling within a one-year periodbeginning in February 2006, the cost of transporting food to importing countries also hasbeen affected."   While much time has been devoted to how much the demand for corn to make ethanol affects food prices - through corn prices. It's interesting how little space and time (in the general media) has been devoted to how ethanol affectst the price of oil/gasoline. Francisco Blanch was quoted in the Wall Street Journal (May, 2008) saying that ethanol has driven down the price of oil about 15%. A thorough study by economists at Iowa State University concluded ethanol held down the price of oil/gas about 32% in 2010. Now since petroleum costs have a much larger impact on the price of food than does corn - (about 3.5 times larger) while ethanol impacts the 1.6% of the retail price of food represented by corn - Ethanol also drives down the petroleum component of food prices (15% to 30%) with the result being that ethanol has very little net impact on the price of food.

  • John Wagner

      I previously stated that petroleum related costs constitute about 6% of the retail price of food. BUT, there is another way petroleum costs affect the price of food.  There is a very clear inverse correlation between the price of oil and the value of the U.S. Dollar.  As oil prices rise the value of the dollar goes down.  Now certainly, as far as exported food-stuffs are concerned when the dollar goes down in value, the price of all products exported from the U.S. goes UP. So petroleum prices impact exported food prices MORE than the 6% figure quoted above which really applies only to food sold in the U.S. markets.

      There is more.  When food is exported it has to be shipped a great distance across the seas.  The ships used to carry the food are powered by diesel fuel.  Shipping costs are directly affected by the cost of crude oil.  So it would seem that ethanol's downward pressure on the price of petroleum is lowering the price of exported foods even more than the 15% to 32% range determined by serious analysts (I have read these studies and know they did not take into account the inverse relationship in the price of oil to the dollar and the resultant impact on the price of exported foods.)

       Also, as a direct cost the cost of petroleum for exported foods is a MUCH LARGER portion of the cost because of the cost of shipping to distant ports.  In fact, shipping costs to places like South Africa and Japan, add another 50% to the cost of food at a domestic port.

      Thus, in lowering the price of oil, ethanol has an even larger beneficial impact on the price of exported goods (including ALL farm commodities - not just corn) than it does for domestically sold food products.

    .... regarding ethanol's impact on corn prices - U.S.note that in from June - July 2010 to June - July 2011 the price of corn increased about 100%.  So how much did the demand for corn to make ethanol go up over the same time period - as a percent of the corn supply?  Well, that would be FOUR percent.  Yes, the increased demand for corn - to make ethanol - amounted to just 4% of the supply of corn.  Now, seriously, does anybody think a demand of 4% of the supply of corn would have a major impact on the price of corn???

       Also consider this.  In Sept of 2011 the number of corn futures contracts held by producers, processors, merchants and final consumers (those who actually have a purpose for corn - e.g. as food - and actually want to take delivery of said corn - was LESS THAN HALF the number of futures contracts for corn helf by SPECULATORS.   That's right, speculators - who have no interest in taking delivery of the corn - more than doubled the demand for futures contracts for corn.  Now, how much of the price increase in corn do YOU think is due to speculation in farm commodities?

  • John Wagner

     The 'study' sited is a clear example of selecting data to confirm a desired conclusion.

     Looking at the study, the authors compared oil prices to prices for wheat and make the astounding statement that:

    "The peak in oil prices follows the peak in wheat prices and so does not cause it."

     This contradicts what every farmer knows. In fact, petroleum related costs represent about 6% of the retail price of food.  Whereas, corn represents about 1.6% of the retail price of food.  I don't know if they will permit urls or links on this site so I can only say Google: "Food Dollar Series: Food Dollar Application" to see USDA's data on this.

     Here's one (among many) studies of the causal relationship of Crude Oil to Food Prices - Google: "The Long Run Relationship Between Petroleum and Cereals Prices"
     the authors conclude: 

    "results of Granger causality tests show that there exist a long run unidirectional
    causality from petroleum price to the three cereals prices, i.e., maize, rice and wheat.
    The said is not true for the reverse. These results suggest that petroleum price factor is
    growing in significance in the cereal complex. This is a plausible result since modern
    agriculture depends heavily on the use of fossil fuel in every stage of food production and
    marketing. The universal adoption of seed fertilizer technology (SFT) is energy intensive;
    that is, production of food is heavily dependent on chemical fertilisers, which uses fossil
    fuel as its primary inputs. The increases in fuel prices have raised the costs of producing
    cereal crops. For instance, the prices of some fertilizers (e.g. triple super phosphate and
    muriate of potash) in US dollar increased by more than 160 percent in the first two
    months of 2008, compared to the same period in 2007. Higher costs for fertilizer, fuel, and
    seeds could cause farmers without access to credit to produce less than they otherwise
    would have, or to shift to crops with fewer inputs requirements. Secondly, gasoline and
    diesel fuel are heavily used in ploughing, planting, cultivating and harvesting. Irrigation
    pumps use diesel fuel, natural gas, and coal-fired electricity. Thirdly, fertilizer production is
    also energy intensive as the mining, manufacture, and international transport of phosphates
    and potash all depend on oil. Lastly, with freight rates doubling within a one-year period
    beginning in February 2006, the cost of transporting food to importing countries also has
    been affected."

    causality from petroleum price to the three cereals prices, i.e., maize, rice and wheat.

    The said is not true for the reverse. These results suggest that petroleum price factor is

    growing in significance in the cereal complex. This is a plausible result since modern

    agriculture depends heavily on the use of fossil fuel in every stage of food production and

    marketing. The universal adoption of seed fertilizer technology (SFT) is energy intensive;

    that is, production of food is heavily dependent on chemical fertilisers, which uses fossil

    fuel as its primary inputs. The increases in fuel prices have raised the costs of producing

    cereal crops. For instance, the prices of some fertilizers (e.g. triple super phosphate and

    muriate of potash) in US dollar increased by more than 160 percent in the first two

    months of 2008, compared to the same period in 2007. Higher costs for fertilizer, fuel, and

    seeds could cause farmers without access to credit to produce less than they otherwise

    would have, or to shift to crops with fewer inputs requirements. Secondly, gasoline and

    diesel fuel are heavily used in ploughing, planting, cultivating and harvesting. Irrigation

    pumps use diesel fuel, natural gas, and coal-fired electricity. Thirdly, fertilizer production is

    also energy intensive as the mining, manufacture, and international transport of phosphates

    and potash all depend on oil. Lastly, with freight rates doubling within a one-year period

    beginning in February 2006, the cost of transporting food to importing countries also has

    been affected."
     While much time has been devoted to how much the demand for corn to make ethanol affects food prices - through corn prices.  It's interesting how little space and time (in the general media) has been devoted to how ethanol affectst the price of oil/gasoline.  Francisco Blanch was quoted in the Wall Street Journal (May, 2008) saying that ethanol has driven down the price of oil about 15%.  A thorough study by economists at Iowa State University concluded ethanol held down the price of oil/gas about 32% in 2010. While much time has been devoted to how much the demand for corn to make ethanol affects food prices - through corn prices.  It's interesting how little space and time (in the general media) has been devoted to how ethanol affectst the price of oil/gasoline.  Francisco Blanch was quoted in the Wall Street Journal (May, 2008) saying that ethanol has driven down the price of oil about 15%.  A thorough study by economists at Iowa State University concluded ethanol held down the price of oil/gas about 32% in 2010. Now since petroleum costs have a much  larger impact on the price of food than does corn - (about 3.5 times larger) while ethanol impacts the 1.6% of the retail price of food represented by corn - Ethanol also drives down the petroleum component of food prices (15% to 30%) with the result being that ethanol has very little net impact on the price of food.
    "The Long Run Relationship Between Petroleum and Cereals Prices"
     the authors conclude: 

    "results of Granger causality tests show that there exist a long run unidirectional
    causality from petroleum price to the three cereals prices, i.e., maize, rice and wheat.
    The said is not true for the reverse. These results suggest that petroleum price factor is
    growing in significance in the cereal complex. This is a plausible result since modern
    agriculture depends heavily on the use of fossil fuel in every stage of food production and
    marketing. The universal adoption of seed fertilizer technology (SFT) is energy intensive;
    that is, production of food is heavily dependent on chemical fertilisers, which uses fossil
    fuel as its primary inputs. The increases in fuel prices have raised the costs of producing
    cereal crops. For instance, the prices of some fertilizers (e.g. triple super phosphate and
    muriate of potash) in US dollar increased by more than 160 percent in the first two
    months of 2008, compared to the same period in 2007. Higher costs for fertilizer, fuel, and
    seeds could cause farmers without access to credit to produce less than they otherwise
    would have, or to shift to crops with fewer inputs requirements. Secondly, gasoline and
    diesel fuel are heavily used in ploughing, planting, cultivating and harvesting. Irrigation
    pumps use diesel fuel, natural gas, and coal-fired electricity. Thirdly, fertilizer production is
    also energy intensive as the mining, manufacture, and international transport of phosphates
    and potash all depend on oil. Lastly, with freight rates doubling within a one-year period
    beginning in February 2006, the cost of transporting food to importing countries also has
    been affected."

    causality from petroleum price to the three cereals prices, i.e., maize, rice and wheat.

    The said is not true for the reverse. These results suggest that petroleum price factor is

    growing in significance in the cereal complex. This is a plausible result since modern

    agriculture depends heavily on the use of fossil fuel in every stage of food production and

    marketing. The universal adoption of seed fertilizer technology (SFT) is energy intensive;

    that is, production of food is heavily dependent on chemical fertilisers, which uses fossil

    fuel as its primary inputs. The increases in fuel prices have raised the costs of producing

    cereal crops. For instance, the prices of some fertilizers (e.g. triple super phosphate and

    muriate of potash) in US dollar increased by more than 160 percent in the first two

    months of 2008, compared to the same period in 2007. Higher costs for fertilizer, fuel, and

    seeds could cause farmers without access to credit to produce less than they otherwise

    would have, or to shift to crops with fewer inputs requirements. Secondly, gasoline and

    diesel fuel are heavily used in ploughing, planting, cultivating and harvesting. Irrigation

    pumps use diesel fuel, natural gas, and coal-fired electricity. Thirdly, fertilizer production is

    also energy intensive as the mining, manufacture, and international transport of phosphates

    and potash all depend on oil. Lastly, with freight rates doubling within a one-year period

    beginning in February 2006, the cost of transporting food to importing countries also has

    been affected."
     While much time has been devoted to how much the demand for corn to make ethanol affects food prices - through corn prices.  It's interesting how little space and time (in the general media) has been devoted to how ethanol affectst the price of oil/gasoline.  Francisco Blanch was quoted in the Wall Street Journal (May, 2008) saying that ethanol has driven down the price of oil about 15%.  A thorough study by economists at Iowa State University concluded ethanol held down the price of oil/gas about 32% in 2010.

     Now since petroleum costs have a much  larger impact on the price of food than does corn - (about 3.5 times larger) while ethanol impacts the 1.6% of the retail price of food represented by corn - Ethanol also drives down the petroleum component of food prices (15% to 30%) with the result being that ethanol has very little net impact on the price of food.

  • Eric Trytko

    Well they have it half right, a return to regulating the commodities market would help food prices and also bring the price of a barrel of oil down about $20-30/barrel.

    What they are missing is that corn is one of the worst items to make ethanol out of.  In a rank of the top 50 crops to make ethanol out of, corn ranks in the low 20's.  The reason the U.S. uses so much corn to make ethanol is first and formost the Corn Lobby.  

    There are more tax incentives to use corn than any other crop material, however, even with those the landscape is changing thanks to R&D spending.  Things like bio-mass, the waste corn stalks, switch grass etc, are all coming to the front for production.

  • John Wagner

     I'm always to any opportunity to learn.  Can you please provide documentation (e.g. url) for the 50 crops rated as ethanol sources.  I know sugar cane is probably at the top, but try growing that in Kansas.

      Also, in this comparison did they take into account the fact that while the starch portion of the corn is used to make ethanol, all the protein is recovered and becomes a valuable high nutrient feed supplement for cattle and substitutes for corn (almost all corn raised in U.S. is for cattle feed) and soy-beans?

     please note that if Combined Heat and Power configuration is used with Corn stover as biomass fuel - the energy balance of corn goes up to 15 to 1 up to around 23 to 1.  For sugar cane processing much of the process heat is provided by bagasse instead of fossil fuel.- this boosts the energy gain relative to fossil energy inputs for sugar cane.

    I'm all for exploring anything that beats corn for ethanol productivity - recognizing we do not have the luxury of stopping the ethanol production we have going right now, while we develop other feedstocks.  The Arab Spring, lest people have caught on, has increased our energy security. Only problem is we don't know by  just how much.  A cut in our petroleum supply of 10% would make our current economic situation look like 'a walk in the park'.