The Impact of Ethanol and Ethanol Subsidies on Corn Prices: Revisiting History

Bruce A. Babcock, Jacinto F. Fabiosa
April 2011  [11-PB 5]

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Suggested citation:

Babcock, B.A. and J.F. Fabiosa. 2011. "The Impact of Ethanol and Ethanol Subsidies on Corn Prices: Revisiting History." Policy brief 11-PB 5. Center for Agricultural and Rural Development, Iowa State University.

Executive Summary

The rapid rise in corn prices that began in the fall of 2006 coincided with exponential growth in U.S. corn ethanol production. At about the same time, new ethanol consumption mandates were added to existing ethanol import tariffs and price subsidies. This troika of subsidies leads critics to view the ethanol industry as being beholden to subsidies, which then leads to the conclusion that ethanol subsidies lead to high corn prices. But droughts, floods, a severe U.S. recession, and two general commodity price surges have also occurred since 2006. It simply is wrong to assume that none of these factors has influenced corn prices.

While we cannot rerun history to see what corn prices would be like today without ethanol subsidies, we can rewrite history in a computer model to estimate what impact subsidies have had on market prices. The model would first need to be calibrated so that its solution re-creates what actually happened in agricultural markets. Then it would need to be rerun after government incentives to produce and consume corn ethanol are removed from the model’s equations. The resulting prices can then be compared to the historical record to estimate the market impacts of ethanol subsidies. This is exactly what we did for the 2005 to 2009 corn marketing years using the same model of the agricultural sector that CARD research staff used for the Environmental Protection Agency to estimate land-use changes from biofuels. To further isolate the effects of ethanol on commodity prices, we also ran a scenario in which we froze ethanol production at 2004 levels.

A number of issues were clarified through this exercise. First, the general pattern of corn prices that we saw in the historical period—increasing prices in in 2006 and 2007, a price spike in 2008, followed by a sharp price decline in 2009—would have occurred without ethanol subsidies or even if corn ethanol production had not expanded. Second, investor fervor for corn ethanol in 2005, 2006, and 2007 would have occurred even without subsidies because a combination of cheap corn, a phase-out of MTBE, and higher crude oil prices made ethanol profitable. Thus, ethanol production would have expanded quite rapidly even without subsidies.

Using the 2004 corn price of $2.06 per bushel as a reference, actual corn prices increased by an average of $1.65 per bushel from 2006 to 2009. Only 14 cents (8%) of this increase was due to ethanol subsidies. Another 45 cents of the increase was due to market-based expansion of the corn ethanol industry. Together, expansion of corn ethanol from subsidies and market forces accounted for 36% of the average increase that we saw in corn prices from 2006 to 2009. All other market factors accounted for 64% of the corn price increase.

Keywords: corn ethanol, corn prices, ethanol subsidies.