Measures of Biofuel Policy Impact on Food Commodity Prices

Abstract

The previous chapter developed the required analytical framework in order to determine how much of the food grain and oilseed price increase observed over the last several years is due to biofuel policies. We established the price links between corn and ethanol, and between ethanol and gasoline. However, we failed to provide empirical estimates of the ethanol price premiums due to the tax credit versus the mandate; these premiums were far too high. Our predicted monthly corn prices went far too low (and even negative). Using annual data, Drabik (2011) estimates that actual ethanol price was, on average, 3.6 times that of the estimated free market levels as per equation (2.2). Therefore, historical ethanol policy price premiums have to be adjusted to account for the ethanol shutdown price (at positive corn prices). In other words, we have to first determine the intercept of the ethanol supply curve and then adjust the data for the redundancy in ethanol price premiums (which we call “water” in a biofuel price premium). This is the first order of business in this chapter; namely, derive the ethanol supply curve and its intercept by analyzing the link between corn and ethanol quantities (the “horizontal link” to complement the “vertical” price link derived in the previous chapter), including the “recycling effect” of DDGS.