Ethanol Drives Up Food Costs

United States agriculture is in a rapid transition from a food and fiber producer to a major energy supplier as well as food supplier. The size and speed of this transition is unmatched in U.S. agricultural history. The rate of change is likely to accelerate in the next two or three years and will have major implications for all industries supplying inputs and services for this sector as well as those processing and marketing its products. The biofuels movement is global, so feed and food ingredients produced outside the U.S. also are being diverted to ethanol and biodiesel fuel and will have an impact on food costs.

Iowa is the epicenter of the explosive growth in the ethanol industry. In late January 2007, existing and planned plants, if all are built, would increase the state’s corn processing capacity (including all other corn-based products except livestock feeds) to the equivalent of 135% of last year’s Iowa corn crop. The likely time frame for these plants to come into operation is within the next three and one-half to four years, or possibly sooner.

Iowa is the largest producer of corn in the U.S. and the largest or second-largest producer of soybeans. Its normal grain production exceeds Canada’s entire grain crop. Iowa also is the leading hog- and egg-producing state and is an important producer of milk and beef. These animal industries supply meat and dairy products to American and foreign consumers and require a large and stable corn supply, usually nearly a third of the crop. Normally, about 28–30% of Iowa’s corn is shipped to users elsewhere in the U.S. and abroad.

Other products coming from Iowa include corn oil, soy oil, and soy protein for food uses, corn sweeteners and starch, and corn-based cereals. To provide enough corn for these various markets, corn production in the state will need to increase very sharply, starting in 2007. Within three or four years, the state’s production may need to increase by 70–80% from recent levels. That means that corn prices will have to be high enough to attract cropland from wheat, soybeans, oats, hay, pasture, and the government’s Conservation Reserve Program. At this writing, corn prices are more than double those of a year ago, and still higher prices appear likely in the next few years.

The picture is similar at the national level. Existing and planned corn-based ethanol plant capacity exceeds recent U.S. corn production, without allowances for feed, exports, or other processing uses. Economic forces pushing more cropland into corn will reduce the supply of wheat, other small grains, soybeans, cotton, and other crops and will bring an across-the-board increase in crop prices. Some cane and beet sugar may also be used for ethanol production. Fruits and vegetables may be less sensitive to the upward price pressure from ethanol, since many of these crops are produced outside the Corn Belt. Greatly increased price volatility has become another market impact. A large block of price-insensitive demand for ethanol is being mandated and will amplify price volatility in poor crop years. For example, in his January 2007 State of the Union speech, the President proposed a mandatory U.S. use of 35 billion gallons of renewable and alternative fuels by 2017. The current mandate from the 2005 Energy Bill calls for 7.5 billion gallons in 2012.

In years when weather problems reduce the corn crop, extremely high and volatile prices for feed and food ingredients are almost guaranteed.

At the retail level, food products such as meat, eggs, milk, and other dairy products are likely to show the largest price increases in the next two to four years. For these products, feed is the largest production cost component. Distillers grain, a by-product of ethanol production, can replace some corn and soybean meal in animal and poultry feed and pet foods. Its greatest potential use is in dairy farms, where it replaces both corn and soybean meal. In beef cattle feed, it mainly replaces corn. Potential use in swine and poultry rations is much more limited. Processing removes about 70% of the original weight of corn, with 30% remaining as distillers grain. Within a few years, technological changes will reduce the distillers grain yield/bushel of corn by removing corn oil for biodiesel production and fiber for ethanol production.

Prices for food ingredients made directly from corn, soybeans, wheat, and other cereal crops also have increased sharply and become more volatile. They may increase further in the next few years as expanded demand for corn reduces land devoted to other crops. In many applications, these ingredients are a small part of the total retail cost and will cause significant but less severe upward pressure on retail consumer prices than those from animal agriculture.

Possible factors that could moderate food price impacts include lower crude oil prices, reduced government subsidies for corn ethanol, or quick development of economical technology for converting cellulose crops and wastes to ethanol. Most close observers believe the latter is several years away.

by Robert Wisner, Ph.D., is University Professor of Agricultural Economics, Iowa State University, Ames, IA 50011 ([email protected]).