An analysis of an increase in the demand for corn

Schwarzenegger Orders Cut in Emissions:

Gov. Arnold Schwarzenegger said Tuesday that he would ask regulators to require the state’s petroleum refiners and gasoline sellers to cut by 10 percent the emissions of heat-trapping gases associated with the production and use of their products.

... Environmentalists expected the order to turbocharge the market demand for corn-based ethanol and biodiesel fuels, and for natural gas, and to jump-start the introduction of experimental fuels like cellulosic ethanol, which is made from plant waste or nonfood crops like switch grass or wood chips.

The contemporary environmental movement links clear air goals to potential profits, and Mr. Schwarzenegger’s order, with input and support from lobbyists from Environmental Defense, the Natural Resources Defense Council and the Hewlett Foundation, mirrors that approach. The companies or industries that stand to benefit financially from his plan include producers of corn-based ethanol, biodiesel and other, more experimental forms of renewable fuels.

In ECON 101 we'd say, an increase in the demand for corn increases the price of corn. Since corn is an input into the production of the corn chip (I hope), the price of corn chips will rise. This might lead to an increase in the price of potato chips (a substitute for corn chips) and a decrease in the price of salsa (a complement of corn chips). The price of beer might fall if beer consumers require a salty snack to go along with a bottle of cold refreshment. Or, maybe that's the tail wagging the dog?

And never, ever, let it be said that the environmental economics blog skimps on hard economic analysis.

Comments

[Matt Bogard]

I'm more concerned with the corn used for animal feed vs. human consumption (as in Corn Chips). Corn raised for direct human consumption is a very small part of the total market for corn. It's market, production, and cost functions are quite different from other types of corn. The different types of corn are not likely close substitutes in production. (even soybeans and corn for feed are better substitutes) I'm not sure if most corn producers grow more or less corn for human consumption based on demands for ethanol or livestock feed since it's not the same corn(this is also a strong rebuttle to those who laud the comment 'eat a steak and starve an African').

Although I agree if corn for ethanol and animal feed becomes profitable enough,some producers may retool and switch to producing commodity grade corn vs food grade corn, causing increased price pressures in the food markets as indicated in the previous post.

But for now I think we'll see greater ramifications from the livestock markets and meat prices. We'll see more corn acres grown at the expense of soybeans, driving up their prices as well.

From the livestock producer's perspective, a good policy question would be, why should government be legislatively creating demand for ethanol and creating a boom market for one industry segment, while increasing the costs ( in corn and feed prices) in another.

[Dano]

Matt,

Thanks for bringing up increases in meat prices. That is what will happen. Then corn grown for food will be diverted and Lay's prices will increase. Then Freedom fries. Then countries with lots of debt service will have trouble feeding their ppl. Then...saaay, what's on ESPN tonight?

Best,

D

[Scott B]

Actually, since corn is an ingredient in Budweiser beer (and several other brews as well), if the price of said input increases, expecting an increase in the price of Budweiser is not unreasonable.

Of course, any increase in the price of corn due to higher demand for corn-based ethanol could be offset by a decrease in demand for corn syrup. Of course, I just made a lot of assumptions (elasticity of demand for corn and corn syrup, changes in quantity supplied and demanded, etc.), but the point is that due to market uncertainty we should all avoid beer brewed with corn.

And grass-fed beef tastes much better anyway.

Cheers,

[wurzike]

I have been amused by quote of Rep Peterson, that I came across to day. So the corn chips, beer and salsa have all been subsidized and we have had a bargain.
Except it's hard for me to forget about the sin tax on alcohol and the subsidies that have been payed for years to farmers not to grow certain crops......does this mean we the taxpayers will get a refund, from all of the subsidies that will not need to be payed or will we be now subsiding farmers to grow more soybeans.

(The chairman of the House Agriculture Committee said higher food prices aren't all bad."Frankly, we have been underpricing our food in this country," said Rep. Collin Peterson, D-Minn. "What this fuel thing is going to do is cause us to re-price our food to some extent. So consumers are going to pay more, and in my opinion, they should be, because we've been subsidizing them.")

[Gary Schwendiman]

It's Economics 101:

1. Increased demand for ethanol leads to higher corn prices

2. Higher corn prices lead to increased production

3. Corn prices fall back to long term average

The long term 50 year average price for corn is $2.50, inflation included. With inflation removed, the price today is 50 cents. This represents a 5 times productivity increase in corn production productivity.

If this reasoning doesn't convince you, ask yourself why there are corn support prices. It's because farmers always plant enough corn to occasionally drive the price of corn down to the support price, which is currently approximately $1.80.

Unless one can somehow prove that the economic laws for corn production have suddenly been altered in the last year, one should expect the corn price to fluctuate around the $2.50 cent level with occasionally volitility caused by speculators.

Gary Schwendiman, Ph.D.
Former Dean
College of Business Administration
University of Nebraska-Lincoln

Now
Chaimran
Ethanol Capital Management
www.ethanolinvestments.com

[Matt Bogard]

I actually just read some pretty interestiing info in AgLender corroborating Mr. Schwendiman's comments. The article cautions lenders, and farmers not to get to crazy about taking on long term debt based on current prices. When they fall back close to the 'natural' level, there could be trouble.

On the other hand, the prospect of lower corn prices in the future should imply better margins for ethanol production right?

But, how long will it take for prices to converge to their 50 year average? If we continue to divert more and more corn to ethanol won't that maintain the pressure for higher prices? Will cellulose based options be on line by this time?