"Converting corn from food to fuel has, at best, dubious net energy benefits, but its impact on food prices, already significant, can only grow over time," says Jeff Rubin, Chief Economist and Chief Strategist at CIBC World Markets. "With food carrying more than twice the weight in the CPI than energy, the policy response to record oil prices may become more inflationary than oil prices themselves.
"In the last two years corn prices have jumped by 60 per cent. Soaring corn prices not only pass directly into animal feed costs and corn-based food prices like tortillas, but they are spilling over to other grain prices as farmers scramble to expand corn production at the expense of other crops. Grain prices are the strongest they have been in memory while global inventories continue to shrink to record lows."
Ethanol is used as an additive to gasoline, and can comprise as much as 10 per cent of the fuel mixture in standard automobiles. Ninety-five per cent of the ethanol produced in the U.S. is distilled from corn. The U.S. Administration has set a target to raise ethanol production from a level of roughly one billion gallons a year in 2000 to 35 billion gallons a year by 2017.
Mr. Rubin notes that huge subsidies are needed to achieve these goals as corn-based ethanol production is simply not economically efficient - not even with $100 per barrel oil. The key reason is the huge amount of energy that is required in first growing and harvesting the corn, transporting it to the distiller, distilling the ground cornmeal into ethanol and then transporting it by truck and train to users across the country. These more costly transportation methods are required because ethanol cannot be transported in conventional pipelines.
These subsidies, worth some $8 billion in 2006, have stimulated the sector as ethanol production hit six billion gallons a year in mid-2007. At this rate of growth, CIBC World Markets expects the Administration's target will be reached by 2012, a full five years early.
However, the bank finds that this rapid conversion of food to fuel will put increased inflationary pressures on food prices. "By the end of next year we predict food inflation will be running well over five per cent," adds Mr. Rubin. "As ethanol production rises to nine billion gallons in 2009, food inflation will approach seven per cent, its highest level in more than 25 years."
He notes that while accounting for less than 15 per cent of the consumer price index, food represents one of the least substitutable areas of consumer demand. For low income Americans, food costs represent nearly 40 per cent of monthly budgets.
When compared with the huge investments in subsidies and the impact of soaring food prices, Mr. Rubin states that the net energy benefits of a U.S. domestic ethanol policy are marginal. "Most recent studies suggest that corn- based ethanol in the U.S. provides only a 25 per cent net energy benefit compared to the energy required in its production. By comparison, Brazilian ethanol, made from sugar cane, provides a 90 per cent increase in energy - and a gallon of pure ethanol holds about 30 per cent less energy than a gallon of gasoline."
He adds that even if the Administration's 35 billion gallon target is met, it will have a negligible impact on U.S. energy independence. Corn for ethanol currently accounts for 13.5 per cent of all corn production in the U.S., yielding roughly 6.2 billion gallons of ethanol which is equivalent to only a one percentage point reduction in U.S. gasoline consumption. Even if the U.S. achieved President Bush's 2017 target of 35 billion gallons per year that would only reduce gasoline consumption by an estimated 6.5 per cent.
"Ethanol indeed has certain benefits, but only for those who grow corn and distill it into alcohol," says Mr. Rubin. "The cost of this endeavour is enormous and is rising with every gallon of ethanol produced. The only thing Bush's renewable energy policy will fuel is inflation."
