The Effect of Ethanol Plant Siting on Corn Basis

By Yehushua S. Fatal | September 23, 2013

Corn prices rose from $2.50 per bushel a decade ago to more than $7 last year. These price increases had both cause and effect relationships with ethanol: more corn demand increased corn price, while local variation in corn prices influenced the siting of ethanol plants. Further, the siting of plants influenced local variation in corn prices. 

Exactly how new ethanol plant siting affects corn prices has not been well understood. Less than a handful of studies have been conducted to address this important question.

A recent study by Fatal and Thurman at the Department of Agricultural and Resource Economics at North Carolina State University has now investigated this question in depth.

The authors conclude that there is a strong and positive relationship between new ethanol plant capacity and corn basis--the difference between local and near delivery futures price--and they illustrate and quantify the impact of this effect around the plant location. By employing a spatial econometric model, they discovered a basis effect equals to 0.0193 cents per bushel for every additional million gallons of annual capacity. This effect diminishes linearly to zero as the distance between corn market and ethanol plant reaches 103 miles.

The basis effect is not uniform across markets as it depends on the market location, which in return determines the total ethanol capacity around it as well as the distance to the market. Calculating the aggregated effect of each corn market from nearby ethanol plants reveals a substantial effect: the addition of ethanol plant capacity in some parts of the country have resulted in a basis increase of up to 13 cents per bushel.

Siting Effects

One would expect that the siting of a new corn-based ethanol plant increases local demand for the grain, therefore distorting the pre-existing demand and supply equilibrium. The new plant adds to the local demand for corn and consequently elevates corn prices, at least in the short run until corn supply adjusts to the new equilibrium. 

Corn supply adjustment is expected to take place in the form of farmers planting more corn subsequently to the price increase, which will offset at least some of the corn price effect. Farmers who observe higher corn price as a result of the new ethanol plant siting, have the incentive to grow more corn and harvest higher profits. For more details about corn acreage adjustments due to ethanol plant siting, see “Corn Farmers Respond to Ethanol Plant Siting”, by Fatal and Thurman, which was published in Ethanol Producer Magazine in October 2012.


Spatial Corn Basis

Taking an advantage of a proprietary and rich panel data set of corn prices at more than 400 market locations in the United States, Fatal and Thurman examined the impact of ethanol plant capacity on corn basis for the years 2002-‘08. Data on corn prices as well as future prices were provided by GeoGrain, which offers market data, tools and intelligence to grain buyers and sellers.

In the analysis, the authors employed spatial economic theory. The foundation of the theory suggests that in the lack of commodity price difference across space, the net price received for the commodity will be determined by commodity transportation cost. It is reasonable to believe that there is a positive correlation between transportation distance and transportation cost, i.e. the further the commodity to be shipped, the higher transportation cost will be, hence the lower the net price (commodity price less transportation cost) received by the commodity seller.

Another premise of the theory is that spatial changes are likely to modify commodity shipping patterns. That is, the siting of a new ethanol plant will alter corn shipping arrangements around the plant.

The way Fatal and Thurman study incorporated the theory is by distinguishing between siting of an ethanol plant “downstream” or “upstream” from a corn market. For example, when an ethanol plant is located between the corn market and the terminal (where most of the corn was shipped to prior to the siting of the new plant), the ethanol plant is considered to be downstream from the market. Alternately, when the market lies between the terminal and the new plant, the ethanol plant is considered to be upstream to the market. 

Both upstream and downstream classifications of ethanol plants from corn markets as well as the transportation distance between the two will determine the potential savings for corn growers.

Spill-Over Effect of Rising Corn Basis

Higher corn basis provides an incentive for farmers to allocate more land and other resources to growing corn at the expense of growing other crops, mainly soybeans. Consequently, the quantity of soybeans produced decreases and its price increases along with corn price. An alternative for allocating more land to corn production at the expense of other crops is dedicating additional lands that are not used for crop production. According to the USDA, cropland used as pasture, reduced fallow and acreage returning to production from expiring Conservation Reserve Program contracts are all land uses that were converted to corn production due to the overall increase in corn price.

An increase in corn basis also raises the input costs of other corn consumers such as feedlot owners. In the last several years, livestock feeders had to compete with the rapidly growing ethanol industry over corn. On one hand, ethanol plants bid up corn price and force feeders to pay higher prices to feed their livestock, but on the other hand ethanol producers who produce distiller’s grain as part of their ethanol production process, sell it back to feedlots as a high protein feed.

Looking at corn prices and the total ethanol capacity at the national level gives insights into the link between energy and agricultural sectors, but will not explain in detail what happens at the local level. This study evaluates the impact of case-by-case ethanol plant siting and its effect on farmers and other corn buyers. 

As we know, the siting of a plant may not only change the transportation distance of corn as corn growers have another option to ship their grain to, but also change shipping patterns therefore affecting basis. Policy makers, as well as corn buyers and sellers can now quantify the magnitude of this effect and use the information to form new policies and better project procurement costs once an ethanol plant is sited in a particular region.

Author: Yehushua Shay Fatal
Senior Research Analyst
Kenan-Flagler Business School
University of North Carolina at Chapel Hill