Cause AND Effect: The Impact of the RFS

The U.S. ethanol industry is now working on ways to implement the renewable fuels standard's numerous mandates and regulations. Meanwhile, some experts are looking at possible long-term effects—both direct and peripheral—that the policy may have on the U.S. grain prices, land availability and the animal feed ingredient markets.
By Kory Wallen | February 01, 2006
How will the 7.5 billion-gallon renewable fuels standard (RFS) impact the U.S. corn market? The answer to that question is anything but simple. Industry experts say predicting what the corn and ethanol markets will look like in 2012 is akin to predicting the weather six years in advance. Economic models have been developed to provide mid- and long-term forecasts of the ethanol and corn markets, but they rely on constantly shifting variables.

At the same time, corn yields are greater than ever—due largely to improved farming techniques and superior crop varieties—and growers are now dedicating acres to corn that had previously been set aside for other crops such as soybeans and small grains. North Dakota, for example, has had a 100 percent increase in corn acreage in the last 10 years. Still, the national increase in corn acreage has been negligible over the same time period, and it's difficult for analysts to say if that will change anytime soon.

Some experts believe that any variation in the amount of U.S. land needed to grow corn will be slight. "The industry was able to go from zero to 4 billion gallons of ethanol without a [significant] increase of corn acreage," says David Morris, vice president of the Institute for Local Self-Reliance, a group that advocates sustainable economic development and keeps a close eye on the ethanol industry. Generally, most experts are predicting a moderate increase in total corn acreage to reach the RFS minimum.

The USDA has crunched some numbers and used models to predict the amount of land that may be required to hit the RFS floor. In 2005, the ethanol industry used 1.575 billion bushels of corn out of a total crop of 11 billion bushels to produce over 4 billion gallons of ethanol—equaling 14.3 percent of the nation's crop yield. "Assuming we have stronger energy prices and we exceed the RFS minimum by a bit, 23 percent of the corn crop will be used for ethanol production in 2012," says Keith Collins, the USDA's chief economist. "That's a big number. That's a good number." Similarly, Morris believes roughly 15 percent to 20 percent of the nation's corn crop will be used in 2012 to meet the RFS requirements.

The USDA came up with its numbers by using the FAPSIM (Food and Agriculture Policy Simulator) economic model. The model takes into account many different situations such as greater yields and increases in total corn acreage planted. The USDA believes that by 2012, total corn acreage will increase by 3 million acres. "Corn acres will go up because of the increase in the price of corn driven by the increase of ethanol production," Collins tells EPM. "Part of the increased demand on corn will be met from the increase of yields, but higher yields won't be enough to keep up with the rapid increase of corn grind. Therefore, more land will turn over to corn production."

Determining a ceiling on the amount of ethanol that can be produced from corn in the United States is, at the moment, a fickle endeavor. "Many have said, including myself, that 7 [billion] to 10 billion gallons [of ethanol production] was the limit for corn. Well, maybe not," Morris says. "If [ethanol production] is only going to use 20 percent at the 7.5 billion-gallon level, it's not inconceivable that it could double." Would it be feasible to utilize 40 percent of corn crops to produce 15 billion gallons of ethanol? According to Morris and the USDA, there are too many variables to answer that question. Regardless of this conundrum, though, the industry is already developing technologies for cellulosic ethanol production—and perhaps making the grain question immaterial.

The cellulose factor
One of the lesser known mandates in the RFS states that after 2012, of all ethanol produced in the United States, 250 million gallons must come from cellulosic ethanol. "This built-in mandate will help spur the development of cellulosic ethanol," Collins says. "There is a general expectation that by the time we get to 2012, there will be a commercially viable cellulosic ethanol production technology." Today, cellulosic technology is improving steadily, but there are some substantial impediments to its commercialization that must be overcome. "There still is some serious research that needs to be done," Collins explains.

Experts are not quite sure if cellulosic ethanol will ever be cheaper than grain-based ethanol. The feedstocks—corn stover, for example—may be cheaper to acquire, but there may be a more expensive commercial conversion process, Collins says. With cellulosic ethanol currently being produced in pilot and demonstration plants today, Morris says the cost of producing cellulosic ethanol currently costs approximately $1 more than producing the fuel from corn. He says that means cellulose still needs a financial and/or technological boost that will put it on the same playing field as grain. Collins tends to agree, saying, "Over time—the next 20 years—cellulosic ethanol will be able to compete with grain ethanol, providing a tremendous opportunity to augment the nation's transportation fuel supplies."

Increasing corn value
As the RFS goes into effect, and with the use of ethanol gaining momentum, farmers are starting to see more value in corn crops versus other crops. "If the price of corn goes up, then people may shift from other crops to corn," Morris says. "The shift would most likely be from soybeans to corn." While many farmers today rotate crops year-to-year, the Iowa Renewable Fuel Association (IRFA) has already seen some Iowa farmers growing corn continuously for a few years before rotating to a different crop. "Producers have well established patterns of crop rotation, but nevertheless we do see such shifting taking place over time as prices continue to rise," Collins says.
Morris adds, "In the last 20 years, the shift in acreage has been toward soybeans, and one might see the shift going back to corn soon."

The price of corn is dependent on a variety of components worldwide. Like any product, corn is reliant on the economic principal of supply and demand. The ethanol industry has undoubtedly increased the demand for corn in the United States, and industry experts say that just meeting the RFS minimum is going to mean higher corn prices then otherwise would be the case. "Corn has been in surplus since the drought year of 1997," Morris says, explaining that the price of corn will presumably go up as soon as the inventory and surplus shrinks. "We're not yet at that point."

Monte Shaw, executive director for the IRFA, agrees. He says it's tough to drive even 20 minutes across the Midwest without seeing a "huge pile of corn"—and most of it is still being used for animal feed.

Collins explains that the more grain ethanol that is produced, the higher corn prices may go. "Higher prices will eventually start to squeeze the profitability of ethanol plants, and could slow or stop the industry's expansion," Collins says. On the other hand, one of the things the USDA has seen in recent months is a changed outlook on future oil prices. "While corn prices would rise with the RFS, they could potentially be offset—or more than offset—by higher energy prices," Collins says.

It remains difficult to determine where ethanol prices will settle out relative to gas prices in the future. Once the country meets the RFS minimum, it will be left up to the market forces to determine the demand for ethanol. "That demand is going to depend on where the price of gasoline is," Collins says. "If gas prices are high enough, people will continue to demand ethanol, and that would be very profitable for ethanol producers. … Or it could be completely the opposite." Morris and Collins say that it's all but assured that it will be profitable to produce ethanol up to the 7.5 billion-gallon minimum, at least for the industry's most efficient producers.

Debunking the food vs. fuel argument
Both Collins and Morris believe there is no argument to be made in the food-versus-fuel issue. "If you look at our numbers, the U.S. can fairly accommodate 8 billion gallons of ethanol production with the combination of higher corn yields and a slight increase in acreage," Collins says. While corn used for ethanol would be otherwise fed to cattle and other livestock, opponents argue that the corn could go to feed the hungry across the world.

The world hunger problem is not a problem of supply but a problem with distribution, Morris contends, saying, "The world produces enough calories and proteins to provide everyone with adequate nutrition. What you have is distribution bottlenecks, corruption and wars." As the current obesity problem shows, there is an overabundance of sugars in the world food supply. Currently, in Brazil 40 percent of its fuel comes from sugarcane. "If people are starving in Brazil, it is not because the sugarcane went to make fuel for cars," Morris says.

Another factor in the food-versus-fuel debate is the increase in corn exports around the world. The emergence of India and China as corn exporters has surprised many, and the South American countries of Argentina and Brazil have stepped up their corn exports as well. "There are going to be a lot of additional sources of agricultural products in the world market to help satisfy the world food demand," Collins says. "Some could come from our acreage expansion; some could come from other countries."

Opportunities to expand corn acreage and corn yields in the United States are abundant. The past two years have produced record average corn yields of 160 bushels per acre in 2004 and 148 bushels per acre in 2005. With the biotech era and genetic technologies unfolding, there is potential for bigger crop yields and perhaps less variable yields in the near future. Plus, there is a substantial amount of acreage—roughly 35 million acres—located in the federal government's Conservation Reserve Program. "On the acreage side, we are well equipped to continue expansion," Collins says. "While we want to [keep some CRP] land in the program—specifically environmentally sensitive land—we don't necessarily need to have all of it there."

The big distillers grains question
Along with the increase of ethanol production (coming generally in the form of dry mills) has in turn, increased the production and distribution of large amounts of distillers grains. The coproduct has typically been used in cattle feed, but has recently made its way into the swine and poultry markets with good success. While it seems to be moving in that direction fairly well, every effect has its cause and secondary implications. The DDGS entering the feed market has—and will continue to have—an effect on corn and soybean meal prices. "The increase of distillers grains will drive down the price of soybeans a little bit, enough to take acreage away," Collins says. Many experts have different assumptions on how DDGS will displace soybean and corn meal. The USDA has done extensive research with animal feed specialists and nutritionists to conclude that DDGS will displace roughly half of the soy and corn meal used today.

In the back of many minds is the unpredictable DDGS export question. "If distillers grains prices continue to rise, it may be more profitable for farmers to export distillers grains versus corn," Shaw explains. In the United States, corn exports are the second largest market for the crop. However, Shaw believes ethanol production, currently the third biggest market for U.S. corn, will take the No. 2 spot by 2008.

With natural gas prices soaring to new heights, Morris says it may even become more economical for plants to burn DDGS as an energy source rather than selling it as feed. "At the point when distillers grains drops below $80 a ton, and assuming that natural gas is above $7 per Btu, you could see producers begin to burn it," Morris says. "There is always a value to the distillers grains. Even if it isn't a value as an animal feed, it can have an energy value." EP

Kory Wallen is an Ethanol Producer Magazine staff writer. Reach him at kwallen@bbibiofuels.com or (701) 746-8385.