Ethanol and Economic Linkages Between Agricultural and Energy Markets.

The growth of the ethanol industry has strengthened ties between agricultural and energy markets. When gasoline prices increase, the demand for ethanol also increases, resulting in higher ethanol prices. Higher ethanol prices make ethanol production more profitable, encouraging greater use of existing capacity and investment in new plants. Stronger demand for corn to make ethanol, in turn, results in higher corn prices with effects across the entire food sector.

Policies complicate the story. Mandates require a certain level of biofuel use even when low gasoline prices or limited corn supplies would otherwise result in reduced ethanol use. Tax credits subsidize biofuel producers and consumers, and tariffs make ethanol imports from Brazil more expensive. Rules related to greenhouse gas emissions favor some types of biofuels over others.  The current combination of policies means that the ties between oil prices and corn prices are potentially quite strong when oil prices are high, but may be much weaker when oil prices are low.

While biofuels continue to contribute only a small fraction of energy needs, the growth of the ethanol and biodiesel industries does have at least some modest impact on fuel markets. Thus, a drought in the Midwest or an increase in livestock production in China will affect not only the price of food, but also the price of fuel.

Work by the Food and Agricultural Policy Research Institute (FAPRI) examines these linkages between agricultural and energy markets, and highlights the sensitivity of those relationships to the policy and market context.