Should We Waive the Renewable Fuel Standard in the Wake of the Drought?

19 january 2013

WASHINGTON, D.C. — In the wake of the devastating heat wave and drought which covered much of the United States this year, it has become clear that there will be less corn available on the market for the remainder of the year and for much of 2013 than there had been in recent years. Livestock, poultry, and ethanol producers already have been hit especially hard by the sharp increase in the price of corn, because corn comprises such a large portion of their production costs. Many livestock and poultry producers have had to liquidate herds and flocks as pastures and forage crops withered, and a number of ethanol producers have had to shut down or curtail production at plants. Further effects will be rippling through the U.S. and global economy in the months ahead.

The question of who will have to cut back on corn consumption in the year ahead has become as much a political question as it is an issue for the market to resolve. Several governors from livestock and poultry producing states, with support from the meat, poultry, and food processing industries, are calling on the Administrator of the Environmental Protection Agency (EPA) to waive some or all of the Renewable Fuel Standard (RFS) for the remainder of 2012 and 2013. Since most renewable fuel today is made from corn, they argue that waiving the RFS would reduce demand for corn significantly, thereby making more available at lower prices for meat and poultry producers and food processors. This in turn, they submit, would benefit consumers who otherwise will face much higher food prices in the months ahead. They say the RFS creates an inflexible demand for corn that is not responsive to higher prices, and that it thus forces meat and poultry producers, food processors, and consumers to bear a disproportionate share of the cost of the extreme weather and a short crop.

However, these issues are much more complex than often portrayed. This issue brief explores some of the questions relating to the impacts of the heat wave and drought on corn and ethanol production, what the RFS entails, and the potential impacts of an RFS waiver on various national priorities.

How much damage did the heat wave and drought cause to the corn crop this year?

We will not know until the 2012 harvest is complete just how big a toll this summer’s extreme weather had on the nation’s corn crop. Corn is the nation’s largest and most valuable crop, valued at more than $76 billion in 2011, according to the National Corn Growers Association (NCGA). In September, the U.S. Department of Agriculture (USDA) estimated that this year’s corn crop will be about 13 percent lower than in 2011 – about 10.7 billion bushels compared to 12.4 billion bushels in 2011. Although the 2012 harvest likely will be the eighth largest in U.S. history, it is certain to fall far short of the 14.7 billion bushels that were expected earlier this year – before the drought set in.

As the extreme weather intensified, the price of corn jumped more than 65 percent between early June and late August, from around $5.10 per bushel to as high as $8.39. The price has since come down to $7.40 (September 18). During the same period, ethanol prices increased about 34 percent, from around $2.00 per gallon to about $2.67, before settling down to $2.28 (September 18).

What will be the economic impact of the extreme weather?

It is difficult to precisely measure the economic toll of a disaster like this. However, this event likely will rank among the most costly natural disasters in the nation’s history. The 1988 drought was estimated to have cost about $86 billion (2006 dollars). The damage from Hurricane Katrina in 2005 reached a similar scale. At the peak of this year’s extreme weather, 33 states and more than half the nation’s counties were affected by drought, according to the USDA.

Much of the damage has already been done to crops, herds, and flocks. Most of the nation’s corn, soybean, hay, and cattle are produced within the affected region. The region also supplies much of the feed for livestock and poultry producers outside of the drought zone. Many herds and flocks have had to be liquidated for lack of affordable feed and forage. Many corn ethanol production plants have shut down or scaled back production due to the lack of corn or poor profit margins.

The USDA Economic Research Service (ERS) estimates that food prices will increase in the months ahead at a higher than normal rate. Overall food inflation for 2012 may be between 2.5 and 3.5 percent, and, for 2013, the rate may be between 3.0 and 4.0 percent.

How is the U.S. corn crop used?

The primary use – more than 60 percent – of the U.S. corn crop is for animal feed. In 2011, this included 36.3 percent which went directly for animal feed; the equivalent of another 12.2 percent in the form of dried distillers grains (DDGs) (a high protein, animal feed co-product of ethanol production); and about 13.0 percent in exports to other countries primarily for animal feed. In addition, a net of about 27.3 percent of the crop was used for ethanol production (after subtracting the DDGs). About 4.1 percent was used to produce high fructose corn syrup. And the remaining 7.1 percent was used for processed food (such as corn starch, corn oil, cereal, and corn meal), bio-based products, seed, and carry-over stocks, according to the NCGA, based on USDA data.