the impact of renewable energy on the u.s. farm policy debate€¦ · the impact of renewable...

The Impact of Renewable Energy on the U.S. Farm Policy Debate

Keith GoodFarmPolicy.com

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A Report to the German Marshall Fund of the United States

Keith GoodPresident, FarmPolicy.com, Inc.1

Journalism Fellow, German Marshall Fund of the United States

May 2007

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1 FarmPolicy.com is a daily summary of news relating to U.S. farm policy. Updates highlight news items dealing with production, trade, development, and transatlantic issues regarding U.S. and EU agricultural policy.


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Since September 2006, the market price of corn and soybeans has climbed significantly, and many agricultural observers point to the increased demand for renewable energy as a leading cause of the upward trend in prices. This report focuses on the factors that will impact the sustainability of the demand-driven surge in the market price of corn and soybeans, as well as the policy implications that higher market prices will have on the development of the 2007 Farm Bill. Congressional Budget Office projections of current programs establish

the amount of money available to lawmakers for crafting agricultural policy. As projected price-triggered budgetary outlays decrease, and Congress begins to function under pay-as-you-go spending rules, options for adding new spending will narrow. Forecasts of lower spending estimates will also limit the flexibility to alter program parameters like loan rates and target prices, or to introduce alternative programs such as revenue insurance. High market prices may also serve to focus policy on income stabilization rather than on income support.

Abstract

The German Marshall Fund of the United States2


In 2006, U.S. producers harvested 70.6 million acres of corn and 74.6 million acres of soybeans. The two crops accounted for 49 percent of total harvested acreage of principal cropland and generated almost $53.5 billion in gross sales for farmers. Corn and soybeans are versatile commodities that are utilized as feed ingredients in livestock rations, in food products for human consumption, and as feedstock for renewable energy production. Both crops are included in the Farm Security and Rural Investment Act of 2002 (2002 Farm Bill) as program commodities. Therefore, the federal government supports the production of these crops through marketing loans. Direct payments and countercyclical payments are also provided to historic producers of these commodities. In 2006, federal subsidy payments related to corn totaled $8.8 billion and accounted for almost half of all government crop subsidy payments. Federal subsidy payments related to soybeans totaled $591 million in 2006.

Since 1985, the U.S. market price of corn and soybeans has varied considerably. The marketing year (September–August) average price of corn

from 1985 to 2005 was $2.22 per bushel. Over these two decades, the marketing year average price of corn ranged from a high of $3.24 in 1995, to a low of $1.50 in 1986. (See Figure 1) For 2006, the U.S. average marketing year price of corn is forecast at $3.20. The U.S. marketing year average price of soybeans from 1985 to 2005 was $5.75 per bushel, with a high of $7.42 in 1988, and a low of $4.38 in 2001. For 2006, the U.S. average marketing year price of soybeans is forecast at $6.30.

Over the past two decades, in combination with price sensitive commodity programs, relative levels of supply and demand for corn and soybeans have generally dictated market prices. Periods of low production and high demand generated high prices, while phases of higher production generally caused the market price to weaken.

The federal farm policy debate mirrored the up and down movement of market prices from the mid-1990s to 2001, and the market price fluctuations were a contributing factor in establishing the 2002 Farm Bill. The time of lower output and higher prices that preceded the passage of the 1996 Farm

Figure 1: Corn and soybean price variability

Source: USDA Agricultural Projections to 2016, February 2007. USDA, Economic Research Service

$ bu

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1980Farm Act

1985Farm Act

1990Farm Act

1996Farm Act

1985 1990 1995 2000 2005 2010 20151980

2002Farm Act

2007Farm Act

Soybeans

Corn

8.00

6.00

4.00

2.00

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Bill appeared to validate the new policy direction that had been formalized in the 1996 agricultural legislation. Increased planting flexibility and fixed payments that were no longer linked to production appeared to be the right policy for the prevailing market conditions. However, discontent with the return to lower market prices in 1997 and 1998, coupled with federal ad hoc emergency assistance packages for many American producers, generated new debate about the most efficient way to stabilize farm income.1

As the market price of corn and soybeans decreased in the late 1990s, policymakers focused their attention on how to assure an income safety net for producers. In addition, in May of 2001, “Congress passed its annual budget resolution for fiscal year 2002, which also provided a multi-year budgetary framework for the new farm legislation. The resolution earmarked a total of $73.5 billion in additional funding for agriculture beyond baseline-projected levels for fiscal years 2002 through 2011.”2 The low market price environment, coupled with additional federal resources led Congress to write a 2002 Farm Bill that included three provisions to support commodity prices: 1) the continuation of marketing assistance loans; 2) direct payments, a fixed payment for each program crop that is not affected by current production decisions or by current prices; and 3) counter-cyclical payments, which were intended to institutionalize the ad hoc emergency disaster payments of the late 1990s.3

In the fall of 2006, corn and soybean prices began to move sharply higher. The average cash price for corn in Illinois in August of 2006 was $2.15, while the average cash price for soybeans was $5.37. By

1 Effland, Anne B.W. “U.S. Farm Policy: The First 200 Years.” Economic Research Service, Agricultural Outlook, March 2000.2 Westcott, Paul; Young, C. Edwin and Price, Michael. “The 2002 Farm Act: Provisions and Implications for Commodity Markets.” Agriculture Information Bulletin No. (AIB778), November 2002.3 Ibid.

February 2007, cash prices for corn and soybeans in central Illinois had jumped to $3.86 and $7.15, respectively, and corn futures for March delivery closed at $4.0625 per bushel on the Chicago Board of Trade, which was $1.72 higher than the contract’s 10-year average.4 The U.S. Department of Agriculture (USDA) anticipates the 2006-07 marketing year average price received by farmers for corn to be in a range of $3.00 to $3.40, while the average cash price received by U.S. farmers for soybeans during this same time frame is expected to range between $6.10 and $6.50 per bushel. USDA projects corn prices to rise for the next few years and to remain above $3.00 for the next 10 years.

Current Market Dynamic

The short-production, strong-demand paradigm that contributed to price spikes over the last two decades no longer appears to accurately explain the current upward trend in prices for corn and soybeans. Since 2004, U.S. corn production has totaled more than 10 billion bushels annually and the 2006 corn crop was the third largest on record. Soybeans have enjoyed similarly high production levels. Since 2004, U.S. annual soybean production has been greater than 3 billion bushels and the 2006 crop was the largest soybean harvest ever recorded at 3.18 billion bushels. South American production has also increased and world supplies are strong. Supply side influences do not adequately explain the recent surge in prices.

Export market demand for corn and soybeans has contributed to the high price levels. Corn exports in 2006 (2.25 billion bushels) were stronger than the average of 1.88 billion bushels over the previous six years (2000-01 to 2005-06), but were below the record levels of 1979-80 (2.4 billion), 1980-81 (2.39 billion) and 1989-90 (2.37 billion). Nonetheless,

4 Robinson, Peter. “Ethanol’s Boom Holds Hidden Costs: Higher Food Prices.” Bloomberg News, February 9, 2007.


USDA estimates that global inventories of corn this year will be at their lowest level since 1978.5 Soybean exports were large in 2006 (1.08 billion bushels), but this level was only marginally above the average of 1 billion bushels over the previous six years (2000-01 to 2005-06). Likewise, corn and soybean demand for feed has been very strong, but use has been in line with historic trends and not large enough to explain current price trends.

The new market dynamic of higher prices with simultaneous levels of high production appears to be stimulated by factors associated with an increased demand in renewable fuels, primarily in the form of corn-based ethanol, building on strong underlying feed and export demand.

Various forms of federal legislation have generated demand for renewable fuels. An early impetus in demand for renewable fuels was federal legislative action stimulated by environmental concerns. Poor air quality in some regions of the country prompted Congress to require fuel refiners to include oxygenates in fuel blends in the early 1990s. After problems associated with a commonly used oxygenate known as MTBE (methyl tertiary-butyl ether) were identified, refiners began to expand the use of ethanol to meet fuel-blending requirements.6

Other federal legislation has also served to increase demand for renewable energy. In 2004, Congress passed an extension of the Volumetric Ethanol Excise Tax Credit (VEETC) provision that extends until 2010 a federal tax credit of $0.51 per gallon, paid to refiners for every gallon of pure ethanol blended into gasoline. In addition, ethanol imports into the United States are currently levied at a tariff of 2.5 percent and a $0.54 per gallon tax is also imposed on imported ethanol.

5 Ibid.6 Novack, Nancy and Henderson, Jason. “Can Ethanol Power the Rural Economy?” The Main Street Economist. The Federal Reserve Bank of Kansas City, January 2007.

One of the more significant pieces of federal legislation impacting ethanol demand was the Energy Policy Act of 2005, which created a new Renewable Fuel Standard (RFS) requiring that gasoline sold in the United States contain a specific minimum amount of renewable fuel. The RFS is legislatively mandated to increase from 2006 through 2012 from 4.0 to 7.5 billion gallons per year.7 In his State of the Union address on January 23, 2007, President George W. Bush called for “setting a mandatory fuels standard to require 35 billion gallons of renewable and alternative fuels in 2017”—nearly five times the 2012 target now in law.

As these legislative initiatives take hold, the market has responded by increasing ethanol and biodiesel production. While testifying before the U.S. Senate Committee on Agriculture, Nutrition and Forestry on January 10, 2007, USDA Chief Economist Dr. Keith Collins explained that, “In 2000, about 1.6 billion gallons of ethanol were produced in the United States, with ethanol utilizing about 6 percent of the 2000 corn harvest. In 2006, an estimated 5 billion gallons of ethanol were produced, and ethanol accounted for 20 percent of the 2006 corn harvest.”

Dr. Collins also noted in his testimony that, “USDA estimates U.S. biodiesel production reached 250 million gallons in 2006, a 173-percent increase from 2005. For the 2005-06 crop year, biodiesel production accounted for 8 percent of soybean oil use; for 2006-07, biodiesel is expected to account for 2.6 billion pounds of soybean oil, or 13 percent of total domestic soybean oil use. The 2.6 billion pounds equals the oil extracted from 229 million bushels of soybeans, or 7 percent of estimated U.S. soybean production in 2006.”

7 Baker, Allen and Zahniser, Steven. “Ethanol Reshapes the Corn Market.” Amber Waves, April 2006.


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As the 2002 Farm Bill is due to expire in September 2007, a key concern for policymakers in drafting the 2007 Farm Bill is the sustainability of these current market conditions.

Strong demand for ethanol also emerged from high crude oil prices in the summer of 2006. In 2004, the world average price of a barrel of crude oil was $28.74 (week ending on January 30). By August 26, 2005, the average world price for a barrel of oil had increased to $58.74; and by June 2006, the average world price of a barrel of oil had surged to $65.11 (week ending on June 30).8

The market dynamic in world crude oil prices was another factor that contributed to higher ethanol prices. In January 2004, the average rack price of a gallon of ethanol in Omaha, Nebraska was $1.40 per gallon. In August 2005, the average ethanol price had climbed to $2.07 per gallon. By June 2006, the market price of ethanol had reached an average per gallon price of $3.58.9 The rise in ethanol prices provided incentives to increase ethanol production capacity either through new plant construction or by expanding existing processing plants.

In addition, the Energy Policy Act of 2005 terminated the gasoline oxygenate mandate that had previously existed in areas that had suffered from poor air quality. As noted before, many refiners had used MTBE as a fuel additive to meet the pre-existing oxygenate requirements. Manufacturers of MTBE have endured the threat of substantial legal liability stemming from concerns that MTBE could contaminate groundwater and cause health risks. The Energy Policy Act of 2005 did not include liability protection for companies that made MTBE. However, some refineries continued to use MTBE up until the time the requirement was dropped. As one news article noted, “Some refineries said the federal requirement to an additive gave them legal immunity from liability suits related to MTBE

8 Energy Information Administration. “All Countries Spot Price FOB Weighted by Estimated Export Volume (Dollars per Barrel) — 1978 to 2007.9 Nebraska’s Unleaded Gasoline and Ethanol Average Rack Prices. Official Nebraska Government Web Site.

contamination of water. The companies are hurrying to switch to ethanol because they fear that the protection will lapse after the [Energy Policy Act of 2005] takes effect.”10 Another news item described the situation this way, “The MTBE industry’s defense in the many lawsuits claiming its product has contaminated water supplies is that since 1990 the government has required use of oxygenates like MTBE. But with that requirement expiring in May [2006], producers and refiners will face far greater liability, which has set off a race to exit the market.”11

The simultaneous transition of the speedy MTBE phase-out, coupled with the new mandated use of renewable fuels, created short-term supply chain gridlocks and bottlenecks, which also contributed to higher ethanol prices in the spring of 2006. Specifically, in a news article from May of 2006, The New York Times reported that, “[Ethanol’s] price is up by about $1.30 a gallon in the last year, in part because of heavy demand for something to replace MTBE.”12

Sustainability

As the 2002 Farm Bill is due to expire in September 2007, a key concern for policymakers in drafting the 2007 Farm Bill is the sustainability of these current market conditions. The projected range of prices for current program crops will be a factor that lawmakers take into consideration when formulating policy goals that seek to stabilize and support farm income. Market conditions that existed during the debates over the 1996 and 2002 Farm Bill did not last. The high price environment of the mid-1990s was not sustained, and

10 Kocieniewski, David and Bajaj, Vikas. “Gas Shortages Could Pose Problem for Drivers on the East Coast.” The New York Times, April 22, 2006.11 The Wall Street Journal. “A Good Gas Idea.” Editorial, May 8, 2006.12 Wald, Matthew L. “New Recipe for Gasoline Helped Drive Up the Price.” The New York Times, May 6, 2006.


Because corn-based ethanol

may have to compete with

unleaded gasoline as a low-cost input

for fuel blenders, as production

exceeds mandate, ethanol demand

will be influenced by the price of oil.

neither has the lower price environment that preceded the passage of the 2002 law.

The profitability of renewable fuels production is a significant factor in the sustainability of the high market price of corn and soybeans. The scope of this analysis will focus on the factors associated with the potential profitability of corn-based ethanol production.

Brief Analysis of Corn-Based Ethanol Production

Demand for ethanol is a key factor in determining its market price level. Recall that fuel blenders must comply with the RFS of the Energy Policy Act of 2005, which was 4.0 billion gallons for 2006 and is mandated to increase to 7.5 billion gallons per year by 2012. The ethanol demand to meet these required levels will be price inelastic, fuel blenders will generally purchase ethanol to meet these guidelines regardless of cost. Even though the Energy Policy Act of 2005 eliminated the gasoline oxygenate mandate, the “law still required refiners to blend gasoline to keep emissions low.”13 As a result, fuel blenders may still need to purchase ethanol for oxygenation purposes, as well as to meet state-level renewable fuel standards. Due to the need to comply with these requirements, the increased use of ethanol as an oxygenate replacement for MTBE, and the value of ethanol as an octane enhancer, ethanol has been priced at a premium relative to unleaded gasoline.14

Demand for ethanol. One factor that will influence the long-run demand for ethanol is determining when production capacity will equal or exceed current demand for blending. Fuel blenders in the

13 Novack, Nancy and Henderson, Jason. “Can Ethanol Power the Rural Economy?” The Main Street Economist. The Federal Reserve Bank of Kansas City, January 2007.14 Nebraska’s Unleaded Gasoline and Ethanol Average Rack Prices. Official Nebraska Government Web Site.

United States operate to make a profit and will seek the lowest-cost inputs available in the market to generate a liquid fuel product. Ethanol production that exceeds the demand of blenders to meet their RFS requirements and satisfy preferred oxygenated levels of fuel blends, will have to compete with unleaded gasoline as a low-cost input for fuel blenders. If the price is not competitive, use will be capped, causing the market price to fall once the supply of ethanol exceeds the mandated plus oxygenate market level.

Infrastructure issues associated with ethanol distribution could also contribute to a cap on use. Due to its chemical composition, current oil distribution networks are not available for ethanol. “Ethanol-blended gasoline tends to separate in pipelines. Further, ethanol is corrosive and may damage existing pipelines. Therefore, unlike petroleum products, ethanol and ethanol-blended gasoline cannot be shipped by pipeline in the United States.”15 As a result logistical limitations and higher costs associated with ethanol transport via barges, rail cars, and tanker trucks could also limit ethanol use.16 Technical adjustments to automobile motors for consumption of ethanol blends that exceed 10 percent may also pressure ethanol to be priced competitive with gasoline as market forces put a ceiling on demand.

Some market analysts have estimated current ethanol blending use at 10 billion gallons, 7 percent of the 150 billion gallons of consumed fuel per year.17 The Renewable Fuels Association currently estimates ethanol production capacity at 5.4 billion gallons. However, as of January 2007,

15 Yacobucci, Brent D. and Schnepf, Randy. “Ethanol and Biofu-els: Agriculture, Infrastructure, and Market Constraints Related to Expanded Production.” CRS Report for Congress, RL 33928, March 16, 2007.16 Ibid.17 Fahey, Jonathan. “Whoops.” Forbes, February 12, 2007.


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construction and expansion estimates indicate that ethanol capacity in the United States could jump to 11.4 billion gallons per year as soon as next year.18 If ethanol supply surges past the current RFS — MTBE oxygenate consumption levels, the excess ethanol will have to be price competitive with unleaded gasoline in order to enjoy sustained demand.

Currently, unleaded gasoline is the most widely used form of liquid fuel in the United States. Since gasoline is made from petroleum, which is derived from crude oil, the price of unleaded gasoline is correlated to the price of crude oil. Because corn-based ethanol may have to compete with unleaded gasoline as a low-cost input for fuel blenders, as production exceeds mandate, ethanol demand will be influenced by the price of oil. An increase in the price of oil will likely make ethanol a relatively cheaper input for fuel blenders to use compared to unleaded gasoline.

Corn and ethanol price relationships. Additional factors regarding the energy properties of ethanol and external economic considerations also have an impact on the relative price of ethanol as a cost competitive alternative for fuel refiners. It is widely understood that the energy value in a gallon of ethanol is approximately 33 percent less than in a gallon of unleaded gasoline and fuel blenders are provided a $0.51 federal tax credit for each gallon of ethanol used in their blends.19

Economists have formalized this analysis with recent examples from the marketplace. If unleaded gasoline sold for $1.69 per gallon (average rack price of unleaded gasoline in Omaha in December 2006) and ethanol was $2.43 per gallon (average rack price of ethanol in Omaha in December

18 Collins, Keith. “Statement Before the U.S. Senate on Agricul-ture, Nutrition and Forestry.” January 10, 2007.19 Hurt, Chris; Tyner, Wally and Doering, Otto. “Economics of Ethanol.” Purdue Extension, December 2006.

2006), the competitive price of ethanol could be calculated. Based on the energy components of ethanol and the blending tax credit, ethanol prices should not exceed the unleaded price of gasoline, times 0.67 (energy adjustments) plus $0.51 (blender tax credit). Using this analysis, wholesale-unleaded gasoline at $1.69 per gallon points to ethanol priced at $1.64 per gallon.20 In addition, a premium might still exist if the market placed value on lower greenhouse emissions from ethanol and on the octane enhancement of ethanol.

Another component in determining the profitability of ethanol production is the price of corn. As the primary input in ethanol generation, the price of corn will influence the breakeven price of ethanol. Economists have created analytical models that incorporate market relationships between the price of a barrel of crude oil and the price of a gallon of unleaded gasoline. These models then derive a corresponding price comparison for a gallon of ethanol based on the energy adjustment and tax credit factors noted previously. After this calculation is complete, analysts estimate the breakeven price of corn for ethanol production.

Researchers at the Federal Reserve Bank of Kansas City determined that, “Based on historical relationships, ethanol prices ranged from $1.55 to $2.13 to $2.71 per gallon to correspond with crude oil prices that ranged from $40 to $60 to $80 per barrel, respectively.” In their simulation, Novack and Henderson determined that if crude oil prices were $40 per barrel, and the market price of corn was $3.50, ethanol producers would lose about 9 cents per gallon of production.

Economists at Purdue University have conducted similar modeling simulations based on the

20 Good, Darrel. “Corn: Small Crop Meets Strong Demand.” University of Illinois Extension, January 7, 2007.


If producers plant more corn, the

price of alternative program crops

such as soybeans and wheat could

also increase.

relationship between the price of crude oil, the price of ethanol, and the price of corn. Based on their modeling, Hurt, Tyner, and Doering found that if the market price of crude oil was $60 per barrel, ethanol producers could pay up to $3.96 per bushel of corn and still breakeven. However, the model also incorporated the value of ethanol as an additive and estimated that with an oxygenate premium of $0.25 per gallon, ethanol producers could purchase corn at $4.82 per bushel and still breakeven at an oil price of $60 per barrel.

The Center for Agricultural and Rural Development at Iowa State University conducted a similar analysis and concluded that when the market price of crude oil is $60 per barrel, the breakeven market price for corn would be $4.05 per bushel. Based on the inverse relationship between the price of a barrel of oil and the relative cost competitiveness of ethanol, the Iowa State economists found that the breakeven price of corn would fall to $2.67 when the price of oil was $40 per barrel and would increase to $5.43 if the price of crude oil rose to $80 per barrel.21

Robert Wisner at Iowa State University has summed up the relationship between the price of ethanol and the breakeven price of corn this way, “Each $0.10 change in the price of ethanol changes the maximum price a new plant can pay for corn by about $0.28 per bushel while still covering costs.” This relationship is based on the assumption of a yield of 2.8 gallons of ethanol from a bushel of corn.

Currently, a compilation of average prices on all by-products sold from ethanol plants from select locations in Iowa are being collected and posted on the Internet by USDA’s Agricultural Marketing

21 Elobeid, Amani; Tokgoz, Simla; Hayes, Dermot J.; Babcock, Bruce A. and Hart, Chad E. “The Long-Run Impact of Corn-Based Ethanol on the Grain, Oilseed, and Livestock Sectors: A Preliminary Assessment.” CARD Briefing Paper 06-BP 49. Cen-ter for Agricultural and Rural Development, November 2006.

Service (AMS). Data sets also incorporate the average price paid for corn, which is then used to determine a gross crush margin. According to a report from February 9, 2007, an average ethanol price of $1.89 per gallon and an average corn price of $3.73 generated a crush margin of $2.68. Similarly, an average ethanol price of $1.79 per gallon and an average corn price of $3.66 resulted in a gross crush margin of $2.48 on February 2.

Corn supply. Factors that impact the supply of corn will also impact the profitability of ethanol production. At current price levels, U.S. producers can be expected to increase corn acres. The magnitude of this increase will have a bearing on potential supply and projected market prices. Some producers will likely change their traditional crop rotations and plant corn after corn if the per acre return of corn production appears to be more profitable than growing other alternative crops, particularly soybeans. Yields will also play a key role in total supply. Average U.S. corn yield set a record in 2004 at 160.4 bushels per acre and was 149.1 bushels per acre in 2006. Although yields have trended higher over the past 30 years, yields will largely be determined by temperature and precipitation levels during the growing season. If supply levels increase enough to lower market price, the gross crush margin could potentially increase, resulting in a greater likelihood of ethanol profitability and continued growth.

If producers plant more corn, the price of alternative program crops such as soybeans and wheat could also increase. International grain producers such as Brazil and Argentina would also respond to higher market prices and change production allocation decisions and increase the amount of soybeans, and corn, that are produced. This could offset reductions in U.S. supplies.

Federal policy. Another factor impacting long-term ethanol use and production is potential change


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in federal policy. Currently, renewable energy initiatives appear to enjoy broad-based bipartisan political support. In his State of the Union address on January 23, 2007, President George W. Bush called for substantially increasing the renewable and alternative fuel standard. Potential changes in the required level of renewable fuels that must be purchased by fuel blenders will have a direct impact on the long-term profitability of ethanol production. In addition, the $0.54 per gallon tax that is currently imposed on imported ethanol is set to expire in 2009. Special interest groups have offered various political arguments regarding this issue. Some maintain the tariff is necessary to protect domestic investments in renewable energy, while others note that the source of renewable fuels used in the U.S. market is not relevant and argue that the tariff is an inefficient policy tool that should be eliminated. The level of the import tariff has also been the subject of some controversy. Economists have suggested that Congress might extend the import tariff in 2009, but lower it to $0.51.22 The level of tariff protection that lawmakers ultimately legislate will influence the future level of ethanol use.

Technological change. The viability of long-term corn-based ethanol use may also be affected by technological changes associated with cellulosic ethanol production, a process whereby ethanol can be produced from alternative feedstocks such as wood, corn stalks, or various kinds of perennial grasses. A variety of technological and market factors are currently limiting ethanol production derived from these sources, including a limited supply of feedstock, lack of infrastructure for commodity transport and storage, and prohibitively high costs of cellulosic ethanol production. Some have estimated that a metric ton of corn can generate about 110 gallons of ethanol. The lone

22 Dow Jones News Service. “Experts: Cong. Might Trim Ethanol Duty.” February 23, 2007.

cellulosic ethanol production facility in operation, which is located in Canada, currently can only produce about 84 gallons per metric ton.23 However, in February of 2007, a U.S. company announced plans to build a cellulosic ethanol plant in Georgia where wood from trees will be converted to ethanol.24 Technological advancements with respect to alternative sources of ethanol feedstock, like wood and grasses, will also impact the future use of corn-based ethanol.

In their annual agricultural baseline projections, released in February of 2007, the USDA estimated that, “Corn used to produce ethanol in the United States continues strong expansion through 2009–10, with slower growth in subsequent years. By the end of the projections, ethanol production exceeds 12 billion gallons per year, using more than 4.3 billion bushels of corn. The projected large increase in ethanol production reflects the Energy Policy Act of 2005, the elimination of MTBE as a gasoline additive, ongoing ethanol plant construction, and economic incentives provided by continued high oil prices.”

The USDA report added that, “Large increases are projected in corn used for ethanol production over the next several years. Relatively high prices for oil contribute to favorable returns for ethanol production, which combine with government programs to provide economic incentives for the large ongoing expansion in ethanol production capacity.”

Federal Budget Considerations

The debate over the 2007 Farm Bill begins in the House and Senate Budget Committees. Projected baseline spending estimates from the Congressional Budget Office (CBO) serve as a basis for setting

23 Judy, Dave. “The Corn Threat.” National Review, February 22, 2007.24 Chapman, Dan. “Georgia Plant to Turn Pine Waste into Etha-nol.” The Atlanta Journal-Constitution, February 8, 2007.


the parameters of federal spending in Budget Committee debate. The CBO estimates, which are released in January, March, and August, forecast federal spending under current law over a multi-year time span, while incorporating current and projected market conditions, structural changes, and economic trends into their analysis. Assumptions and examination of current and future ethanol use will be a key factor in formulating long-term market price estimates for program crops such as corn and soybeans. Since some federal farm subsidy payments are based on market prices, these estimates will have a direct bearing on calculations regarding the future level of farm program spending.

The Budget Committees use the March CBO budget baseline as a starting point when generating the specific allocation levels that the Agriculture Committees must operate within. Since the Budget Committees determine spending levels for federal farm programs, the CBO baseline estimates and Budget Committee determinations will have a direct and significant impact on the Farm Bill debate. Parliamentary procedure allows the Budget Committees to exceed CBO baseline estimates for spending, which has happened previously in 1994, 1999, 2000, 2001, 2002, and 2005. However, once the Budget Committees settle on final limits for spending, it becomes procedurally difficult for the Agriculture Committees to exceed these predetermined spending limits when formulating the new federal farm law.

An issue that could complicate the task of the Budget Committee exceeding CBO estimates in this Congress is the concept of “Pay-as-you-go spending,” or “PayGo.” Under this legislative paradigm, which has been adopted by the House and Senate Budget Committees, outlays in federal expenditures that exceed the budgeted allotment can only be approved if the additional spending is “paid for” with an equal reduction in associated spending

in another program, or through an increase in taxes which would generate offsetting income.

CBO’s March 2007 baseline indicated that projected Commodity Credit Corporation (CCC) program expenditures are $27.5 billion lower in FY2008-2016 (See Figure 2) than the CBO estimate from March 2006. CBO lowered budget projections for corn payments by $4.2 billion for FY 2007, $3.9 billion for FY 2008, and $2.9 billion for FY 2009 compared to last year’s estimates. In fact, corn related payments account for almost $15 billion of the $27.5 billion in projected reductions in CCC program payments from last year. “The ‘smaller pie’ does not reduce the ability to continue current programs, but baseline price forecasts affect how legislative proposals are scored against the baseline.”25

As expected returns from corn production increase, producers will likely devote more of their production allocation to corn acreage. On March 30, 2007, USDA reported that, “Driven by growing ethanol demand, U.S. farmers intend to plant 15 percent more corn acres in 2007 … producers plan to plant 90.5 million acres of corn, the largest area since 1944 and 12.1 million acres more than in 2006.”26 The increase in demand for corn acres may put upward pressure on the market price of other program crops such as soybeans, wheat, and cotton. As producers shift acreage out of these commodities and into corn, the supply of other program crops may decrease. According to USDA, “The increase in intended corn acres is partially offset by a decrease in soybean acres in the Corn Belt and Great Plains, as well as fewer expected acres of cotton and rice in the Delta and Southeast. U.S. farmers plan to plant 67.1 million acres of

25 Monke, Jim. “Farm Commodity Policy: Programs and Issues for Congress.” Congressional Research Service, RS21999, March 8, 2007.26 USDA Press Release. “Corn Acres Expected to Soar in 2007, USDA Says.” March 30, 2007.


11

A simple extension of the 2002 Farm Bill would not only be one of the lowest-cost options available to lawmakers, but it might also be one of the only ways for farm policy to fit within a low budget baseline for spending on the 2007 Farm Bill.

soybeans, the lowest total since 1996 and a decrease of 8.4 million acres — or 11 percent — from 2006. Area planted to cotton is expected to total 12.1 million acres, down 20 percent from 2006.”27 Upward price pressure associated with planting decisions could lower CCC payments for other commodities even further.

In addition to crop allocation decisions, the potential of adverse growing conditions during spring planting, or more importantly, during mid-summer crop pollination, could also put upward pressure on the market price of corn. As one market report noted recently, “The crop intentions are just one data point in a long crop year. Going forward, there will be increased focus on whether farmers actually do what they say they are going to do in terms of planting and the impact of weather patterns on yield.”28

27 Ibid.28 Moskow, Robert and Aquino, P.I. “Corn Supplanting Soybean Acreage.” Barron’s Online, April 2, 2007.

Implications

Reduced federal budgetary outlays for farm program spending will have an impact on legislative proposals that would significantly alter the structure of U.S. farm policy. Some farm policy observers have pointed out that the current budget picture strengthens the case for a general extension of the current law. A simple extension of the 2002 Farm Bill would not only be one of the lowest-cost options available to lawmakers, but it might also be one of the only ways for farm policy to fit within a low budget baseline for spending on the 2007 Farm Bill. In addition, an extension of the 2002 Farm Bill would be a move in the direction of a free-market program for corn, soybeans and wheat. At current target prices, it appears likely market prices will remain above price-triggered payment levels for loan deficiency payments, as well as countercyclical payments.29

Anticipating the possibility of a lower CBO baseline, farm groups and other organizations have begun to

29 Babcock, Bruce A. “Farm Policy Amid High Prices: Which Direction Will We Take?” Iowa Ag Review, Fall 2006.

Figure 2: Ethanol demand impact on commodity program costs: 2007 Baseline minus 2006 Baseline

Source: CBO March 2006 and 2007 Baselines

0

-1

-2

-3

-4

-5

-6

-7

$bill

ion

2006 2007 2008 2009 2010 2011Fiscal year

2012 2013 2014 2015 2016

Other commodity and conservationCorn payments


articulate farm policy goals that reflect the current political situation.

The nation’s largest agricultural organization, the American Farm Bureau Federation (AFBF), has indicated that funding for the 2007 Farm Bill should be the same level as was authorized in the 2002 Farm Bill, with an inflation adjustment. AFBF has expressed concern that if lawmakers are limited to current CBO estimates, “adequate funding will not be provided for the commodity title.”30 Meanwhile, other groups, including the National Association of Wheat Growers (NAWG) and the American Soybean Association (ASA), have called for higher target prices in the next Farm Bill as a way to recapture lost federal allocations from higher market prices.31

Other commodity groups, such as the National Corn Growers (NCGA Report), have also anticipated the likelihood of lower government allocations for price-triggered payments and have called for reforms such as revenue insurance (NCGA). Organizations such as The Chicago Council on Global Affairs (CCGA) and the American Farmland Trust (AFT) have also suggested reform ideas that include revenue insurance and other forms of agri-environmental payments that would provide government assistance that is not based solely on market prices.32

On January 31, 2007, U.S. Secretary of Agriculture released the USDA’s 2007 farm bill proposals. According to its news release, “The more than 65

30 American Farm Bureau Federation (AFBF) Press Release. “AFBF Urges Funding Next Farm Bill at 2002 Level.” December 7, 2006.31 National Association of Wheat Growers (NAWG) Press Re-lease. “NAWG Board Approves 2007 Farm Bill Proposal.” Octo-ber 5, 2006. American Soybean Association (ASA) Press Release. “USDA Announcement Affirms Why Soybean Growers Need Better Income Safety Net in 2007 Farm Bill.” October 12, 2006.32 Chicago Council on Global Affairs (CCGA) Report. “Modern-izing America’s Food and Farm Policy.” September 27, 2006; American Farmland Trust (AFT) Report. “Agenda 2007: A New Framework and Direction for U.S. Farm Policy.” May 2006.

proposals correspond to the 2002 farm bill titles with additional special focus areas, including specialty crops, beginning farmers and ranchers, and socially disadvantaged producers.”

In part the USDA proposal would:• Strengthendisasterreliefbyestablishinga

revenue-based counter-cyclical program, providing gap coverage in crop insurance, linking crop insurance participation to farm program participation, and creating a new emergency landscape restoration program;

• Provide$1.6billioninnewfundingforrenewable energy research, development and production, targeted for cellulosic ethanol, which will support $2.1 billion in guaranteed loans for cellulosic projects and includes $500 million for a bio-energy and bio-based product research initiative, and;

• Increaseconservationfundingby$7.8billion,simplify and consolidate conservation programs, create a new Environmental Quality Incentives Program and a Regional Water Enhancement Program.33

More generally, a recent Congressional Research Service Report indicated that, “The Administration’s proposal for the 2007 farm bill is unusually detailed compared with past Administration proposals. The stated goals, according to USDA Secretary Mike Johanns, take a ‘reform-minded and fiscally responsible approach to making farm policy more equitable, predictable, and protected from challenge.’ ”34

The legislative task of increasing target prices, loan rates or creating a revenue insurance program will

33 USDA Press Release. “Johanns Unveils 2007 Farm Bill Propos-als.” January 31, 2007.34 Johnson, Renee. “Farm Bill Proposals and Legislative Action in the 110th Congress.” Congressional Research Service, RL 33934, March 22, 2007.


13

Future ethanol-industry growth will require increased investment in technologies that use cellulosic feedstocks.

be difficult under the current budget scenario. Not only have projected Title I commodity payments been substantially lowered, but political pressure for increased spending in other Farm Bill titles will make necessary PayGo offsets for expanding or creating new commodity programs problematic. Likewise, reform ideas such as farmer savings accounts, a risk management tool whereby the government would provide matching funds for producer deposits in approved savings programs, would likely require additional levels of federal allocations and hard to find PayGo offsets.

A separate budgetary and policy pressure point could stem from a recent World Trade Organization (WTO) ruling regarding U.S. compliance with international trade rules and existing planting restrictions on farm program base acres. A recent Congressional Research Service report explained that, “Planting flexibility was created in the 1990 farm bill to allow farmers to respond to market signals when choosing crops, but has restrictions to protect fruit and vegetable growers who do not receive direct subsidies. Flexibility refers to the ability to receive government payments for a base crop (such as corn) and simultaneously grow a different program crop on those base acres (such as soybeans, but not fruits and vegetables). Farmers who violate the planting restriction on fruits and vegetables do not receive program payments on acres in violation, and they must pay an additional financial penalty based on the market value of the fruits and vegetables planted.”35

With respect to this planting restriction issue, USDA noted in a recent report that, “In March 2005, the WTO found that direct U.S. payments for cotton, and by extension all program commodities, do not meet the definition of decoupled payments because eligibility for payments restricts production

35 Monke, Jim. “Farm Commodity Policy: Programs and Issues for Congress.” Congressional Research Service, RS21999, March 8, 2007.

of fruit and vegetables.”36 Some farm policy observers have suggested that specialty crop growers “may seek some type of compensation” if the planting restriction were lifted.37

Beyond the parameters of WTO compliance, specialty crop growers may point to expanded overseas competition, “as well as a change in the government’s nutrition pyramid in 2005, new concerns about nutrition in the federally funded school meals program and the growing organic foods market” as persuasive factors that warrant a greater share of federal farm resources in the budgetary debate.38 In addition, “The 108th Congress passed the first law intended to address selected issues of importance to the specialty crop industry as a whole (the Specialty Crops Competitiveness Act of 2004, P.L. 108-465).”39 Many observers have suggested that this law, which included block grant provisions for State’s to improve industry competitiveness, as well as additional support for research, was a precursor of the potential political momentum that specialty crop producers may attempt to expand on in the 2007 Farm Bill debate. However, finding budgetary offsets will be no less difficult under this legislative scenario than would be expected from other reform proposals that would require additional resources.

Some environmental groups have noted that the current market environment and budget projections highlight the advantages of multi-year, contractually based payments that are predictable

36 Johnson, Demcey; Krissof, Barry; Young, Edwin; Hoffman, Linwood; Lucier, Gary and Breneman, Vince. “Eliminating Fruit and Vegetable Planting Restrictions: How Would Markets Be Affected?” USDA-ERS, November, 2006.37 Monke, Jim. “Farm Commodity Policy: Programs and Issues for Congress.” Congressional Research Service, RS21999, March 8, 2007.38 Hedges, Stephen J. “To Subsidize Actual Food.” The Chicago Tribune, March 16, 2007.39 Rawson, Jean M. “Specialty Crop Issues in the 109 Congress.” Congressional Research Service, RL32951, October 24, 2006.


and stable. Programs such as the Environmental Quality Incentives Program, Conservation Reserve Program, Wetlands Reserve Program, and the new Conservation Security Program, if expanded in the 2007 Farm Bill, could provide more support to agricultural producers than unpredictable, price-triggered payments, these organizations claim.

A major factor impacting the success of multi-year, contractually-based payments and enrollments in these types of conservation programs will be the level of bids that are made and accepted to participate in the program. As prices for some program crops increase, producers will anticipate higher returns and increased income from growing commodities such as corn and soybeans. A recent newspaper article stated that, “Landowners are becoming reluctant to enroll property in the [Conservation Reserve] program because the annual payments they would receive are falling far behind what the land will rent for as cropland, according to local Agriculture Department officials and national wildlife organizations.”40 Policymakers may consider adjusting formulas that are used for calculating conservation enrollment payments if this trend continues and if they desire to see currently enrolled acres in the Conservation Reserve Program.

At the same time, livestock producers have argued that non-sensitive land enrolled in the Conservation Reserve Program be released without penalty and loss of program benefits. Since the higher prices of corn and soybeans mean tighter profit margins for livestock growers, swine, turkey, chicken, and cattle producers have maintained that federal policy makers should help maximize the level of corn production to alleviate the economic stress that higher market prices are having on other segments of the agricultural economy. In addition, these

40 Brasher, Philip. “Soaring Crop Prices Force USDA to Boost Payments to Farmers for Conservation Land.” The Des Moines Register, March 24, 2007.

producers note that if market prices for corn and soybeans stay at relatively high levels, consumer expenditures for meat products could increase.

National livestock groups have also called for some type of alteration to current federal ethanol subsidies. In general these groups suggest that ethanol is no longer an infant industry and they recommend that the federal provisions supporting the ethanol industry (tax credits and import duties) be allowed to expire and that market forces should thereafter be allowed to allocate resources within the affected feed grain and agricultural markets.

Meanwhile, key lawmakers are also seeking to expand the energy title in the 2007 Farm Bill. Specifically, House Agriculture Committee Chairman Collin Peterson has noted that, “Future ethanol-industry growth will require increased investment in technologies that use cellulosic feedstocks. Additional research is also important to take us to the next level of efficiency for biofuel production. The Farm Bill can help us reach the potential of this exciting industry by including funds for research to develop fully these areas of study.”41 Similarly, Senator Richard Lugar (R-IN) has stated that, “We must accelerate the commercial production of cellulosic ethanol, made of more abundant and less expensive biomass, such as agricultural waste and switchgrass. Federal research to commercialize cellulosic ethanol, which I first proposed and which became law in 2000, must be expanded further.”42 Federal support for alternative feedstocks for ethanol production will also provide an additional source of budgetary pressure.

Two bills have been introduced in the House of Representatives that contain specific legislative ideas with respect to the 2007 Farm Bill. The

41 Peterson, U.S. Rep. Collin (D-MN). “Change for the better.” The Hill, March 13, 2007. 42 Lugar, U.S. Sen. Richard (R-IN). “Energy Opportunities Create New Farm Policy Possibilities.” The Hill, March 13, 2007.


15

Budgetary pressures stemming from high market prices, brought on in large part by the increased use of renewable fuels, will impact the policy direction of the 2007 Farm Bill.

Healthy Farms, Foods, and Fuels Act of 2007 (H.R. 1551) “makes a major new investment in the development of renewable energy on American farms, promotes resource conservation, provides consumers with healthier food choices, and boosts farm profitability. The [Act] also includes a provision to assist farmers in transitioning to organic production, and expands programs to bring healthier foods to school cafeterias.”43

And secondly, the Equitable Agriculture Today for a Healthy America Act (EAT Healthy Act) “would support specialty crop growers by increasing market access, encouraging and facilitating consumption of nutritious agricultural products, funding research programs and increasing opportunities for family farmers in conservation programs.”44

Iowa State University Professor Bruce Babcock has recently summarized how Congress might respond to the current conditions in the agricultural economy in formulating future policy. Dr. Babcock indicated that, “Although it is hazardous to forecast how Congress is likely to respond to high prices, past experience suggests a probability of near zero that Congress will declare the end of farm subsidies. Three more likely options for Congress are:

1. Declare victory over low prices but keep current programs and associated target prices in place just in case this victory is short-lived.

2. Keep current programs but raise target prices for all crops or for those crops that would not otherwise receive payments.

3. Change farm programs so that they provide a better financial safety net, with payments arriving when they are needed.”

43 Kind, Ron. Rep. “Reps. Kind and Gerlach, Senator Menendez Introduce Major Farm Bill Reform Legislation.” News Release, March 15, 2007.44 Cardoza, Dennis Rep. “Reps. Cardoza, Putnam, Salazar, Kuhl, Larsen, McCarthy Introduce Bipartisan Bill Promoting Specialty Crops.” News Release, March 20, 2007.

In a broader sense, high market prices may also serve to focus policy on income stabilization rather than on income support. The USDA’s proposal to revise the Counter-Cyclical Program to make it become revenue-based rather than price-based is one example of this concept. Historically, “farm price and income support programs have been the core of agricultural policy in the United States.”45 However, as policymakers begin formulating a law that will govern U.S. farm policy for the next five years, higher market prices for key program crops will have to be considered; producers will be deriving a greater share of their income from the market place and the impact of federal farm subsidy payments on the economic security of many farm households will decline. Traditionally, lawmakers consider the outlook of the agricultural economy, among other factors, when formulating policy, and federal farm “programs have been adjusted over time as policymakers have responded to the political, social, and economic pressures that agricultural productivity growth, market integration, and structural change have imposed on the farm sector.”46

Despite the competing interests for scarce budgetary resources, lawmakers will begin to reconcile the current demand driven market dynamics and policy ideas that focus on price and income stabilization, such as revenue insurance and farmer savings accounts, may be considered more seriously than in the past. Budgetary pressures stemming from high market prices, brought on in large part by the increased use of renewable fuels, will impact the policy direction of the 2007 Farm Bill.

45 Dimitri, Carolyn; Effland, Anne and Cooklin, Nelson. “The 20th Century Transformation of U.S. Agriculture and Farm Policy.” USDA — Economic Research Service, June 2005.46 Ibid.


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