Pictures of a Middle East oil sheik may foster dislike, anger, frustration, and other negative emotions because they have control over the price we pay for crude oil and eventually gasoline. But standing beside the sheik in his white gown and distinctive head gear may be a Midwestern farmer with his own distinctive head gear with a seed corn logo. As the bio-fuels era moves into a higher gear, it is ironic these boys on the opposite ends of the love-hate spectrum could be in cahoots.

Early in the gasohol era, ethanol promoters touted the slogan “There is an oil well in every cornfield.” So right they were, although it has taken nearly three decades for ethanol prices to become linked to the price of crude oil. They are in lock-step says Purdue economist Wally Tyner and colleague Farzad Taheripour, whose analysis of the integration of the energy and agricultural markets is focused on a new generation of Cornbelt ethanol sheiks. Their research shows there is a very low correlation between energy and agriculture, but when they correlate ethanol with either crude oil or gasoline, the correlation jumps to nearly 90%.

The linkage began growing stronger as ethanol refiners began to consume more than 10% of the corn crop, and with 30% of the crop headed into refinery this year the relationship strengthens further. They suggest it is “perhaps the most fundamentally important change to occur in agriculture in decades.” A major part of the ethanol industry is the governmental subsidy of 51¢ per gallon that petroleum blenders receive in the form of a tax credit. Tyner’s study looks at variations of that subsidy: elimination, fixed per gallon, variable linked to crude oil prices, and a renewable fuel standard.

The economists say the subsidy adds about $1.60/bu. to the breakeven price that a refiner can pay for corn, and without the subsidy, corn prices would be less because ethanol production would be diminished. They say with the subsidy and high oil prices, ethanol is profitable since it is priced parallel to crude oil. Any reduction in demand for oil would be a reduction in demand for ethanol and corn prices would fall. The economists say, “With no subsidy, there is no ethanol production until oil reaches $60. However, by the time oil reaches $120, ethanol production is 12.7 BG. The renewable fuel standard is another mechanism for implementing a variable subsidy. Consumers pay at the pump instead of through their tax bill.”

Parallel with the higher ethanol production, corn production increases with higher crude oil prices, and Tyner says corn production for ethanol reaches nearly 12 billion bushels when crude oil reaches $120 per barrel. But ironically with the federal mandates promoting ethanol production, corn production reaches 12.68 billion bushels at $40 oil since higher oil prices diminish corn profitability. Their analysis says the 51¢ subsidy will push corn prices to $5.65 at $120 oil, and without the subsidy it would be $4.60 at $120 oil. They contend the federally mandated Renewable Fuel Standard does a better job of supporting corn prices because the subsidy at low oil prices is much higher.

At $120 oil, Tyner’s analysis shows the 51¢ subsidy would cause 52% of the corn to be used for ethanol production, and less than 1.5 billion bushels would be exported. Under that same scenario nearly $9 billion would be paid by the government to subsidize ethanol production. They conclude there are large differences in corn production, use, exports, and value all determined by the price of crude oil, as a result of the brotherhood between ethanol and oil. Consequently, the type of subsidy provided by the government to foster more ethanol use has a substantial effect on the corn market.

Summary:
With an increasing among of ethanol being produced from corn, and the ethanol impact on corn production, use, and value, there is a direct connection between the price of crude oil and corn. Higher oil prices will push up ethanol production, as well as push up corn production, use and value, and push down other uses such as corn exports. However the way the government promotes ethanol production through a variety of subsidies will also change the production and value of corn.