The Impact of Renewable Energy

on the U.S. Farm Policy Debate

Keith Good
FarmPolicy.com
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 The Impact of Renewable Energy
on the U.S. Farm Policy Debate

A Report to the German Marshall Fund of the United States

Keith Good
President, FarmPolicy.com, Inc.1
Journalism Fellow, German Marshall Fund of the United States

May 2007

Abstract. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
Report.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2
Bibliography . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16

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.
Abstract
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.
The Impact of Renewable Energy 1
on the U.S. Farm Policy Debate
The Impact of Renewable Energy
on the U.S. Farm Policy Debate

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

1980 1985 1990 1996 2002 2007

Farm Act Farm Act Farm Act Farm Act Farm Act Farm Act
8.00
Soybeans
6.00
$ bushel

4.00
Corn
2.00

0.00
1980 1985 1990 1995 2000 2005 2010 2015
Source: USDA Agricultural Projections to 2016, February 2007.
USDA, Economic Research Service

2 The German Marshall Fund of the United States

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.
The Impact of Renewable Energy 3
on the U.S. Farm Policy Debate
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.
4 The German Marshall Fund of the United States
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.
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 As the 2002
oxygenates like MTBE. But with that requirement Farm Bill is due
expiring in May [2006], producers and refiners will
to expire in
face far greater liability, which has set off a race to
September 2007,
exit the market.”11
a key concern
The simultaneous transition of the speedy MTBE for policymakers
phase-out, coupled with the new mandated use of in drafting the
renewable fuels, created short-term supply chain 2007 Farm Bill is
gridlocks and bottlenecks, which also contributed the sustainability
to higher ethanol prices in the spring of 2006. of these current
Specifically, in a news article from May of 2006, market conditions.
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.
The Impact of Renewable Energy 5
on the U.S. Farm Policy Debate
 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
Because corn- with the potential profitability of corn-based
based ethanol ethanol production.
may have to
Brief Analysis of Corn-Based
compete with
Ethanol Production
unleaded gasoline
as a low-cost input Demand for ethanol is a key factor in determining
for fuel blenders, its market price level. Recall that fuel blenders
must comply with the RFS of the Energy Policy
as production
Act of 2005, which was 4.0 billion gallons for 2006
exceeds mandate,
and is mandated to increase to 7.5 billion gallons
ethanol demand per year by 2012. The ethanol demand to meet
will be influenced these required levels will be price inelastic, fuel
by the price of oil. 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.
6 The German Marshall Fund of the United States
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.
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
Good, Darrel. “Corn: Small Crop Meets Strong Demand.”
20
University of Illinois Extension, January 7, 2007.
The Impact of Renewable Energy 7
on the U.S. Farm Policy Debate
 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
If producers plant of ethanol as an additive and estimated that
more corn, the with an oxygenate premium of $0.25 per gallon,
price of alternative ethanol producers could purchase corn at $4.82
per bushel and still breakeven at an oil price of
program crops
$60 per barrel.
such as soybeans
and wheat could The Center for Agricultural and Rural Development
also increase. 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.
8 The German Marshall Fund of the United States
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
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
Dow Jones News Service. “Experts: Cong. Might Trim Ethanol
22
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.
Chapman, Dan. “Georgia Plant to Turn Pine Waste into Etha-
24
nol.” The Atlanta Journal-Constitution, February 8, 2007.
The Impact of Renewable Energy 9
on the U.S. Farm Policy Debate
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
10 The German Marshall Fund of the United States
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.
USDA Press Release. “Corn Acres Expected to Soar in 2007,
26
USDA Says.” March 30, 2007.
Figure 2: Ethanol demand impact on commodity program costs: 2007 Baseline minus 2006 Baseline

0
-1
-2
-3 A simple extension
$billion

of the 2002 Farm

-4
Bill would not
-5 Other commodity and conservation
only be one of
-6
Corn payments the lowest-cost
options available
-7 to lawmakers, but
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
Fiscal year it might also be
Source: CBO March 2006 and 2007 Baselines
one of the only
ways for farm
soybeans, the lowest total since 1996 and a decrease Implications policy to fit within
of 8.4 million acres — or 11 percent — from a low budget
2006. Area planted to cotton is expected to total Reduced federal budgetary outlays for farm program baseline for
12.1 million acres, down 20 percent from 2006.”27 spending will have an impact on legislative proposals
spending on the
Upward price pressure associated with planting that would significantly alter the structure of U.S.
2007 Farm Bill.
decisions could lower CCC payments for other farm policy. Some farm policy observers have pointed
commodities even further. out that the current budget picture strengthens the
case for a general extension of the current law. A
In addition to crop allocation decisions, the potential simple extension of the 2002 Farm Bill would not
of adverse growing conditions during spring planting, only be one of the lowest-cost options available to
or more importantly, during mid-summer crop lawmakers, but it might also be one of the only ways
pollination, could also put upward pressure on the for farm policy to fit within a low budget baseline
market price of corn. As one market report noted for spending on the 2007 Farm Bill. In addition, an
recently, “The crop intentions are just one data point extension of the 2002 Farm Bill would be a move
in a long crop year. Going forward, there will be in the direction of a free-market program for corn,
increased focus on whether farmers actually do what soybeans and wheat. At current target prices, it
they say they are going to do in terms of planting and appears likely market prices will remain above
the impact of weather patterns on yield.”28 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
27
Ibid.
Moskow, Robert and Aquino, P.I. “Corn Supplanting Soybean
28
Babcock, Bruce A. “Farm Policy Amid High Prices: Which
29

Acreage.” Barron’s Online, April 2, 2007. Direction Will We Take?” Iowa Ag Review, Fall 2006.

The Impact of Renewable Energy 11

on the U.S. Farm Policy Debate
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.
12 The German Marshall Fund of the United States
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:
• Strengthen disaster relief by establishing a
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 $1.6 billion in new funding for
renewable 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;
• Increase conservation funding by $7.8 billion,
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.
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
Future ethanol-
the government’s nutrition pyramid in 2005,
industry growth
new concerns about nutrition in the federally
funded school meals program and the growing will require
organic foods market” as persuasive factors that increased
warrant a greater share of federal farm resources investment in
in the budgetary debate.38 In addition, “The 108th technologies that
Congress passed the first law intended to address use cellulosic
selected issues of importance to the specialty feedstocks.
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.
Rawson, Jean M. “Specialty Crop Issues in the 109 Congress.”
39
Congressional Research Service, RL32951, October 24, 2006.
The Impact of Renewable Energy 13
on the U.S. Farm Policy Debate
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.
14 The German Marshall Fund of the United States
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
Peterson, U.S. Rep. Collin (D-MN). “Change for the better.”
41
The Hill, March 13, 2007.
Lugar, U.S. Sen. Richard (R-IN). “Energy Opportunities Create
42
New Farm Policy Possibilities.” The Hill, March 13, 2007.
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 Budgetary
However, as policymakers begin formulating a pressures
law that will govern U.S. farm policy for the next stemming from
five years, higher market prices for key program
high market
crops will have to be considered; producers will
prices, brought
be deriving a greater share of their income from
on in large part
the market place and the impact of federal farm
subsidy payments on the economic security of by the increased
many farm households will decline. Traditionally, use of renewable
lawmakers consider the outlook of the agricultural fuels, will impact
economy, among other factors, when formulating the policy
policy, and federal farm “programs have been direction of the
adjusted over time as policymakers have responded 2007 Farm Bill.
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.
The Impact of Renewable Energy 15
on the U.S. Farm Policy Debate
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