Over the past decade, the United States has experienced a dramatic boom in ethanol production. The rapid expansion of ethanol was largely driven by the Renewable Fuel Standards (RFS), first introduced in 2005, which mandates that 36 billion gallons of renewable fuel are produced per year by 2022, 15 billion gallons of which can come from corn ethanol. The RFS mandates are under debate, though as of early 2015 there has been no official change to the mandate. Ethanol is the second largest user of corn in the United States, and the corn consistently outpaces all other crops in harvested acreage and cash receipts. With possible changes to the RFS on the horizon, understanding how changes in the ethanol industry may impact corn prices can inform decisions being made by farmers and investors today.
While many studies point to ethanol raising the price of corn, it does not affect all corn producers equally (McNew and Griffith 2005; Lewis 2010). If transporting corn is costly, the opening of an ethanol plant or an increase in existing local ethanol capacity will increase demand for nearby cash sales of corn and are expected to increase the local corn price. Knowing how an ethanol plant affects the price of corn received, a farmer may choose to alter cropping strategies to maximize profit when they learn new ethanol plant capacity will come online in their area, or livestock producers may choose to change the mix of feed to include dry distillers grains (a by-product of ethanol) and reduce corn consumption.
Figure 1. 2007 corn yields and ethanol plant locations
Source: Wade, G. (2009). 2007 Corn for Grain Yield per Harvested Acre by County and Ethanol Plants (map). In USDA-NASS (Ed.), ESRI Map Book (24th ed.). Redlands, CA: ESRI Press
Figure 2. Ethanol plants and predicted basis, December 2005 and December 2009
Although U.S. ethanol capacity increases annually, capacity under construction drops, as can be seen in figure 3. This decrease in construction, coupled with a decaying rate of growth in the ethanol industry, is indicative of a maturing ethanol market in 2009 and 2010.
Figure 3. U.S. ethanol production capacity and expansion annually
Research indicates ethanol plant owners choose locations based not only on corn price and production but on factors such as natural gas prices, local labor markets, and taxes (Lambert et al. 2008; Sarmiento and Wilson 2008). I include the flow of natural gas, the cost of natural gas, and the cost of diesel fuel, as well as county demographics and the existing ethanol production in and around the county of interest. I then use the predicted ethanol capacity to determine the effect on local corn basis.
I use local corn basis to reflect local supply and demand conditions and capture both local storage and transport costs. If basis is weak (cash prices are low compared to futures), farmers may decide to store their corn until prices rise. If ethanol capacity increases, corn demand in the area will increase, and the plant may need to offer higher prices to incentivize farmers to sell instead of store. However, as ethanol plants open nearby, corn doesn’t have to be shipped as far and transportation costs decrease. This may mean that the prices ethanol plants pay for corn are not as affected by changes in transportation costs as elevators who have to ship corn further, which may be why I do not find the price of diesel to be significant in the capacity choice of ethanol plants, but I do find it to be significant in the determination of basis.
This research focuses on the temporal and spatial factors driving ethanol plant location and capacity decisions and how those decisions affect local corn price. I use novel data from 2005 to 2010 across the Corn Belt with spatial lag techniques and instrumental variables. This study is the first to include data from a maturing market. In addition, I incorporate ethanol plant ownership information. Co-op owned plants consistently account for one third of the ethanol production in my data set. The annual co-op and private ethanol plant capacity of my data can be seen in figure 4, along with annual corn basis.
Figure 4. Annual farmer and private capacity (MGY) and corn basis ($/bu.)
I find that an increase of 100 million gallons per year (MGY) of ethanol capacity in the county of interest leads to a basis increase of almost 6 cents/bu., that the effect decays over space and that the effect is stronger when corn supplies are tight (as they were in 2008). Previous studies find that on average, a new ethanol plant increases basis between 2.21 cents/bu. and 12.5 cents/bu. I find that not accounting for the choice of where a plant locates causes an underestimate of the effect of a change in ethanol capacity on basis. The estimated effect is almost 1.5 cents smaller for 100 MGY capacity increase within county if one ignores the plant location decision than if one does not. These relationships can be seen in figures 5 and 6.
In figure 5, each line represents results under different amount of space with 2 lags including 2 rings of counties surrounding the county of interest and 5 lags including 5 rings of counties. Each ring’s effect is separated to see how changing ethanol production in that rings affects local basis in the county of interest. The line titles “OLS” represents the results when ethanol capacity choice is not taken into account. In figure 6, results are broken down by year and each year includes 4 rings of counties. The line titled “Full Sample” represents results when all years are examined together.
Figure 5. Spatial effects under different lags
Figure 6. Year/capacity interactions
When results are examined by region, the effect of a change in ethanol capacity in the Plains (where most ethanol capacity is located) has a larger effect on local basis than one in the Great Lakes.
I find no direct relationship between whether the ethanol plant is owned by farmers or not on local basis. However, farmer ownership does directly influence ethanol plant capacity, leading to an increase in capacity compared to private ownership. Because of this increased capacity, farmer ownership indirectly leads to increases in local basis. The average percent of capacity owned by farmers is 34.6 percent in each ethanol producing county. If the percent of farmer owned capacity in the county of interest increases from 0 to 34.6 percent, the average for ethanol producing counties, ethanol capacity in the county of interest increases by about 4.8 MGY from what would be produced if all capacity was privately owned. An increase of 4.8 MGY in ethanol capacity within the county of interest is associated with an increase of about 0.28 cents/bu. in the local basis.
The location and size of an ethanol plant affects local corn prices. Changes to the RFS, which are likely to affect ethanol production, will affect the landscape of local corn prices and farmer revenue. Being aware that the ethanol plant two counties over is changing its production, and understanding how that change will affect their local basis will affect farmer decisions such as about how much acreage of corn to plant and whether to expand livestock. Changes in the ethanol industry can ripple through the entire economy from changing corn or livestock production all the way through to altering the amount of chicken on our weekly menus at home. How those ripples expand depends on the underlying choices made at each step, and understanding how a change in the ethanol production landscape can affect the local price of corn is a good first step.
Lambert, D., M. Wilcox, A. English, and L. Stewart. 2008. “Ethanol Plant Location Determinants and County Comparative Advantage.” Journal of Agricultural and Applied Economics 40(1):117–135. Available here.
Lewis, K. 2010. The Impact of Ethanol on Corn Market Relationships and Corn Price Basis Levels. Michigan State University. Available here.
McNew, K., and D. Griffith. 2005. “Measuring the Impact of Ethanol Plants on Local Grain Prices.” Applied Economic Perspectives and Policy 27(2):164–180. Available here.
Miller, E. 2015. Changing Ethanol Capacity’s Effect on Local Corn Basis. University of Illinois at Urbana-Champaign.
Sarmiento, C., and W. Wilson. 2008. “Spatial Competition and Ethanol Plant Location Decisions.” In American Agricultural Economics Association 2008 Annual Meeting. Orlando, Florida. Available here.
 Local basis is the difference between the local cash price and the corn futures price of the contract that matures soonest (i.e., the nearby futures price). In my paper, I use the Chicago-based futures price.