3 Powerful Graphs Behind the Food-vs.-Fuel Debate

Earlier this summer I learned how inelastic ethanol policies affect the refining industry and consumers when I spoke with Charles Drevna, president of the American Fuel and Petrochemical Manufacturers. Unfortunately, the fuel pump isn't the only way ethanol affects your family budget. In a recent interview with renowned agricultural economist Dr. Thomas Elam, president of FarmEcon LLC, I turned my attention to the food-vs.-fuel debate in an attempt to answer one burning question: "How much does ethanol production contribute to rising food costs?"

The following three graphs from Dr. Elam's report Food Costs Are Eating American Family Budgets provide a powerful backdrop for the food-vs.-fuel debate. All are based on real-world industry data from inherently unbiased sources such as the U.S. Department of Agriculture and the U.S. Department of Commerce. What will they uncover about the controversial topic of ethanol production?

The trend was our friend
In 1950, the average American spent approximately 26% of his or her disposable income on food. Think about that. For every $100 leftover after taxes, individuals had just $74 to spend on non-food expenditures. Luckily, advances in agricultural production, logistics and transportation, and food availability have steadily lowered the amount of money spent putting food on the table. Food expenditures as a percent of disposable income fell to 20% by the mid-1960's, zoomed lower than 16% in the early 1980's, and ducked under 12% for the first time in history in 2000.

That's quite the trend, except for one thing: It's reversing.

Source: FarmEcon LLC, Food Costs aAre Eating American Family Budgets.

Food prices are affected by many variables, such as input costs to farmland (energy, fertilizer, and the like), fuel prices, and selling prices for crops. There is no single cause and effect. Unfortunately, there's a mountain of evidence supporting claims that increasing ethanol demand is a major contributor to higher commodity prices of most major agricultural crops.

More land for biofuels, less for food
It's no coincidence that the ratio in the preceding graph begins to stray from the historical trend in 2006 and grows to its largest deviation in 2012 -- that's exactly the same time period the Renewable Fuel Standard, or RFS, was enacted and enforced. The RFS mandates how much ethanol and biodiesel must be blended into the nation's fuel supply each year. While biodiesel production can be non-competitive with food production, nearly 85% (by weight) of feedstock supplying the industry in July came from soybean and corn plantings. Ethanol is sourced virtually exclusively from corn.  

What companies are driving this demand? Renewable Energy Group (NASDAQ: REGI  ) supplies nearly 17% of the nation's biodiesel but has been adding feedstock flexible capabilities to all of its facilities. That means the company can switch between soybean oil, corn oil, tallow (animal fat), and yellow grease during times of food price volatility. One of REG's biggest goals is to not compete with the food industry, although that's easier said than done.

Meanwhile, the country's top four ethanol producers -- POET, Valero, Archer Daniels Midland (NYSE: ADM  ) , and Green Plains Renewable Energy (NASDAQ: GPRE  ) -- account for approximately 40% of all ethanol production. While Valero operates ethanol facilities primarily to hedge its fuel blending business the others operate vertically integrated agribusinesses in ethanol production, corn oil processing, and marketing and distribution. That doesn't necessarily alleviate the problem. Consider that Green Plains, the fourth largest ethanol producer listed, needs 280 million bushels of corn each year to produce 790 million gallons of ethanol.  

Similarly, agricultural giant ADM processes about 912 million bushels of corn each year, or about 7.5% of the nation's annual crop. The company sells products to the food, animal feed, and ethanol markets, but the latter has given the greatest boost to the bottom line in recent years. ADM's corn processing business saw bioproduct sales increase 31% to $4.2 billion in the first half of 2013 compared with the prior-year period thanks to higher ethanol sales volumes and higher ethanol selling prices.  

Why use corn? It's an extremely good source of the sugar dextrose, which is fed to yeast to produce ethanol. Waste biomass is returned to the market as dried distillers grains with solubles, or DDGS, which is primarily used as animal feed despite its lower nutritional value (making it an inadequate alternative to corn). Even when accounting for DDGS returned to the system and improving corn harvests, it's quite evident that ethanol demand is straining the system.

Source: FarmEcon LLC, Food Costs Are Eating American Family Budgets.

It's not as if everything we eat contains corn, so why is the crop so important to food prices?

How major crops respond to corn's dominance
One thing not evident from the preceding graph is that the amount of land dedicated to corn crops has generally increased in each year since the RFS. That mitigated some of the impact from the 2012 drought. However, it has also led to increased competition for land between the nation's most important crops, which has driven prices higher to make them more competitive with corn plantings. It's a vicious cycle.

Source: FarmEcon LLC, Food Costs Are Eating American Family Budgets.

Since these crops make up the foundation of the nation's food supply -- (they're inelastic) -- price increases are felt all the way up the value chain until consumers foot the bill. For instance, higher animal feed prices make poultry more expensive to raise for Tyson Foods (NYSE: TSN  ) , which increases supermarket prices. Also consider that the company is vulnerable to such volatility for the several months it takes to grow its poultry. If it takes two months to raise a chicken, but feed prices spike at the one-month mark, then increased supermarket prices for chicken will lag by one month. It means consumers end up paying for increased crop prices several times for the same spike: once for direct cost increases on products without much market lag time (grains, vegetables, and the like), again for products with moderate lag time (poultry), and once more for products with greater lag time (cattle and pigs, which take up to 24 months to mature).

Foolish bottom line
Let's be clear: Increased demand for biofuels, namely ethanol, doesn't account for all of the increases in food prices since 2005. Dr. Elam estimates that 44% of the increase comes from higher prices for major agricultural crops, which evidence suggests are caused in large part to the RFS. I have historically been a supporter of a national biofuel program as long as it's grounded in reality. Unfortunately, it appears we have a lot of work to do before we can achieve that.

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Read/Post Comments (10) | Recommend This Article (2)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On October 19, 2013, at 5:39 PM, ssteady wrote:

    Question- is disposable personal income constant, increasing or decreasing from 2006 through this year.

  • Report this Comment On October 20, 2013, at 6:48 AM, flint2202 wrote:

    Please post more graphs showing:

    The cost of oil, gas and diesel from 2005 to 2012, which accounts for higher transportation costs for all goods, and translates to higher prices for all food.

    Also, please show the higher cost of other goods which are minimally or unaffected by planting corn for ethanol. (fruits, vegetables, seafood etc) during the same period.

  • Report this Comment On October 20, 2013, at 9:11 AM, astamp wrote:

    You do realize that 2012 was the worst drought we had seen in over 20 years, right? Prices were significantly higher because of supply issues, not ethanol. Strange how you left that part out...

    If you want to have an intelligent discussion on ethanol that is fine, but doing what you're doing here is unethical.

  • Report this Comment On October 20, 2013, at 12:27 PM, TMFBlacknGold wrote:

    @ssteady,

    Disposable personal income has both increased and decreased, as have food prices, since the 1950's. The longer term trend is what is important. There's also a very strong correlation between the start of the RFS and the disassociation from the trend.

    --Maxxwell

  • Report this Comment On October 20, 2013, at 12:30 PM, TMFBlacknGold wrote:

    @flint2202,

    I encourage you to read Dr. Elam's report, where he states that higher commodity (crop) prices account for 44% of the increase in food prices while acknowledging other factors.

    --Maxxwell

  • Report this Comment On October 20, 2013, at 12:35 PM, TMFBlacknGold wrote:

    @astamp

    I mentioned the 2012 drought:

    "One thing not evident from the preceding graph is that the amount of land dedicated to corn crops has generally increased in each year since the RFS. That mitigated some of the impact from the 2012 drought. However, it has also led to increased competition for land between the nation's most important crops, which has driven prices higher to make them more competitive with corn plantings."

    You also wrote:

    "If you want to have an intelligent discussion on ethanol that is fine, but doing what you're doing here is unethical."

    There is nothing unethical about reporting the findings of independent economic studies. I have actually been one of the biggest supporters of ethanol here at TMF and am simply trying to report both sides of the issue. Some of my previous work:

    50 Billion Reasons to Support Ethanol:

    http://www.fool.com/investing/general/2013/05/19/50-billion-...

    4 Big Reasons to Increase Ethanol Blends:

    http://www.fool.com/investing/general/2013/02/11/4-big-reaso...

    --Maxxwell

  • Report this Comment On October 21, 2013, at 9:02 AM, jrbolt wrote:

    What these poorly researched "Food vs Fuel" myths never account for is the rising cost of seafood.

    How much #2 yellow dent corn does a mackerel eat??

  • Report this Comment On October 22, 2013, at 9:02 PM, Hayseedfool wrote:

    Real Income peaked in 2007 and has since dropped 8.5% it would appear people are simply needing to spend a proportionally larger share of shrinking income on staples.

  • Report this Comment On October 25, 2013, at 12:25 PM, MWinMD wrote:

    Why on earth isn't the EPA raising the RFS for advanced biofuels made from NON-food feedstocks (like grease and animal fats) to compensate for lowering the ethanol obligation? This is a no-brainer as far as I can see. There is excess capacity in that industry, the fats-derived biofuels have a much better greenhouse gas footprint, and there are no indirect land use issues with it.

    Any idea whether the EPA is considering this slam-dunk win-win-win move? Global warming isn't going to go away, despite all these other issues you bring up in this article.

  • Report this Comment On October 27, 2013, at 11:55 AM, TMFBlacknGold wrote:

    @MWinMD,

    Grease and animal fats can only be easily processed into biodiesel, so it wouldn't be a direct substitute for lowering ethanol volume obligations. However, blenders are already buying biodiesel RINs when they cannot find ethanol RINs on the market because they count for 1.5 times the credit.

    --Maxxwell

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