Few will argue the point that rising ethanol production was a key driver of rising corn prices since 2006. But University of Illinois economist Scott Irwin has done work showing, as he puts it, “how conventional wisdom regarding the direction of causality between ethanol and corn prices has been turned on its head recently.” In other words, we’ve reached the point, now that the blend wall has been reached, where it’s more a case of corn prices determining the price of ethanol!

Irwin’s work assumes ethanol supply in the short run cannot exceed U.S. production capacity of about 15 billion gallons, regardless of price. And his work shows the intersection of the supply and demand curves determines the equilibrium price at about $1.70 per gallon recently. The primary shifter of the ethanol supply is the price of corn because corn is 80 percent of the cost associated with ethanol production in the U.S. Thus, the pricing of corn beyond its sole value as an ethanol feedstock is back to hinging on domestic and foreign feed grain markets until/unless a way can be found to breach the 13.8 billion gallon “blend wall,” where essentially every gallon of gasoline used in the U.S. contains 10 percent ethanol.

For a time it was thought that the wall could be breached by increasing use of E85. But that’s going nowhere for two reasons: First, there’s resistance among gasoline retailers to even offer it because of limited demand. Second, even consumers with flex-fuel vehicles who use E85 are disappointed in the loss of fuel economy.

Many refuse to buy it again unless priced at enough discount to E10 to compensate for poorer mileage. So, Irwin and colleague Darrell Good looked at three other alternatives EPA might choose from for dealing with the reality that existing RFS mandates exceed this “blend wall.” They narrowed it down to three routes EPA might do to to adjust the RFS in 2014 and 2015:

1. Status Quo: No change to volume levels in the RFS statute except writing down the cellulosic andate to the low levels actually being produced.

2. Writedown: Reduce the advanced and total RFS volume levels in parallel to the reduction of the cellulosic mandate.

3. Freeze: Keep the advanced, total and renewable RFS volumes frozen at 2013 levels.

Sure enough, in a “leaked” proposal sent to the White House prior to the partial government shutdown, EPA used elements of all three. The leaked documents showed EPA proposing corn ethanol blending at 13.0 billion gallons in 2014. That is down from 13.8 billion for 2013 and well under the 14.4 billion gallon mandate for 2014.

EPA also proposed the biodiesel mandate hold steady in 2014 and 2015 at 1.280 billion gallons, same as in 2013. Further, the advanced fuels requirement would be slashed to 2.21 billion gallons from 2.75 billion in 2013.

Corn and soybean markets reacted negatively because these “leaked” proposals were for deeper cuts than most anticipated. Just days after the “leak,” EPA officials were back-pedaling furiously, insisting the “leaked” proposals indicating significant cuts to ethanol mandates for 2014 were only “draft proposals” and that “decisions about the mandates for next year have not been finalized.” Further, EPA Administrator Gina McCarthy said that no decisions would be made on 2014 standards until “stakeholders have a chance to comment on any proposals.” And that, sadly, almost guarantees final proposals will be a muddled mixture of politics and economics that will satisfy no one. AG