Rationing the 2012 corn crop - Are we there yet?
7) The projection of ethanol use of corn is calculated as a residual, which means we assume that ethanol use is the most price elastic component of corn usage.
It is widely argued that ethanol use is perfectly price inelastic up to the quantity mandated under the Renewable Fuel Standard (RFS). But this ignores the feature of the RFS that allows fuel blenders to accumulate carryover stocks of RINS credits that can be used to meet the mandate in lieu of blending actual gallons of ethanol. Previous estimates of the stock of RINS found in this earlier farmdoc daily post by Nick Paulson indicate that blenders probably hold at least 2 billion gallons of RINS that could be used to partially meet the RFS mandate during the 2012-13 marketing year. Technically, we assume that ethanol use is the most price elastic category up to the point where the available stock of RINS is used up. Without policy changes ethanol use after the stock of RINS is used up would become perfectly price inelastic. One additional topic deserves mention. Fuel blenders also have the option to defer up to 20% of the RFS mandate in a given year but this “borrowing” has to be made up in the following year. This could make the breakpoint where ethanol use becomes perfectly inelastic even lower. However, we do not believe it is reasonable to project substantial usage of the borrowing provision because the additional quantities would push ethanol blending above the 10% blend wall in the following year. See our earlier post here for a discussion of ethanol blend wall issues.
8) The projected average farm price for each scenario uses the USDA projection as a starting point and applies an estimate of the total price flexibility coefficient reported in a recent article by Mike Adjemian and Aaron Smith found here. We use their flexibility estimates for the current era of large ethanol use. Specifically, we use an estimate of -3, which, in order to be conservative, is approximately equal to the upper end of the 95% confidence limit (smallest in absolute value) of their flexibility estimates for the current time period. This estimate implies that for each 1 percent total supply declines price is projected to increase 3%.
The projections based on the previous assumptions are found in Columns 2 through 5 of Table 1. Note the very modest declines in feed and residual use of corn with lower yields and higher prices, which seems to be a contradiction of assumption (6). However, total corn-based feed consumption would decline much more rapidly than implied by the corn feed and residual projection. This is due to the decline in feeding of distiller’s grain, which is driven by the more rapid pace of decline in ethanol use (and production). Progressively more liquidation of livestock numbers would be required with each 5 bushel decline in the average corn yield through this implied distiller’s grain pathway.