Trends: Ethanol and Food Prices

Is it fair to blame ethanol for skyrocketing global food prices? While mandated increases in biofuel production have put pressure on crop supplies and prices, here's the real truth: higher corn prices are responsible for only 3 percent of the more than 40 percent hike in world food prices.

Here in the United States, food prices are up about 4 percent, just 1.5 percent above normal inflation. Higher corn prices have added only two cents to the price of a box of corn flakes and 11 cents to a gallon of milk from corn-fed cows.

This is according to the U.S. Department of Agriculture, which points out that higher costs for a particular ingredient have a relatively small impact on retail food prices. Less than 20% of total food cost is the underlying food value (e.g., cost of grain). The other 80 percent goes to production costs, including fertilizer, transportation, and distribution.

And that means oil.

Oil prices rose 70 percent from April 2007 to April 2008, directly affecting food costs. For the first four months of 2008, fertilizer costs rose 67 percent and fuel increased 43 percent. That sent food commodities - all farm products, including corn - up 46 percent.

The dollar's depreciation hasn't helped, either. World crop prices are denominated in U.S. dollars, just as with oil. Plus, weather problems in Australia, Canada, Ukraine, and the European Union contributed to a low global wheat crop, driving up prices for cereal and bakery products. Many countries have placed restrictions on food exports and economic growth in India and China has increased the demand for food, especially for grain-intensive meat products.

Also, hedge funds, index funds, and sovereign wealth funds entered the agricultural commodity markets, mostly for purposes of diversifying financial portfolios - not for any interest in agriculture.

Let's take a closer look at corn production. In 2007, American farmers produced 13.1 billion bushels of corn, 10 percent of which was processed directly into human food. Another 2.9 billion bushels were used to make 7 billion gallons of ethanol, and corn-for-ethanol demand this year will go up to 4 billion bushels.

But even with that increase, there will be enough corn to supply the domestic market, increase exports to record levels, and stockpile a 10 percent surplus. Oil prices would be at least 15 percent higher without the ethanol currently blended into gasoline. That would drive food prices even higher.

Corn-based ethanol production will level out at 15 million gallons in 2015. Increases in ethanol production beyond that, to a target of 36 billion gallons by 2022, must come from cellulosic or other non-corn feedstocks.

The leading cellulosic contender is switchgrass, a hardy perennial that thrives in adverse conditions and can be grown virtually anywhere, including land not currently farmed. It absorbs carbon from the atmosphere and deposits it in the soil. Experimental strains are being developed for planting on marginal, highly erodible lands similar to those in the USDA Conservation Reserve Program - 35 million acres that farmers are currently paid not to plant.

Cellulosic ethanol production using existing technology is estimated to cost $2.25 per gallon, making it competitive with gasoline (assuming $120/barrel oil). Advanced processes are targeting a production cost of $1 to $1.50 per gallon. That would be below the cost of corn-derived ethanol.

Better crop yields will be key to increased biofuel production. An improvement of 55 percent would enable biofuels to satisfy as much as 40 percent of global fuel demand by 2030, easing the pressure on oil and substantially curbing CO2 emissions - all of which would be great news for consumers and the environment.

Eric Fedewa is Vice President, Global Powertrain Forecasts at CSM Worldwide (www.csmauto.com), a company that provides the automotive community with the knowledge and foresight to make well-informed, timely decisions.