Analyzing the Influence of Energy Policy

Five years in, the impact of federal energy legislation on commodity and retail food prices is measured.
By Jake Ferris | September 23, 2013

Now that the Energy Independence and Security Act of 2007 has been in effect for more than five years, we have more information available to assess its effectiveness and the impact this and earlier federal energy legislation have had on the prices of food commodities and U.S. retail food prices. We’ll address five questions:


1. Have retail food prices actually accelerated upward in the past five years?   

Yes, they have. This is evident in Table 1, which presents the percentage point changes in the Bureau of Labor Statistics’ Consumer Price Index for All Food from one five-year average to the next since 1983-’87. Somewhat remarkable is that these changes were very close to 20 percentage points until 2008-’12. The five-year average for 2008-’12 was 31.6 percentage points above 2003-’07—about 50 percent more than for the previous periods going back to 1983-’87.


2. Was the EISA the major reason ethanol production capacity increased in 2007-’12?   

Yes. To measure the extent to which the ethanol industry responded to profits and to the renewable fuel standard (RFS1) and its 2007 revision (RFS2), a regression equation was based on the Renewable Fuels Association’s database for capacity under construction or expansion from 1990 to 2013 as of Jan. 1 of each year.  The independent variables were: 1) real profits the previous year for a typical dry mill plant and 2) the RFS1 or RFS2 two years prior.  Applying this equation, with reduced profits equivalent to ethanol’s excise tax exemption/blenders’ tax credit and with the elimination of the RFS1 and RFS2, cut the intended capacity under construction or expansion in 2007 in half with no increase after 2007.  The conclusion is that EISA was responsible for as much as 80 percent of the expansion in ethanol production in 2007-'12.  


3. Was the expansion in ethanol production the driving force in the sharp increase in commodity prices?      

It was the major cause. The problem is to measure the impact. The focus is on the five crop years of 2007-’11 compared to the five crop years of 2001-’05 when farm prices for corn hovered around $2 per bushel. Table 2 indicates the absolute and percent changes for key agricultural commodity prices between these two five-year periods.

The ending stocks of corn dropped from 15.4 percent of utilization in 2001-’05 to 11.6 percent in 2007-’11, ranging in the latter period from 7.9 to 13.9 percent.  Only two years from 1960 to 2006 had carryovers less than 7.9 percent and in only nine years below 13.9 percent. In other words, in 2007-’11, ending stocks were at pipeline levels, just enough to provide the transition between crop years. For that reason, corn prices were very sensitive to changing supply-demand balances. The change in stock levels from 2001-’05 accounted for about $1.28 of the $2.49 per bushel increase in corn prices (Table 2)—just over 50 percent. About 18 cents per bushel can be attributed to breakeven corn prices for ethanol production, which tended to be above the market.

While farmers responded well to the higher corn prices in expanding harvested acreage by 15 percent, they also incurred higher production costs, mostly due to higher energy prices. About 75 cents per bushel, or 30 percent, of the $2.49 per bushel increase in corn prices can be traced to higher variable costs of production. Adding $1.28 per bushel for ending stocks, 18 cents per bushel for ethanol returns and 75 cents per bushel for higher production costs equals $2.21 out of the $2.49 per bushel increase in corn prices. This leaves 28 cents per bushel unexplained. A small part might be attributed to a weak dollar, which encouraged exports, but most of the 28 cents could be considered as speculation. A caveat is the difficulty in separating speculation from the increased inelasticity of demand when supplies are at pipeline levels.


4. How much did the increase in food commodity prices contribute to higher retail food prices?   

To measure the impact of higher food commodity prices on retail food prices, the calendar years of 2008-’12 were compared with 2002-’06. Even with higher feed costs, livestock producers expanded between these two periods. This includes beef, pork, broilers, turkeys, eggs and milk.  Adjustments were made, and livestock prices did increase. Somewhat remarkable was that, except for milk, the increases in livestock prices were almost identical (one-to-one) to the increase in feed costs per hundredweight (cwt.), pound or dozen. Of course, these comparisons are in nominal terms and do not reflect general cost inflation. For broilers, turkeys and eggs, adjustments could be made in a relatively short time, so real gross margins over feed costs were about the same in 2008-’12 as in 2002-’06. For hogs, real gross margins were down about $3.50 per cwt. For cattle feeding and dairy, where adjustments take more time, real gross margins on cattle feeding were down about $6.35 per cwt. and for milk down about $2.30 per cwt. To put these changes in perspective, livestock producers were benefitting from $2.15 per bushel corn in crop years 2001-’05. Also, increased feeding of distillers grains replaced 80 percent of the reduction in feeding of corn in energy equivalents and offset a small reduction in the feeding of soybean meal in protein equivalents by a substantial margin.    

To link both crop and livestock prices to retail food prices, a portion of an econometric model of U.S. agriculture called AGMOD was employed. The analytical procedure used was to compare five-year average food prices in calendar 2008-’12, as measured by the Consumer Price Index of the U.S. Department of Labor, with the five-year average for 2002-’06 and determine the extent to which agricultural prices contributed to the increase. In the food price sector, statistical regression equations generated forecasts of 17 major CPI classifications of food consumed at home, which were translated to food consumed away from home and the combined index of all food. Each equation includes the price of the relevant agricultural commodity and an indicator of general inflation to measure the marketing spread between the farm or wholesale agricultural commodity price and the retail price. The regression estimates were based on annual data, typically going back to the 1970s.    

For example, the equation for pork includes: 1) the price of barrows and gilts and 2) the Chained Price Index for the Gross Domestic Product’s Personal Consumption Expenditures of the U.S. Department of Commerce, an indicator of inflation, which accounts for the marketing spread between wholesale hog prices and the retail price of pork. The equation for cereals and bakery products includes the farm price of wheat and the Gdppipce. The equation for salad dressing includes the wholesale price of soybean oil and the Gdppipce. The results are displayed in Table 3.  

Retail food prices at home and away from home both increased about 20 percent between 2002-’06 and 2008-’12 as did the total (19.90 percent). Higher commodity prices added about 4.4 percent to food prices at home and about 3.0 percent to food prices away from home for a total of 3.80 percent. Viewed in another way, the 3.80 percent was 19.1 percent of the 19.9 percent hike in the CPI index for total food.     

As covered in Question 3, part of the increase in commodity prices can be attributed to higher production costs. This takes a percentage point off the 3.80 percent to 2.77 percent, basically transferring the impact of EISA more to crude oil prices, which doubled between the two periods.

5. What credit should be given to EISA for reducing costs of the U.S. farm program in 2007-’11 and years to come?   

The higher commodity prices have reduced the costs of the federal farm programs, amounting to nearly $3.5 billion annually in crop years 2007-’11. With the likely elimination of the direct payment feature in new farm legislation, billions more will be saved. Factoring in these savings, the conclusion is that EISA has had and will continue to have a minor impact on U.S. retail food prices, less than 2.5 percent. Details are in Staff Paper 2013-02 of the Department of Agricultural, Food and Resource Economics at Michigan State University entitled, “Impacts of the Federal Energy Acts and Other Influences on Prices of Agricultural Commodities and Food.” For a copy go to http://purl.umn.edu/150245.


Author: Jake Ferris
Professor Emeritus, 
Department of Agricultural, 
Food and Resource Economics
Michigan State University
Phone 517-337-2955
jakemax33@comcast.net