The relative impacts of corn and energy prices in the grocery aisle need to be better understood by critics and the public.

Retail food prices measured by the Consumer Price Index (CPI) have begun to accelerate and are beginning to approach rates of increase last seen in mid-2004. Critics of renewable fuels are blaming the recent increases on high corn prices caused by increasing ethanol production. They fail to point out that corn prices are only one of many factors that determine the CPI for food, and in fact, directly affect only a small share of retail food prices. n Increases in energy prices, for example, exert a greater impact on food prices than does the price of corn. A 33 percent increase in crude oil prices – which translates into a $1-per-gallon increase in the price of conventional regular gasoline – results in a 0.6 percent to 0.9 percent increase in the CPI for food. An equivalent increase in corn prices – $1 per bushel – would cause the CPI for food to increase only 0.3 percent.

Tough Critics
The ethanol and corn industries are under attack by a wide range of critics for causing everything from sharply higher food prices for American consumers to shortages of Mexican tortillas – and even potentially higher tequila prices. Expansion of the ethanol industry to meet clean air standards and reduce dependence on imported petroleum has boosted demand for corn, the primary feedstock for U.S. ethanol. This increased demand has caused corn prices to rise to their highest levels since 1995.

Critics contend that the recent increase in retail food prices measured by the CPI for food is the direct result of higher corn prices caused by ethanol demand and that an even larger increase in food prices is in store for American consumers. The actual record on the relationship between ethanol, corn and retail food prices is less clear. In the past five years, ethanol production has more than doubled, increasing from 2.14 billion gallons in 2002 to 4.86 billion gallons in 2006. In this same period, the demand for corn to produce ethanol grew from 996 million bushels to 2.2 billion bushels. Through most of this period, cash market corn prices were relatively stable. From January 2002 through September 2006, corn prices averaged $2.18 per bushel. However, between September 2006 and May 2007, corn prices jumped 61 percent to $3.56 per bushel in May 2007.

During this same period, the CPI for food averaged a year-over-year increase of 2.4 percent. In fact, the inflation rate for food declined from a five-year peak of 4.1 percent in May 2004 to a 2.5 percent year-over-year rate in September 2006. However, since September 2006, the CPI for food has accelerated to a year-over-year rate of 3.7 percent in April 2007, an increase of 1.2 percent. During this same period, cash market corn prices increased $1.15 per bushel.

Although it is tempting to blame the food price inflation of the past eight months on higher corn prices, most of the increase in food prices was the result of foods not impacted by corn such as fish, fruits and vegetables, sugar and sweeteners, and food away from home.

Meat, poultry, eggs and dairy products – the foods where corn is a major input and are most affected by rising corn prices – accounted for about 0.2 percent of the 1.2 percent acceleration in food price inflation between September 2006 and April 2007. Rising energy prices had a more significant impact on food prices than did corn.

Future Food Prices
Retail food prices are not likely to accelerate significantly in 2008 and beyond, even as ethanol production continues to expand. In fact, consumers will be more severely affected by rising gasoline and energy prices than by increases in corn prices.

Increasing petroleum prices have about twice the impact on consumer food prices as equivalent increases in corn prices. A 33 percent increase in crude oil prices – the equivalent of $1 per gallon over current levels of retail gasoline prices – would increase retail food prices measured by the CPI for food by 0.6 to 0.9 percent. An equivalent increase in corn prices – about $1 per bushel over current levels – would increase consumer food prices only 0.3 percent.

The reason for the larger impact on food prices from petroleum and energy prices stems from the relative importance of energy in food production, packaging and distribution compared to that of a single ingredient. While petroleum and energy prices affect virtually all aspects of agricultural raw material transportation, processing and distribution of all finished consumer food products, corn prices affect only a segment of consumer foods – livestock, poultry and dairy. Corn is an important feed ingredient for livestock and poultry producers and changes in corn prices can have significant impacts on profitability and production.

However, meat, poultry, fish, eggs and dairy products account for only a fifth of the CPI for food which, in turn, is only 15 percent of the overall CPI. Crude oil and refined petroleum prices have increased sharply in the past several years and have put considerable pressure on consumers. Energy plays a significant role in the production of raw agricultural commodities, transportation and processing, and distribution of finished consumer food products. Several studies have looked at the impact of increased energy prices on food prices.

Reed, Hanson, Elitzak and Schluter utilized three different model structures to examine the impact of a doubling of crude oil prices on the CPI for food. They concluded that the short-run impact of a doubling in crude oil prices would cause a 1.82 percent rise in average food prices in the short run and 0.27 percent in the long run.
Corn and energy prices both affect consumer food prices. However, because increases in corn prices are limited to a relatively small portion of the overall CPI for food, an increase in corn prices resulting from higher ethanol demand or a supply disruption such as a major drought is expected to have about half the impact of the same percentage increase in petroleum and energy prices.

John M. Urbanchuk, director of LECG LLC, is responsible for economic, planning, marketing and policy analysis consulting services to firms and associations involved in the agriculture, renewable fuels and consumer foods industries. The Renewable Fuels Association commissioned this study. For more information, please go to www.ethanolrfa.org