Let’s start this blog off with a pop quiz. The good things in life are brought to you by a) science and engineering or b) lobbying? I’ll come back around to the answer to this quiz later.
Welcome to the food versus fuel debate, round two, brought to you courtesy of the West Coast legislators and their renewable low carbon biodiesel initiative. And, let’s start by acknowledging that no one is going to leave this debate happy. Just like ethanol, some groups will gain a strong advantage which they will defend forcefully, while most people will be slightly disadvantaged, leaving them indifferent to making a change. You can see this political calculus in just about everything the government does and maintains. Each situation has its own unique structure and numbers. Some of them are durable, but others change because technology or demographics erodes the situation, favoring one group over the others. So, it pays to look at the numbers and structures around renewable biodiesel.
The West Coast legislators started with the well-known political syllogism. We need to do something about climate change. This is something. So, we need to do this something. In this case, it was mandating a percentage utilization of renewable low carbon biodiesel. Just like ethanol, the final consumer finds the cost of the required component blended into a complicated and volatile commodity like gasoline or diesel. It’s impossible to disentangle all the moving pieces and establish the final cost impact on the consumer. However, we can track the impact on prices as the requirements have ramped up over time. With food inflation at the front and center of the economic situation, this impact is getting renewed scrutiny.
The year-over-year CPI inflation rate for fats and oils reached 6.9% in September 2021. This is the highest rate in more than a decade, and includes the sharp run-up around the drought of 2012 and all the increased demand for soybeans from China. These CPI fats and oils prices don’t include the food ingredient costs that go into other manufactured foods. Restaurants are facing much higher price increases for their cooking oils to fry and to make foods. Pet food manufacturers are dealing with double-digit price increases in edible oils that go into pet food. Cattle, hog, and poultry feeders are dealing with the same double-digit price increases for their feed rations. Same as with foods consumed by people, oils and fats make animal rations more palatable and nutritious, and it’s very difficult to reformulate them without these fats and oils.
It’s clear that the consumer is paying a higher price for fats and oils in foods, and through all the ways fats and oils are used in food ingredients. However, can it be said that the renewable biodiesel mandates are the only cause of the increase? Of course, it’s more complicated than that. Both grains and oilseed prices jumped in 2021 due to poor crop production in 2019 and 2020. Also, China switched from avoiding U.S. soybeans in 2018 as a source of imports, and returned as a major buyer in 2020 and 2021. This type of commodity price volatility is part and parcel of the food world. Weather events and trade disputes come and go, and they typically leave the consumer food prices unchanged. But, the low carbon renewable biodiesel mandates are a different issue. They represent a structural change that will permanently change the demand structure and food prices.
So if the consumer is paying higher prices for food and fuel, is the U.S. farmer getting the benefit? Once again, it is more complicated than this. Just like with ethanol, the U.S. farmer was told that a new demand stream for corn and soybeans would increase the price of grains and oilseeds, and that, in turn, would lead to higher sales revenue and hopefully higher net profits.
The U.S. farmer will grow 502 million metric tons of corn and soybeans in 20211, and they will receive $134 billion in crop receipts2 for these crops, contributing to the second highest net farm income ever of $113 billion. Without a doubt, if not for the new demand streams from ethanol and biodiesel, this level of crop production would crush prices and lower net farm income.
But, does most of the benefit of biodiesel end up with the U.S. farmer? The answer is clear. No, most of the additional value-added to soybeans and other oilseeds occurs after the farmer sells it. The following graph shows that the renewable biodiesel initiative has changed the system in a big way. First, it is important to remember that soybeans are 20% oil and 80% meal (for all the soybean crushers out there, the actual numbers are slightly different). What a soybean crusher can afford to pay farmers for soybeans is mathematically set by that the 20% oil/80% meal ratio. The components revenue less the cost of the soybeans and the cost of crushing is the profitability of crushing soybeans. Historically, soybean oil and soybean meal moved in a rough tandem to the value of soybeans. However, the renewable biodiesel initiatives have broken that relationship. As crushers have produced more soybean oil to satisfy the mandates, they flooded the market with soybean meal, not mandated. The price of soybean oil soared, and the price of soybean meal has plunged, leaving the value of the soybean little changed.
The above graph shows the radical departure in the relationship of soybean oil and soybean meal to soybeans. The market quotes the price of soybeans in dollars per bushel (60 lbs. per bushel), the price of soybean meal in dollars per ton, and the price of soybean oil in cents per lb. To show these three distinct products and pricing units, I indexed all three back to 2016, using the USDA’s Iowa pricing. In October 2021, soybeans are 28% higher than their 2016 average, soybean oil is up 125%, while soybean meal sells for the same price as in 2016. If you apply the ratio of 20% soybean oil and 80% soybean meal, the price of soybeans fits precisely the two component values. This makes it hard to argue that the soybean growers are better off because of biodiesel because the excessive supply of soybean meal limits what the crusher can pay farmers for the soybeans.
So, who is reaping the benefits of the renewable biodiesel mandate? There are large number of companies that turn the soybean oil (and other oils, fats, and greases) into biodiesel, and then sell it to the fuel blenders. Many of the traditional agribusinesses, and even petroleum companies, have announced plans to ramp up investment and production to meet this new demand stream. After the renewable biodiesel is produced and sold, fuel distributors have to blend and transport, thus adding on their margins as well. This complicated and multi-tiered relationship makes tracking the profitability of renewable biodiesel extremely difficult. Further, the revenue and costs are not the only components. The blending credits are volatile and difficult to track back to the different participants. But, at the end of the process stands the consumer paying a higher price either at the pump or at the supermarket. Does the consumer get a good cost/benefit from reduced carbon emissions? Like I said in the beginning, no one will leave this debate happy.
So, to answer to the pop quiz at the start of this blog, I’m going with science and engineering as the answer to what brings good things to life. I guess there is a need for lobbyists, but they might be in over supply at the moment.
1USDA WASDE reported 10/12/2021
2USDA ERS Farm Income Forecast 9/2/21