The Biofuel Connection: Impact of US Regulation on Oil and Food Prices

Abstract

Biofuel policies are frequently mentioned in the policy and academic debates because of their potential impact on food prices. In 2005, the United States authorities passed legislation under which corn-based ethanol became in practice the only available gasoline additive. Some studies have then argued that ethanol and biodiesel subsidies in advanced economies may have strengthened the link between the prices of oil and those of some food commodities. This paper tests whether the response of food commodity prices to global demand shocks and to oil-specific demand shocks has changed following the introduction of this legislation. Our results show that corn prices exhibit a stronger response to global demand shocks after 2006. Some short-lived but statistically significant response to oil-specific demand shocks is also documented. Close substitutes of corn in the feedstock business (eg soybeans and wheat) exhibit comparable but more muted responses, while other food commodities unaffected by biofuel policies do not change their behaviour. We also report some evidence that global liquidity is a factor driving global demand shocks, and through that channel may have affected food commodity prices.

Keywords: oil price, corn price, food prices, ethanol, biofuel, VAR

JEL Classification: H23, O13, Q16, Q48