Did the Renewable Fuel Standard Shift Market Expectations of the Price of Ethanol?

57 Pages Posted: 6 Jan 2017 Last revised: 11 Jan 2018

See all articles by Christiane Baumeister

Christiane Baumeister

University of Notre Dame

Reinhard Ellwanger

Government of Canada - Bank of Canada

Lutz Kilian

University of Michigan at Ann Arbor - Department of Economics; Centre for Economic Policy Research (CEPR)

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Date Written: December 20, 2016

Abstract

It is commonly believed that the response of the price of corn ethanol (and hence of the price of corn) to shifts in biofuel policies operates in part through market expectations and shifts in storage demand, yet to date it has proved difficult to measure these expectations and to empirically evaluate this view. We utilize a recently proposed methodology to estimate the market’s expectations of the prices of ethanol, unfinished motor gasoline and crude oil at horizons from three months to one year. We quantify the extent to which price changes were anticipated by the market, the extent to which they were unanticipated, and how the risk premium in these markets has evolved. We show that the Renewable Fuel Standard (RFS) is likely to have increased ethanol price expectations by as much $1.45 in the year before and in the year after the implementation of the RFS had started. Our analysis of the term structure of expectations provides support for the view that a shift in ethanol storage demand starting in 2005 caused an increase in the price of ethanol. There is no conclusive evidence that the tightening of the RFS in 2008 shifted market expectations, but our analysis suggests that policy uncertainty about how to deal with the blend wall raised the risk premium in the ethanol futures market in mid-2013 by as much as 50 cents at longer horizons. Finally, we present evidence against a tight link from ethanol price expectations to corn price expectations and hence to storage demand for corn in 2005-06.

Keywords: Biofuels, policy uncertainty, term structure of price expectations, price shocks, market integration, anticipation, storage demand, risk premium, crude oil, gasoline, corn

JEL Classification: Q18, Q28, Q42, Q58

Suggested Citation

Baumeister, Christiane and Ellwanger, Reinhard and Kilian, Lutz, Did the Renewable Fuel Standard Shift Market Expectations of the Price of Ethanol? (December 20, 2016). CFS Working Paper, No. 563. Available at SSRN: https://ssrn.com/abstract=2893037 or http://dx.doi.org/10.2139/ssrn.2893037

Christiane Baumeister

University of Notre Dame ( email )

722 Flanner Hall
Notre Dame, IN 46556
United States
+1 574 631 8450 (Phone)

HOME PAGE: http://https://sites.google.com/site/cjsbaumeister/

Reinhard Ellwanger

Government of Canada - Bank of Canada ( email )

234 Wellington Street
Ontario, Ottawa K1A 0G9
Canada

Lutz Kilian (Contact Author)

University of Michigan at Ann Arbor - Department of Economics ( email )

611 Tappan Street
Ann Arbor, MI 48109-1220
United States
734-764-2320 (Phone)
734-764-2769 (Fax)

Centre for Economic Policy Research (CEPR)

London
United Kingdom

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