Policy Options for Integrated Energy and Agricultural Markets*

I the past, agricultural markets have been well integrated. Markets for different energy commodities, especially liquid energy products, also have been tightly linked. But agricultural markets and energy markets have not been closely correlated. Table 1 contains partial correlation coefficients between pairwise prices (both levels and first differences) of corn, soybeans, crude oil, gasoline, and ethanol obtained from monthly data for the period 1982–2007. Clearly, the energy pair correlations are quite high ranging from 0.86 to 0.98, while the energy agricultural correlations are quite low, ranging from 0.13 to 0.25. The corn-soybean pair has a correlation of 0.72. Historically recognizing this market separation, we have evaluated energy and agricultural commodities and policies apart. Can we continue to do that in the future? Until 2002, the fraction of the U.S. corn crop going to ethanol had always been less than 10%. As recently as 2004, it was about 11%. But in 2007, the fraction of the corn crop going to ethanol will be about 22%, double that three years ago—even with about a 25% increase in corn production in 2007. This fraction may exceed 30% in 2008 and it could even approach 40% depending on what happens to corn acreage and production. Massive production of energy, mainly liquid fuels, from agricultural resources will link agricultural and energy markets tightly (Schmidhuber). The new market integration is perhaps the most fundamentally important change to occur in agriculture in decades. The link between energy and agricultural markets requires an integrated environment to study these markets and design policy alternatives to guide them toward designated goals. This article develops an integrated partial equilibrium framework to analyze economic impacts of four alternative policies that can be implemented in promoting ethanol