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

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. JEL Code: Q18, Q28, Q42, Q58

Prices for a second‐generation biofuel industry in Canada: Market linkages between Canadian wheat and US energy and agricultural commodities

“…Ethanol prices tended to be volatile in 2013, and may have been reacting to the aforementioned price changes in the corn market. Furthermore, as the United States approached the ethanol‐gasoline E10 blend wall in 2013–2014, policy uncertainty from the Environmental Protection Agency (EPA) regarding future ethanol demand may have affected ethanol price volatility (Baumeister et al., 2017; Knittel et al., 2015). US ethanol prices then declined substantially in 2014 and have remained low since.…”

Using Market Expectations to Test for Speculative Bubbles in the Crude Oil Market

“…Oil price expectations, besides their use in forward‐looking economic models, play a central role in generating economic projections, in understanding the extent to which energy markets anticipate changes in economic policy, and in the determination of the value and size of strategic petroleum reserves (Baumeister and Kilian , Baumeister, Ellwanger and Kilian , Newell and Prest ). Given their importance and wide use, it is no surprise that different expectation measures have been proposed in the literature.…”

“…On the grounds of its predictive accuracy and economic plausibility, we choose to work with the financial market expectation measure proposed by Baumeister and Kilian () in our empirical application. Other recent studies that apply the same methodology for measuring financial market expectations include Baumeister, Ellwanger, and Kilian () and Newell and Prest ().…”