Does ethanol production affect corn basis volatility?

Abstract

Purpose

South Dakota is ranked sixth nationally for corn and ethanol production (EP). The purpose of this paper is to investigate the relationship between corn-EP and corn basis volatility using South Dakota data.

Design/methodology/approach

A mixed regression modeling approach was adopted to analyze state EP data, and quarterly corn production and price data for five crop reporting regions in South Dakota (1990-2014).

Findings

From 2004-Q4 to 2013-Q4, ethanol and corn production in South Dakota increased by 735.50 million gallons and 228.30 million bushel per year, respectively. Empirical estimates indicate that increased EP narrowed the corn basis by 6.16 cents per bushel, and increased corn basis absolute volatility by 2.25 cents. However, increased corn production widened the corn basis by 27.56 cents per bushel and decreased absolute basis volatility by 4.32 cents. On average, for this period, increased EP offset the effect of rapid corn production on average basis and basis volatility in the State of South Dakota. Empirical evidence presented clarifies how the relationship between EP and corn production variability effects the cash basis and basis volatility in local markets.

Research limitations/implications

Research limitations include the use of statewide EP due to the lack of regional data, and the use of aggregate price data rather than local cash market data.

Practical implications

During normal crop production years, corn production is a predominant driver for impacting corn basis and basis volatility. In this case, EP plays a secondary role and dampens the corn production effect by narrowing the cash basis and increasing volatility. However, when a negative corn production shock occurs, then EP amplifies the effect of reduced corn production. In this case, EP strengthens market forces that are narrowing the cash basis and amplifies the market forces that are increasing the volatility of the cash basis.

Social implications

Negative corn production shocks occurring in regions where corn production and corn-based EP are dominant agricultural activities will increase basis volatility, reducing hedging effectiveness. Expansion of the ethanol blending wall in the future may exacerbate the market forces that have evolved in local cash corn markets as EP renews its expansion in major corn production regions. As a result, producers and grain elevator managers need to be aware that traditional hedging strategies may become less effective as one consequence of a renewed expansion of EP in the USA.

Originality/value

The literature on the effect of corn-EP on corn basis volatility is limited. This is the first study to apply a mixed modeling approach to the issue of how EP affected corn basis and basis volatility.

Citation

Fausti, S.W., Qasmi, B. and Mc Daniel, K. (2017), "Does ethanol production affect corn basis volatility?", Agricultural Finance Review, Vol. 77 No. 4, pp. 506-523. https://doi.org/10.1108/AFR-05-2016-0050