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

57 Pages Posted: 9 Jan 2017

See all articles by Christiane Baumeister

Christiane Baumeister

University of Notre Dame; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR)

Reinhard Ellwanger

Government of Canada - Bank of Canada

Lutz Kilian

Federal Reserve Banks - Federal Reserve Bank of Dallas; Centre for Economic Policy Research (CEPR)

Multiple version iconThere are 4 versions of this paper

Date Written: January 2017

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, corn, crude oil, gasoline, market integration, policy uncertainty, Risk premium, storage demand, term structure of price expectations

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? (January 2017). CEPR Discussion Paper No. DP11740, Available at SSRN: https://ssrn.com/abstract=2896030

Christiane Baumeister (Contact Author)

University of Notre Dame ( email )

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National Bureau of Economic Research (NBER) ( email )

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Centre for Economic Policy Research (CEPR) ( email )

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Reinhard Ellwanger

Government of Canada - Bank of Canada ( email )

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Canada

Lutz Kilian

Federal Reserve Banks - Federal Reserve Bank of Dallas ( email )

2200 North Pearl Street
PO Box 655906
Dallas, TX 75265-5906
United States

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

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