Over the last half of 2014, energy prices fell sharply, with crude oil prices down more than 40 % and natural gas prices down more than 20 percent. Further, energy prices are expected to remain lower than previously projected through at least 2016.
The agricultural sector will benefit from lower energy prices primarily because of reduced production and transportation costs. Additionally, biofuel markets are potentially affected by lower energy prices, but the effect on the demand for ethanol is expected to be modest. Effects on individual commodities, therefore, reflect the importance of energy in production costs and whether the commodity is used as a biofuel feedstock, an input in the production of biofuel. Overall effects on acreage and agricultural commodity prices are anticipated to be modest. Farm-sector production expenses are reduced by about $5 billion annually for 2015 and 2016.
Editor’s Note: Below is the Background, Summary and Conclusions from the USDA report: Effects of Recent Energy Price Reductions on U.S. Agriculture. The full 19-page pdf includes more crop information, charts and graphs and is available here.
Energy prices affect the production costs of agricultural commodities, as well as the demands for certain agricultural products, particularly biofuel feedstocks. Changes in the cost of production can directly affect the net returns (expected and realized) from producing different crops, and planting decisions at the farm level reflect producers’ expectations of those net returns.
All else equal, when the cost of producing a commodity declines, the returns to producing that commodity increase, so lower production costs tend to encourage greater production. Since production costs vary by commodity, relative net returns also play a key role in determining acreage allocations among crops.
Any changes in acreage allocations and production–based on expected net returns–have implications for the market price of each commodity, reflecting the new equilibrium between supply and demand. Hence, prices for agricultural commodities are tied, at least indirectly, to energy market developments through the link to production decisions.
Summary and Conclusions
The latter half of 2014 showed a sharp reduction in oil and natural gas prices, with expectations that energy prices would remain lower than previously projected, at least through 2016. Energy prices affect a number of markets, including agriculture and biofuels, which also interlink with one another.
This report analyzes effects of lower energy prices in 2015 and 2016, focusing on crop-sector effects. Lower energy prices affect production expenses, which in turn affect total operating costs, acreage allocations, and commodity prices. Additionally, lower energy prices can affect biofuel markets, changing the demand for feedstocks, especially corn for ethanol.
Our analysis suggests that lower energy prices will have a small effect on agriculture in 2015 and 2016. With lower prices of oil and natural gas, costs of production are lower than previously projected–however, this effect is minimal for two reasons.
First, prices for energy-related inputs fall by less than the change in energy prices.
Second, energy-related costs represent only a portion of total operating expenses.
Nonetheless, with lower costs of production, farmers have incentives to adjust planted acreage in 2015 and 2016–a scenario with lower energy prices shows total acreage increases a small amount relative to a reference scenario (with higher energy prices) and the mix of crops planted changes slightly.
In addition to the small changes in production costs, another factor causing the small acreage effects is that crop acreage supply response is inelastic to changes in producer net returns, meaning changes in producer net returns lead to relatively small acreage changes. As a result of the acreage shifts in the lower energy cost scenario, commodity prices generally decrease. However, price effects in the alternative scenario are small compared with a reference scenario with higher energy prices.
Overall farm production expenses in the sector are reduced.
Lower energy prices in 2015 and 2016 are also expected to have a variety of effects on the biofuels market. Primarily, lower natural gas prices reduce ethanol production costs, increasing ethanol availability.
Furthermore, as lower gasoline prices (in response to lower oil prices) lead to higher gasoline consumption, the market for ethanol blends increases. However, as the price of gasoline decreases relative to ethanol, refiners become reluctant to blend more ethanol with gasoline (for energy and octane) because of ethanol’s increased relative cost.
Overall, lower energy prices in 2015 and 2016 will minimally increase the demand for ethanol, reflecting the increase in gasoline consumption. At the same time, lower corn prices are expected to combine with reduced natural gas prices to increase ethanol output.