We know the answer to this one...

The ethanol boom is being studied closely to try to get some handle on what the longer term implications for farmers might be. Consider this interesting study by economists at the University of Illinois ["Call us if you can play football! Even a little bit!"].

Once Federal mandates for use of biofuels are reached, ethanol's primary use will be as a substitute for gasoline. As such, the ethanol price will have to be competitive with the gasoline price so that consumers will buy ethanol-blended fuels. Because corn is the major production cost for ethanol, the price an ethanol producer will be willing to pay for corn, hereafter referred to as the break-even corn price, will be directly related to the ethanol price. As the ethanol price increases, the break-even corn price increases. Moreover, ethanol price will be directly related to crude oil price. Therefore, break-even corn prices will be positively related to crude oil prices. As crude oil price increases, the price of gasoline will increase leading to higher ethanol and break-even corn prices. Conversely, decreases in crude oil price will lead to a lower gasoline price, a lower ethanol price, and a lower break-even corn price. [More]

There follow neat rows and columns of figures, but the punchline for me was the assumption I have highlighted above: "Once Federal mandates for the use of biofuels are reached". This year will get us to around 6B gpy (gallons per year) on our way to a mandate of 7.5 gpy.

But wait, why not just move the goal line?

Refiners would be forced to triple their use of fuel ethanol over the next decade, under legislation expected to start moving through the Senate this spring.

The legislation, outlined Tuesday by leaders of the Senate Energy and Natural Resources Committee, would require use of 18 billion gallons of biofuels by 2016 and 36 billion gallons by 2022.

All but 15 billion gallons of that biofuel each year would have to come from sources other than corn, such as crop residue, switchgrass and forestry waste. [More]

My perception is at the first sign of markets adjusting to higher corn prices and reducing farmer margins to historic levels, heavy ag lobbying will get the mandate raised. Cash rents, seed, fertilizer, machinery, etc. are already responding to producer liquidity and exercising pricing power. Keep in mind the market still isn't paying the current price for corn right now. End users are still partially feeding off doofs like me who will deliver some $2.50 corn this fall. (I don't want to talk about it!)

My suspicion is the input cost spiral will truly take off this winter as almost all of us sell crops with averages starting with threes and sevens. Producer margins will head back to more modest levels and, having tasted better, intense pressure wll arise for lawmakers to deliver.

From a politician's point of view, mandates are a beautiful thing, man. You don't need a budget for starters. You simply speak and somebody else has to figure out how to pay for it. Having experienced this magic power once, it will be hard to resist repeating. Especially if the farm bill turns out to be less than a crowd pleaser for your farmer constituents.

Getting back to the oil/corn price analysis, such studies make for interesting conversation. But it seems more likely we are in for a punctuated equilibrium model of price evolution - not a smooth curve.

[via farmgate]