Don Farrall
By Emily Balsamo and Arthur Yu
In a glance
- Ethanol production has stabilized over the past 15 years, but it still accounts for a large share of corn use in the United States.
- The corn and ethanol futures markets are related, but prices can move independently due to several factors
The relationship between corn and ethanol prices is complex. In the center are the nation’s supplies of corn, a field crop harvested annually; and ethanol, an alcohol distilled primarily from corn (in the United States) and usually blended with gasoline to fuel automobiles. The relationship is characterized by a strong positive relationship but is also characterized by many factors that contribute to less than perfect compatibility.
A boom in ethanol production occurred at the turn of the 21st century, as the US political climate supported a policy of reducing dependence on foreign oil. Although ethanol production has stabilized over the past 15 years, it still represents a very large share of total domestic corn disappearance, second only to its use in feed. Corn and ethanol futures have different listing cycles and distinct seasonality. In addition, the underlying commodities in question respond to unique supply and demand dynamics that contribute to independent price movements.
Ethanol is an alcohol derived primarily from corn in the United States. Ethanol is blended with gasoline at an average ratio of 10% ethanol and 90% petroleum-based gasoline. Corn is the main input for ethanol production in the United States, while ethanol production accounts for about 35% of corn disappearance domestically. Animal feed, exports and processed food ingredients are also putting pressure on the corn demand side, while weather, farming sentiment and productivity are driving corn supplies. Conversely, demand for ethanol is driven by policy, particularly in the form of the EPA’s Renewable Fuel Standard, and supply depends on production capacity.
The following figure shows the front-month futures settlement prices for Corn Futures and Chicago Ethanol (Platts) Futures, with the latter converted from the traditional quote in US dollars per gallon to dollars per bushel at a conversion rate of 9.30917797 gallons per bushel. Corn futures prices were converted from US cents per bushel to dollars per bushel. 
The two producers’ first-month daily settlement pricing shows a highly statistically significant relationship, showing a correlation coefficient of 0.83, indicating that corn derivatives may serve as a rough hedge for ethanol derivative pricing, and vice versa. The following figure plots first-month corn futures against first-month Chicago ethanol futures (Platts) prices, where each point represents a unique trading date since May 2014.
Cointegration between corn and ethanol pricing was established using the Engle-Granger test; Therefore, correlation analysis was performed on levels, not on differences.
Nothing is perfect
Several factors contribute to the corn and ethanol markets showing a less than perfect correlation. One reason corn and ethanol futures do not move in tandem is the difference in listing cycles between the two derivative producers. Corn futures, a physically delivered product, are scheduled to expire in March, May, July, September and December, with the last month marking the new crop instrument. In contrast, ethanol is financially settled and listed monthly. With a highly storable base product, ethanol futures exhibit distinct seasonality from corn futures.
While the strong positive correlation between corn and ethanol futures prices provides valuable insights for hedging, it is essential to recognize the nuances in each market and the factors that contribute to independent price movements. A comprehensive understanding of these dynamics is critical to developing effective risk management strategies in the corn and ethanol futures markets.
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Editor’s note: The summary points for this article were selected by Seeking Alpha editors.
