Inside the Black Box: the Price Linkage and Transmission between Energy and Agricultural Markets

Abstract

Despite a growing literature on the integration of energy and agriculture, few have rigorously examined structural changes in the evolution of related energy and agricultural prices. Motivated by strong comovement and increasing volatility of energy and agricultural prices, we examine dynamic evolutions of ethanol, gasoline, and corn prices over the period of March 2005-March 2011. A structural change is found around March 2008 in the pairwise dynamic correlations between the prices in a multivariate GARCH model. A structural VAR (SVAR) model is then estimated on two subsamples, one before and one after the identified change point. Using the novel method of "identification through heteroscedasticity", we exploit the time-varying price volatilities to fully identify the SVAR model. In the more recent period, ethanol, gasoline, and corn prices are found to be more closely linked. Specifically, ethanol (corn) shocks have the largest impact on corn (ethanol) price. The strengthened corn-ethanol relation can be largely explained by the new developments of the biofuel industry and related policy instruments. Variance decomposition shows that for each market a significant and relatively large share of the price variation could be explained by the price changes in the other two markets. For example, corn price changes explain 27% of the variation of ethanol prices, and shocks to ethanol price account for 23% of the variance of corn prices. The results are robust to the inclusion of seasonal dummies, and various representative macroeconomic and financial indicators.

Volatility linkages between energy and agricultural commodity prices

“…However, they do not consider comovements in the level of prices. Du and McPhail (2012) investigate dynamic evolutions of ethanol, gasoline and corn prices in the United States with a DCC-GARCH model with structural breaks. The results reveal time varying conditional correlations and variances of the prices can largely be explained by price changes in the other markets.…”

Does Federal Crop Insurance Make Environmental Externalities from Agriculture Worse?

“…Standard increased the volatility of corn prices by strengthening the linkage between energy and corn markets (McPhail, Du, and Muhammad, 2012;Du and McPhail, 2012;McPhail and Babcock, 2012). For simplicity, assume that only yields are stochastic, in which case the variance of profits is ( • + • ) = 2 • ( ), indicating that variability increases exponentially with the crop price.…”

Interdependencies between Biofuel, Fuel and Food Prices: The Case of the Brazilian Ethanol Market

“…However, the US biofuel industry has attracted more attention than the EU biofuels sector and the Brazilian biofuel markets [50][51][52][53][54][55][56][57][58][59][60][61][62]. In particular, the link between the sugar and energy markets and between ethanol and crude oil/gasoline markets was examined by four authors.…”