Consumers in the U.S. are seeing the effect of the drought ravaging corn production at the gas pump, and it won't help the economy.
Prices for ethanol, the vegetable-based fuel that accounts for 10% of the gasoline mix that the majority of U.S. cars run on, have jumped by nearly one third to $2.60 per gallon since May because of worries about hot, dry weather that has baked most of the country since June. Nearly all of the ethanol consumed in the U.S. comes from corn, production of which will fall to the lowest level in nearly two decades due to the drought, the U.S. Department of Agriculture said Friday.
The increase in ethanol prices helped spark a 16-cent jump in the national average gasoline price in July--the biggest increase for that month on record--to $3.45 per gallon. Four cents of that spike are attributable to ethanol, said Michael Green, spokesman for the American Automobile Association, a consumer travel group.
To be sure, crude oil prices, which rose in July and account for 62% of the cost of gasoline, have a bigger impact on overall prices. So do refinery outages: a fire at Chevron Corp.'s (CVX) refinery in Richmond, Calif., Monday raised the spot price of gasoline in the San Francisco Bay area by as much as 35 cents during the week.
But the severity of the drought and the resulting rise in corn prices could start to hit harder at the pump. If corn prices remain at current levels, ethanol prices could rise another 20 cents to $2.80 a gallon, said Michael McDougall, senior director at brokerage firm Newedge.
The rising influence of ethanol on gasoline prices underscores the impact of federal biofuel mandates to lower consumption of fossil fuels. Federal regulations require that 10% of every gallon of gasoline sold consists of ethanol. Currently biofuel makers are trying to get the government to increase the ethanol mandate to 15%, but the measure is opposed by automakers and fuel refiners that say it could damage engines. It's also opposed by some who say the environmental benefits of corn-based ethanol are dubious.
Corn futures have shot up 60% since closing at $5.10 a bushel on June 15, around the time when the effect of the drought became evident. Ethanol prices haven't risen as quickly because of a production glut that brought stocks of the fuel to a record high of 23 million barrels in March, according to the U.S. Energy Information Administration. But that glut is subsiding as the high cost of feedstock has made production unprofitable. Experts say ethanol prices will rise rapidly as the glut works itself out.
"If corn prices stay high, eventually ethanol prices will catch up," said Bill Day, spokesman for Valero Energy Corp. (VLO), the largest U.S. refiner by processing capacity and one of the biggest ethanol producers in the country.
The U.S. average retail price for gasoline was $3.67 on Friday, according to AAA's Daily Fuel Gauge report, up 4 cents from a year earlier.
The rise in ethanol prices is an unwelcome event at a time when the economy tries to work its way out of a slowdown.
The normal household spends about 4% of its income on gasoline and fuel, according to federal Bureau of Economic Analysis. Every few extra cents spent on gasoline is money not spent in the wider economy, said Richard Hasting, macroeconomic analyst at Global Hunter Securities.
"I would definitely be concerned about the prolonged, elevated nature of gasoline and energy spending," Hastings said. "It's impacting the spending on the service economy."
Write to Ben Lefebvre at ben.lefebvre@dowjones.com
Copyright (c) 2012 Dow Jones & Company, Inc.
