Weather Plays Larger Role in Global Fuel Prices

The record storms and floods that swept through the U.S. Midwest last month struck at the heart of the corn-growing region, drowning fields and dashing hopes of a bumper crop.

They also brought into sharp relief a new economic hazard. As the world grows more reliant on crops like corn and palm oil for its fuel supply, it is becoming vulnerable to the many hazards that can damage agriculture, ranging from droughts to plagues to storms.

The U.S. floods have helped send the price of ethanol there up 21 percent since the beginning of June. They appear to have had little effect on the price of gasoline at the pump, as ethanol represents only about 6 percent of U.S. transport fuel today.

But that share is expected to rise to at least 20 percent in coming decades, similar to a broad global trend toward increased use of biofuels. Experts fear that a future crop failure could take so much fuel out of the market it would send prices way up. Eventually, the cost of filling a fuel tank could depend as much on hail in Nigeria or a plant fungus in Malaysia as on oil-pipeline bombings in Nigeria.

"We are holding ourselves hostage to the weather," said John Reilly, a senior lecturer at the Massachusetts Institute of Technology and an ethanol expert. "Agricultural markets are subject to wide variability and big price spikes, just like oil markets."

Three years ago, the world discovered that the vicissitudes of the weather could have a powerful effect on energy prices when two hurricanes struck the Gulf Coast of the United States. Hurricanes Katrina and Rita led to the worst fuel disruption the country had ever seen, interrupting a quarter of the nation's oil production and shutting down dozens of refineries for weeks. Lines formed for the first time since the 1970s as gasoline spiked above $3 a gallon, a record at the time.

The increasing dependence on crops for motor fuel adds another level of weather vulnerability.

Estimates released Monday suggest that damage from the floods may not have been as bad as initially feared. But corn and ethanol prices are still up substantially from their recent lows on fears that supplies would be tight over the next year. Ethanol, which was already rising before the floods, has nearly doubled in the United States from its low of $1.50 a gallon in September.

Unexpected interruptions in oil supplies have been a critical factor driving oil prices above $140 a barrel lately. On Monday, crude hit a new record of $143.67.

Given the tight oil market, there is little untapped capacity that can be brought online rapidly to make up for sudden interruptions in supplies, either of oil itself or of the biofuels that increasingly help augment the oil supply.

In the 1980s, that extra cushion peaked at around 20 percent of global oil consumption. Today, it represents only about 2 percent of world demand - less than Iran's petroleum exports. Analysts have warned that such record-low levels of spare capacity pose unprecedented risks to the stability of oil markets, and introduce a significant premium in the price of oil.

"There is now a vulnerability to perfect storms, not just in a metaphorical sense, but increasingly in a literal sense," said Daniel Yergin, the chairman of Cambridge Energy Research Associates, a consulting firm. "In addition to geopolitical risks, you must now add weather risks."

While storms, torrential rains and hurricanes have always been a part of energy production, the United States is growing increasingly vulnerable to the weather factor. The areas where most of the country's new oil and ethanol supplies are coming from - the farm belt and the Gulf of Mexico - are prone to hazardous weather.

"Our energy policy is like playing Russian roulette with every chamber loaded," said Lawrence Goldstein, an energy analyst at the Energy Policy Research Foundation, a group backed by the oil industry. "We've doubled up on the weather risk."

Both the U.S. government and the ethanol industry recognize the risks of tying fuels to crops. The secretaries of energy and agriculture, in a joint letter to the Senate, recently said: "If we assumed a supply disruption of ethanol, we would expect a fairly large increase in the price of gasoline until ethanol supply were re-established or new market equilibriums were achieved."

Backers of biofuels contend that an increasing ethanol supply is keeping gasoline prices from rising even higher than they have, by anywhere from 35 cents to 50 cents a gallon, or 5 cents to 8 cents a liter. They also point out that the government's ethanol mandate, which requires oil companies to blend ethanol into motor fuel, can be suspended in an emergency. And they believe that future ethanol supplies will be derived from materials like switchgrass or wood chips that are resistant to bad weather.

Bob Dinneen, president of the Renewable Fuels Association, the industry's main U.S. trade group, said only two ethanol refineries shut down because of the storms out of 160 nationwide. Both will reopen soon, he said.

"There is a lot of overblown concern that is not really justified by the facts on the ground," Dinneen said. "Certainly the weather is going to have an impact on all sorts of industries. It had an impact when Katrina wreaked havoc on the refining industry. It has an impact on ethanol production, but it has been minimal."

Andy Karsner, the assistant secretary for energy efficiency and renewable energy at the U.S. Energy Department, said that corn ethanol was a necessary precursor to more advanced biofuels. Suspending the ethanol mandate now, as some have suggested, would have a "chilling effect" on new investments, he said.

In recent years, corn ethanol has been one of the few sources of supply growth in transport fuels. Indeed, biofuels have become the single biggest source of new fuels produced outside countries belonging to the Organization of Petroleum Exporting Countries in recent years.

Production worldwide is expected to grow by 330,000 barrels a day this year to 1.4 million barrels a day, according to the International Energy Agency.

In the United States, bipartisan public policies have driven the rise of the ethanol industry.

Congress has set rising requirements for oil companies to blend ethanol with gasoline, backed with generous subsidies that should total $12 billion this year, according to estimates by Barclays Capital.

The European Union is also planning to dramatically raise the amount of biofuels blended into diesel and gasoline as part of the bloc's efforts to fight climate change and bolster energy security.

Farmers have gone into overdrive to meet the ethanol demand, turning more than a quarter of the U.S. corn crop to making ethanol. As a result, last year's corn crop reached a record of 13 billion bushels.

Farmers who support the government's ethanol policy argue that truly disastrous weather in the corn belt does not happen often.

"The last time we had real weather problems in the corn belt was 1988," said Tom Buis, the president of the National Farmers Union. "That's pretty rare."

Emerson Nafziger, a professor of agronomy at the University of Illinois, said farmers still had time to recover this year, to some degree. But he said this year's storms were the first real test for the nascent ethanol industry.

"We may end up feeling we dodged a bullet this year," he said. "We've had a run of fairly favorable weather in recent years. But there is no guarantee it will stay that way."