Modeling the price relationships between crude oil, energy crops and biofuels

This paper explores the relationships between the prices of crude oil, corn and ethanol over the period from January 1986 to August 2015 using a Vector Autoregressive Model and Vector Error Correction Model. The structural breaks are endogenously determined using these variables and then the overall period is divided into three sub-periods. A long-run causal relationship among these three prices is found and depends on the level of the crude oil prices. The empirical results show that the corn price is driven by ethanol prices, but that the price of corn did not influence ethanol prices until 2005. However, there is a unidirectional causality that runs from crude oil prices to ethanol prices throughout the period. The empirical results indicate that a 1% increase in ethanol consumption could have reduced the crude oil price by 6.08% in the case of the U.S. during the period from 1987 to 2011, which implies that the development of ethanol production is one way of controlling inflation in relation to crude oil prices.

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