Price Relationships and Feedstock Supply for a Second-Generation Ethanol Industry in Canada

Abstract

There is potential for a second-generation ethanol industry that uses wheat straw as a feedstock to emerge in Western Canada. This thesis presents three analyses that investigate regional and international factors that influence the future success of this industry. The first two analyses investigate price relationships between markets related to the existing first-generation ethanol industry: Canadian wheat, and US corn, ethanol, and gasoline. The price of Canadian wheat is included to represent a market that may be closely linked to the supply of wheat straw, which could be a second-generation ethanol feedstock. The first analysis investigates time-varying relationships among these markets. Results suggest that the Canadian wheat market is positively correlated with the US corn and ethanol markets, which may be a significant source of the downside and upside risk to ethanol producers in the future. The second analysis investigates volatility transmissions among the same markets. Results indicate that Canadian wheat prices are not affected by price shocks or volatility in other markets. Still, volatility in the Canadian wheat market may influence volatility in the ethanol market. The first two analyses also find that there is a long run equilibrium price relationship between all markets, but that changes to this relationship only affect short term price movements in the wheat and ethanol markets. The results suggest that both the feedstock supply and the marginal revenue of second-generation producers could be susceptible to price changes in related markets. The relationship between agricultural prices and the supply of wheat straw is investigated in the third analysis. A dynamic programming model is used to analyze optimal crop and straw management decisions of a farmer under varying price processes and soil conditions. In general, results suggest that wheat straw supply is responsive to price but also depends on the amount of soil organic matter and whether there is a high risk of canola disease. Because these factors are spatially heterogeneous over the province, the availability of straw will also be heterogenous. Overall, the results of this thesis provide essential information for the investment strategies of prospective ethanol producers and for policymakers who are interested in the emergence of renewable energy industries.