Corn-based ethanol subsidies push prices skywardCorn-based ethanol subsidies push prices skyward

by paul Frumkin


In September, a letter endorsed by officials from 16 prominent restaurant chains and the National Council of Chain Restaurants was delivered to lawmakers on Capitol Hill, urging them to repeal a federal tax credit for corn-based ethanol producers and a tariff on imported ethanol.


The signatories charged that the government’s aggressive policy of fostering the use of corn — the chief ingredient in U.S. livestock feed — as a fuel source is artificially inflating corn prices and thereby driving other food-chain commodity costs skyward. As a result, restaurateurs find themselves facing historically high food costs at a time when a weakened U.S. economy is prompting many Americans to curtail their spending.


“The high level of industry participation on this letter is significant and demonstrates the breadth and depth of concern about this issue within the industry,” said Rob Green, executive director of the NCCR.


The letter contained the names of major American chains representing thousands of restaurant locations, such as Brinker International, Burger King, Darden Restaurants, Domino’s Pizza, McDonald’s, Wendy’s, White Castle and others.


Few within the foodservice industry are finding themselves immune to the effects of soaring food costs, the result of a perfect storm of multiple market conditions that are driving prices upward. But while other macroeconomic trends such as heightened demand in China and India, soaring global energy prices, calamitous weather conditions, speculation in the financial markets and seasonal price fluctuations are contributing to higher commodity costs, the federal government’s longtime policy of subsidizing food for fuel seems wrongheaded to many in the restaurant community — and, potentially, correctable.


“Everyone in the industry has seen increases for a variety of reasons,” said David Head, chief executive of O’Charley’s Inc. in Nashville, Tenn. “But the [federal] ethanol subsidies have definitely cut into the amount of corn that is produced for feed, which seems to have increased the cost of animal protein.”


Since corn is the foundation of so much food around the world, Head continued, “it seems somewhat counterintuitive that we’re focused on subsidizing ethanol production rather than on feeding America.”


James Greco, chief executive of Burlington, Vt.-based Bruegger’s Bagels and co-chief executive of Le Duff America, is of the same mind.


“The government subsidies for [corn-based ethanol] are raising the cost of food,” he said. “As a national policy, that’s just wrong. As a society, we can find ways to deal with higher fuel prices; there are not the same ways to deal with higher food prices. We should not, as a nation, have in place policies that subsidize fuel at the expense of food.”


Corn-based ethanol is a renewable energy resource favored by environmentalists and many within the government for use as an oxygenator in gasoline that helps reduce exhaust emissions and is seen as being better for the environment than other additives. The Food and Energy Security Act of 2007 mandates a steep increase in the production of ethanol by 2022, which has persuaded farmers to either divert their corn harvest for ethanol production or even convert former wheat and soybean fields to grow more lucrative corn crops.


Today, approximately 40 percent of the U.S. corn crop is being converted into corn-based ethanol, which yielded about 13.2 billion gallons in 2011. That figure is expected to rise to 15 billion gallons by 2015, with another 21 billion gallons coming from advanced biofuels like cellulosic and non-corn-based ethanol by 2022, according to the American Coalition for Ethanol.


A report published by the Congressional Budget Office in 2009 found that about 5 percent of food price increases could be attributed to expanded production of ethanol products. 


“And since there is more ethanol being used in 2011 than in 2009, you can extrapolate that that number is higher now,” said Scott DeFife, executive vice president of policy and government affairs for the National Restaurant Association, which also is actively urging lawmakers to reconsider the government’s ethanol policies.


Both the NCCR and the NRA have long voiced their opposition to the 45-cents-per-gallon Volumetric Ethanol Excise Tax Credit and the 54-cents-per-gallon tariff on imported ethanol — which notably targets Brazil and its sugar-based ethanol industry — and have encouraged lawmakers to end the subsidies, arguing that they also are costing taxpayers billions of dollars a year.


And while the subsidies are slated to end Dec. 31, opponents worry that Congress might be persuaded by supporters to extend them. Last June, both organizations praised the Senate when it voted by a margin of 73 to 27 to end the ethanol blender tax credit and tariff immediately.


“It really signaled to the ethanol community that things were going to be different,” DeFife said, adding that if the House had passed a similar measure, it could have saved the deficit-focused government between $5 billion and $6 billion. “But they didn’t.”


In the meantime, the associations and members of the foodservice industry are keeping up the pressure by, among other things, conducting grassroots lobbying on Capitol Hill. The NCCR letter was mailed to lawmakers in both chambers, and the association is encouraging its members to engage with their elected officials over the issue, Green said.


Ethanol, in fact, emerged as one of the central focuses of the NCCR’s recent Chain Restaurant CEO Policy Summit in Washington, D.C.


“Everyone recognizes that there are geopolitical issues that are beyond our control,” Green said. “But the ethanol issue is one area where we can effect change.”


The NRA also has thrown its support behind a bill sponsored by Reps. Bob Goodlatte, R-Va., and Jim Costa, D-Calif., which would allow for reduction in the use of corn-based ethanol when supplies are tight, enabling more corn to be diverted for feed. 


“It would provide flexibility based on real-world conditions,” DeFife said. “We’re not opposed to ethanol, but when [the government] ramps up at such a high rate and adds financial incentives, they’re making a policy decision to divert food for fuel.”


Meanwhile, wholesale food costs in general continue to rise. The U.S. Bureau of Labor Statistics Food Price Update showed that average wholesale food prices increased 0.6 percent in September, marking their fourth consecutive monthly increase and 13th gain over the past 15 months. Consequently, wholesale food prices are expected to post their strongest annual increase in more than three decades. On a year-to-date basis through September, average wholesale food prices rose 7.8 percent.


But even though the diversion of corn for ethanol use is contributing to higher food costs throughout the country, the restaurant industry is not passing the increases along to the consumer at as steep a rate as grocery stores, the NRA said.


For the year ended in September, grocery stores raised their prices an aggregate 6.3 percent, marking the strongest 12-month gain in nearly three years. By comparison, restaurants increased menu prices only 2.6 percent over the same 12-month period, more than a full percentage point below the overall inflation rate of 3.9 percent, the NRA said.


As a result of escalating food costs and gloomy forecasts about future pricing, restaurants are being forced to readdress their own purchasing policies. Lou Miaritis, senior vice president of franchise and purchasing for Uno Restaurant Holdings Inc. in West Roxbury, Mass., said the government’s ethanol strategy has created a climate of doubt within the supplier community.


“Under normal circumstances, suppliers are willing to secure business over longer periods of time,” Miaritis said. “But with the uncertainty about such basics as corn, soybeans and wheat, they are less willing to go to any particular length of time on booking supply. It also causes us as buyers to be [reluctant] to [sign long-term contracts]. No one knows if there is any reliability in the market.”


Citing examples of corn’s recent “remarkable ups and downs,” Miaritis noted that it was trading at $3.66 a bushel in July 2010. By April 20, 2011, the price had doubled to $7.33 a bushel. As of Oct. 18, it had declined to $6.41. 


“It’s proven problematic to book steaks and hamburger [and other protein],” he said. “As a result, we’re buying shorter. We’re looking at windows of three to six months. Normally, we look at six months to a year, depending on where the market might be. It’s made the job more complicated.”


Even in the face of the current volatility, though, Uno has been able to maintain a steady food cost by working closely with suppliers, he said. 


“We’re working with vendors and distributors in managing freight differently,” he said. “We’re also evaluating packaging — buying 15 items in a case instead of a dozen items.”


The company also is actively managing the menu, he said. 


“We might remove certain items and put others on.”


With some items, though, the chain is forced to bite the bullet. For example, Uno introduced a hand-formed 8-ounce burger recently, and then watched as the price of ground beef rose 15 percent. 


“We didn’t want to downgrade the portion or the quality, … or raise prices,” he said. “So we had to find other ways on the menu to mitigate the cost.”


Jamie Richardson, vice president of government and shareholder relations at White Castle System Inc. in Columbus, Ohio, also noted that beef prices have impacted the quick-service chain’s business. White Castle owns and operates three meat plants, where the beef is ground and formed into patties for its more-than-400 locations. 


“The price of beef for us increased in the double digits over last year,” he said. “We had initially forecast increases, but we weren’t even close.”


Richardson said that because less wheat is being planted by farmers who want to take advantage of the higher corn prices, wheat prices also have increased. 


“So the price of buns has risen, too,” he said. “And with the customer trying to keep his head above the water, it’s really difficult to take price increases,” he added.


O’Charley’s Head said the casual-dining company is addressing higher costs by developing new products that have “high guest demand” but are sensitive to pricing concerns. The chain, which sells a high percentage of beef items, has created several new steak dishes “that don’t have any menu history, but have good value and good margins.”


For example, O’Charley’s rolled out a new steak dish called Blue Ridge Sirloin that is served with a barbecue demi-glace, blue cheese and Onion Tanglers. 


“It’s a new cut, has a new plate presentation. … It’s great sirloin at a value price,” he said.


Gary Schwartz, vice president of supply chain at P.F. Chang’s China Bistro Inc. in Scottsdale, Ariz., said the higher prices also have prompted the casual-dining chain to work more closely with its vendors. 


“We’re not doing anything in terms of changing specifications or portions or quality,” he said. “But we’re widening our net of vendors and working to find other ways to drive cost out of the system.”


Like Uno and many other operators, P.F. Chang’s is opting to lock in supplies chiefly with short-term contracts. 


“A couple of years ago, we pursued the opposite strategy,” Schwartz said. “Now, we’re thinking short-term unless there’s a compelling reason to do otherwise.”


Meanwhile, he said, “our job is to bring in the highest possible product at the lowest possible cost. Menu decisions will be made later. The last thing we want to do is to take price.”


Greco of Bruegger’s and Le Duff America also noted that the push to produce corn-based ethanol has inflated the price of wheat, which is a key commodity for the bagel-cafe operator.


“Fortunately for Bruegger’s, we have had a hedging strategy in place,” he said. “We were already locked in for most of the calendar year when the price of wheat started to climb earlier this year, so we didn’t see much of an increase.”


He said, however, that the company will see “a little increase” in the fourth quarter “because we were not hedged in for the period.”


Greco said the company also has hedged on two other major items — cream cheese and coffee, which recently came down from previous highs.


Greco said he is uncertain about what to expect over the next year as far as inflation is concerned.

“To some extent, it depends on what’s happening with the world economy,” he noted.

In the meantime, though, he remains resolute on the corn-based ethanol issue.

“We need to stop subsidizing fuel at the expense of food. We should stop subsidizing ethanol manufacturing and encourage the development of other technologies, like switchgrass and nonfood sources of ethanol.”


Richardson agreed. 


“There are so many things we can’t control, like the weather,” he said. “But when we can have influence, policy-wise it doesn’t make sense to have fuel compete [with] food.”


Contact Paul Frumkin at [email protected].