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Abstract
In response to the development of the U.S. ethanol industry, the Chicago Board of Trade (CBOT)
launched the ethanol futures contract in March 2005. This contract is promoted by the CBOT as
allowing ethanol producers to hedge corn crushing using strategies similar to those used in
soybean crushing. The similarities end, however, when the lack of short-term correlation
between corn and ethanol prices is compared to the strong correlation between soybean and soy
product prices. This contrast motivates the examination of the price risk management
capabilities of the CBOT’s ethanol futures contract.
Standard hedging methodology is applied to weekly cash and futures price data from March 23,
2005 through March 7, 2007. Findings include (1) for two- to eight-week hedging horizons, the
ethanol futures contract effectively hedges ethanol inventory price risk. The effectiveness of the
hedge increases with the hedging horizon. Thus, ethanol producers and brokers can use the
ethanol futures market to reduce the price risk of holding ethanol inventories. (2) Contrary to
anecdotal evidence, ethanol futures are not significantly inferior to gasoline futures for hedging
ethanol price risk and for a four-week hedge they are significantly superior to gasoline futures.
Thus, ethanol producers and brokers get greater price risk protection from hedging with ethanol
futures than with gasoline futures. (3) The corn crushing hedge, utilizing corn and ethanol
futures contracts, is an effective means to “lock in” a processing margin. The effectiveness of
this hedge increases as the hedging horizon increases. Finally, to understand the processing
hedge, the corn crush hedge and the soybean crush hedge were compared. I found that (4) the
price risk of corn crushing is greater than that of soybean crushing and the effectiveness of corn
crush hedging exceeds that of soybean crush hedging. This difference is explained by the high
correlations in the soybean complex.