The 2012 Drought Will Hit Your Wallet, But Not for the Reasons You May Think -- Washington May Be More to Blame

As American farmers continue to battle one of the worst droughts in modern U.S. history, food commodity prices are on the rise, which will mean skyrocketing prices at the grocery store, right?

Not necessarily.

Any pain in the wallet for consumers won't come directly from higher costs for raw commodities. It'll be because of federal ethanol mandates -- specifically the 2007 Energy Independence and Security Act, which, as The Washington Examiner’s Conn Carroll notes, requires that every gallon of gas contain 10 percent ethanol by 2022.

Here’s the problem: Corn has increased in value because it has decreased in supply. This means ethanol, which is corn-based, will become more expensive to produce. But fuel providers need to have that ethanol mixed with their product. Therefore, the federal mandate leaves fuel providers with no choice but to increase their prices so that they can afford to stay compliant.

You know what this means, right? It means the cost of bringing goods (i.e. food, clothes, TVs, radio, etc.) to market will increase exponentially and this is where U.S. consumers will get hit. Unless merchants charge a price that offsets what it costs them to bring their goods to consumers, they'll post a loss. Therefore, they'll have to increase the cost of product to make up the difference, which means consumers end up paying higher prices.

That's why there's a war raging in Washington over the ethanol mandate as it relates to the damage done to corn crops by the drought.

On one hand, you have proponents of ethanol mandate arguing that it should remain in place because it’ll make the whole world clean (or something). On the other hand, you have various groups, such as U.S. ranchers, arguing for an easing of the mandate because it will help bring down both the price of corn (ranchers benefit) and fuel (pretty much everyone benefits).

But let’s start with the increase in raw commodities:

Courtesy Zero Hedge

The U.S. Agriculture Department has twice slashed its forecast for this year's corn and soybean output because of the drought and now expects the nation to produce 10.8 billion bushels of corn, the lowest amount since 2006.

"If that estimate holds, the federal government says it will be enough to meet the world's needs and avoid shortages, but experts say food prices will almost certainly climb as corn is an ingredient in many products,” the AP reports.

Add to that the fact that the USDA last week estimated that "50 percent of the corn crop was in poor or very poor condition, compared to 15 percent at the same time last year," according to france24.com, and the fact that 39 percent of this year’s soybean crop is in poor condition or worse and you start to get an idea of how bad the supply lines have been hit.

But wait! That’s not all: “The drought has also hit feeds for livestock like hay, forcing ranchers to trim their herds, which analysts expect could push up the price of meat in the coming year.”

This means we’ll all end up paying much, much more for groceries, right? Well, according to United States Secretary of Agriculture Tom Vilsack, poor harvest output resulting in an increase in commodity prices doesn't necessarily dictate the price you pay for food.

“While commodity prices are rising, they have very little impact on the prices folks pay at the grocery store. Other factors such as energy and transportation costs comprise 86 percent of the food cost at the retail level, while raw commodities make up only about 14 percent [emphasis added],” he writes for CNBC.

“In other words, even if every commodity (whole beef cattle, bushels of corn, tons of butter, etc.) doubled in price tomorrow, food prices would increase by just 14 percent. And that won’t happen,” he writes, adding that the feds expect, if anything, food price inflation to rise by only 1 percent above the historic average (2.5 -- 3 percent) in 2013.

Therefore, if the drought hits U.S. consumers, it won't be because of a rise in commodities. It will be because of the cost of the EPA’s ethanol mandate.

“Corn, an ever-present ingredient in food and a major source of feed for cattle and chicken ... makes up a sizable and growing share of U.S. transportation fuels,” MarketWatch reports.

“Under the 2005 U.S. Renewable Fuel Standard, a certain volume of the nation’s transportation fuel must be blended with such nonfossil fuels as ethanol, which is distilled primarily from corn. This year’s ethanol requirement is 13.2 billion gallons, up from 12.6 billion gallons in 2011. That figure is set to grow to 13.8 billion gallons in 2013,” the report adds.

So, let’s do a quick recap: The price of corn has gone up as its supply has gone down. Because of the rise in the price of corn, the cost of producing ethanol has risen. Fuel providers need ethanol in order to remain in good standing with the EPA, meaning the cost of fuel will rise with the cost of ethanol. If fuel goes up, then so too does the cost of bringing goods to market, which, unless the feds ease mandate requirements, will be the real reason consumers end up paying more.

As of this writing, the EPA is contemplating whether it should ease up the mandates.

“Congress has ... given EPA the authority to ... grant a full or partial waiver if implementation would severely harm the economy or environment of a state, region, or the entire country, or if EPA determines that there is inadequate domestic supply of renewable fuel," the EPA said in a statement. "EPA and its federal partners continue to closely monitor the drought’s impacts on crop supplies."

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The Associated Press contributed to this report. Front page photo courtesy the AP.