Volume 3: Innovative Solutions for Energy Transitions: Part II

How Does Uncertainty Impact Biofuel Prices? Christoffer Wadström, Gazi Salah Uddin, Jose Areola Hernandez, Anupam Dutta, Ali Ahmed

Abstract

In this study we investigate the impact of Geopolitical Risk (GPR), US Economic Policy Uncertainty (EPU), St. Louis Fed Financial Stress Index (STLFSI), and market volatility (VIX) on the prices of US and Brazilian ethanol and Malaysian palm oil. By applying quantile autoregressive and quantile causality methods we can illustrate the dynamic relation between uncertainty and biofuel prices. Our results show that all measures of uncertainty influence ethanol and palm oil prices in both the lower and upper tails of the distribution. Furthermore, uncertainty seems to impact both U.S. and Brazilian ethanol prices price in a similar fashion, even if there are clear differences in the impact pattern. In the case of U.S. ethanol price, the results imply a slightly symmetrical impact pattern, with weak indications that uncertainty is triggering changes in price returns in the lower, towards the extreme, tails of the distribution. There are also clear indications that uncertainty impacts ethanol returns in the upper tails of the distribution, with a slight shift towards the middle quantiles. The results suggest that U.S. ethanol prices are more affected by uncertainty when the market conditions are positive rather than negative. In the case of Brazilian ethanol prices, the analysis also displays a symmetrical uncertainty impact pattern in both the lower and the upper tails of the distribution. However, unlike the other biofuel prices, there are indications that uncertainty also affects prices in the middle quantiles. Uncertainty has a stronger impact on Malaysian palm oil prices both near the middle quantiles as well as in the upper and extreme tails of the distribution. These results may indicate a sensitivity to uncertainty near normal market conditions and to large and extreme positive returns. Our results provide valuable insights into the price dynamics of biofuels. This knowledge is important for the transition to a sustainable energy system, especially in sectors not easily electrified such as aviation, shipping and certain types of industrial processes. Furthermore, our results also have implications for the financial sector and for risk management strategies.

Keywords Biofuels; Uncertainty, Quantile Causality, Geopolitical Risk, Economic Policy Uncertainty.