The national average corn yield was the main focus of cash and futures market traders in the October 8, 2010, World Agricultural Supply and Demand Estimates (WASDE) report. Many market analysts consider this report a “game changer.” The resulting price rally in crop markets has people beginning to ask if this could be a repeat of the 2008 price spike.
No one knows for sure what the answer is. There are similarities in current market conditions, compared with those experienced during 2008. However, there also are some very important differences.
Let’s take a look at some of the key factors that may influence how high corn prices may go.
The corn ending stocks estimate of 902 million bushels is arguably the most important number in the October WASDE report. The corn stocks-to-use ratio, which is a percentage measure of reserves, is forecasted to be a near-record low of 6.7%. The drought-reduced 1996 crop resulted in a 5% stocks-to-use ratio, which is the lowest ratio in the past 35 years.
Very small projected reserves increase the uncertainty concerning available supplies and increase prices to ration use. It also causes end users to carefully re-evaluate how much they can afford to pay for corn. The three largest uses of corn are animal feed (approximately 40%) ethanol (approximately 35%) and exports (approximately 15%). How much can each of these sectors afford to pay for corn? What changes can they make to adjust to higher corn prices? The answers to these questions will determine the upper price ranges for corn.
Although corn is the preferred feed for most livestock species, the U.S. livestock sector has proven to be very creative in using alternative feed sources when corn prices increase. However, prices for the alternative feed sources also increase as corn prices rise. These increases usually are based upon the relative feed value of corn.
The first alternative for a livestock producer facing rising corn prices is to switch from feeding corn to using a substitute feed. The next alternative, as feed prices continue to increase, is to cull underperforming feeder and breeding stock, which eventually reduces the number of producing animals within the supply chain and reduces the amount of feed required. The final alternative is to exit the livestock enterprise if feed prices increase dramatically and financial losses persist.
Unfortunately, the dairy, pork and poultry sectors are just beginning to recover from a period of sustained losses. It is likely that any planned expansion of the livestock herd has been delayed by the increase in corn prices. It is unclear how much higher corn prices can rise before the livestock sector begins a second round of industry contraction.
The ethanol industry also is recovering from a period of financial stress and industry restructuring. Corn makes up 65-70% of the total cost of producing ethanol, so corn prices have a significant impact on the profitability of an ethanol processor. The relationship between ethanol prices and corn prices is a key element in determining how much an ethanol processor can pay for corn profitably.
There is a strong relationship between crude oil prices and gasoline prices, and between gasoline prices and ethanol prices. In 2008, rising corn prices were matched by rising energy prices, including ethanol. As long as ethanol prices rose faster than corn prices, ethanol processors could afford to pay for the increased cost of corn. However, the current price relationship between corn and ethanol makes it difficult for ethanol processors to bid for corn aggressively. This suggests that ethanol processors may begin cutting production if energy prices do not keep pace with rising corn prices.
The mandatory use of ethanol for motor fuels, required by the Renewable Fuels Standard, places a floor on the blending and use of ethanol. This requirement should help stabilize ethanol prices and ensure that the corn used by the ethanol industry does not drop below the requirements. However, ethanol and gasoline prices will need to remain strong to entice ethanol processors to produce above the minimum mandatory levels.
Changes in corn export levels, due to rising prices, are the most difficult to predict. The relatively low value of the U.S. dollar is making it easier for international buyers to purchase U.S. corn. As the value of the U.S. dollar drops, it takes less currency to purchase a bushel of U.S. corn. In 2008, most market analysts expected corn exports to drop off as corn prices increased. However, this did not happen because the relatively low value of the U.S. dollar eased the price increases. The U.S. dollar index varied between 70-75 during the first half of 2008. The U.S. dollar index is now trading between 77-80.
The drought in the Black Sea region of Europe also is helping support U.S. corn exports. This region typically produces and exports significant amounts of feed wheat and barley. The drought reduced production caused Russia to issue an export ban. The ban has reduced the available feed grain supplies in the world market, which has increased interest in U.S. corn. However, given the weakened U.S. and world economic condition, how high can food and feed prices rise before consumers reduce their purchases of meat and shift to lower-priced sources of vegetable protein?
While higher corn prices are possible, it is unlikely that prices will reach the levels seen during the 2008 peak. The ability of the key users of corn to pay those prices has changed.
There are several indicators that can be used as signals for changes in the ability to pay higher corn prices. For the livestock sector, it is meat prices. If retail meat prices strengthen, a portion of the increased price can be used to pay for corn. For the ethanol sector, it is gasoline prices. If retail gasoline prices strengthen, ethanol can be used as a replacement for gasoline rather than a mandated additive. For exports, it is the value of the U.S. dollar. If the value of the U.S. dollar remains low, it moderates the impact of higher domestic corn prices.
The corn market will continue to be volatile as these signals change and until the ultimate size of the crop is finally known. Spending a little bit of time each day to monitor the market news can pay big dividends.