Fundamentals Remain Strong

Market gyrations can temporarily obscure the fundamentals. Although corn prices dipped in response to the flagging stock market, demand for corn should continue to pressure supplies. Ethanol producers also need to track crude oil prices as they have an increasingly important impact on prices. EPM talks to Iowa State University economists who have been plotting the numbers.
By Susanne Retka Schill | November 03, 2008
The financial troubles on Wall Street affected the grain markets much like the weather does. Just as the June floods affected the market psychology and sent corn markets sky high last summer, the credit crisis put the commodity markets into a dive. Predicting such gyrations is impossible, but analysis shows the fundamental drivers of the corn market still indicate strong demand keeping pressure on supplies in the next few years. However, the corn market is increasingly influenced by crude oil's relationship with ethanol demand.

Bob Wisner, an Iowa State University agricultural economist specializing in biofuels, expects the use of corn in the ethanol industry to grow and to keep the pressure on corn prices.

He has charted expected growth in the ethanol industry against the USDA supply and demand estimates using the Renewable Fuels Association's numbers indicating 1.984 billion gallons of ethanol capacity are under construction in late 2008. Several of those plants are scheduled to come on line in the last half of the current corn marketing year. Another major component of the expansion in the 2008-'09 corn marketing year will come from new ethanol plants that were operational for only part of the previous year. "I would expect that expansion in ethanol will give important support for corn prices and be an important factor encouraging the corn market to pull some acreage in from other crops."

Wisner has plugged those demand figures into a spreadsheet built on the USDA's supply and demand reports and includes scenarios for low, medium and high yields. (See chart on page 71). The chart shows the numbers for the 2008-'09 crop using the crop estimates from the October USDA World Agricultural Supply and Demand report. The 2007-'08 figures are for the marketing year that closed in September (for the crop harvested in 2007), and show the October USDA projections for total usage.

Wisner says the low, medium and high scenarios show varying yields based on yield trends, plus or minus two or three bushels on either side. The line for historical probability indicates how often the national average corn yields were above or below the trend line since USDA began tracking the national average corn yield. "One good year like 1994 or 2004 would take a lot of pressure off the corn supply," he comments. "And conversely if we had a year with a drought like in the 1980s or the 1993 flood year, it would tighten the supplies dramatically."

Crude Oil Impact
The other big factor for corn ethanol use is the price of crude oil, Wisner adds. "We saw that last winter when the bidding war for acres of corn, soybeans and wheat was fueled by a surge in crude oil prices," he says. Prices of $71 a barrel at the end of June 2007 rose 41 percent to $100 per barrel in February. "That was an important driving force in the commodity market," he recalls. At the same time, the Energy Bill was passed with increased mandates for corn ethanol and cellulosic ethanol, adding even more bullishness to the market.

Crude oil prices have a huge impact. Wisner's chart in August, based on the prices at that time, projected a range of corn prices for the current marketing year of $5.10 to $5.90 per bushel. Adjustments to the USDA projections for corn supply from the October report, and the weakening of the crude oil market in early October, dropped the corn price range to $4.10 to $4.50.

Recalling last year's bidding war for acres among corn, soybeans and wheat, Wisner says, "those prices looked very high at the time, but looking back after what we saw in early June and July they now look low to a lot of people." There is still a need for the market to balance the acreage between soybeans and corn, but how intense the competition between the crops will be depends on several factors. The October supply and demand report showed sharply higher soybean supplies than expected, which would dampen the bidding. However, several other factors will be watched closely, Wisner says. "Crude oil prices will be very important. South American weather and final acreage actually planted there will help to determine how many soybean acres we need in the U.S. to meet growing world demand," he says. "What we've seen so far is that the increased acreage in South American soybeans will be quite modest. We won't be able to sharply reduce our soybean acres here to meet growing world demand."


1. Marketing year starts at Sept. 1 of the production year and ends Aug. 31 of the following year.
2. DDGS substitution for corn feeding is based on 17 pounds of DDGS per bushel of corn. Assumed total DDGS consumption: 42.5% fed to dairy, 32.5% to beef, 5% hogs, 5% poultry and 15% exported in 2007-'08 with gradually increasing future exports and a slightly decreasing percentage fed domestically.
3. Includes corn equivalent of DDGS exports
4. Medium yield approximately equals 1990-2007 trend yield. 1995-2007 yield trend is modestly higher, with two low years and one very high year tilting the trend line upward. Actual yield has been below the 1995-2007 trend all but one year (2004) since 2002. Actual yield has been below the 1990-2007 trend all except two years since 2004.
Key Balance Sheet Assumptions:
1. No changes in Conservation Reserve Program
2. Crude oil price stays in $75 to $95 per barrel range
3. U.S. ethanol mandates, blending credit and import tariff are unchanged and enforced
4. U.S. and world economies have gradual slowing of growth through 2010
5. U.S. dollar stabilizes relative to foreign currencies near Oct. 7, 2008 levels
6. U.S. biodiesel mandate is implemented for 2009 and 2010



SOURCE: ROBERT WISNER

If Ethanol Use Hadn't Expanded
Wisner also has used his Ethanol Usage Projections and Corn Balance Sheet to run a "what if" scenario. Where would corn prices be if the ethanol industry hadn't expanded to use 2.7 billion bushels more corn than it had in 2004? Taking into account the lower ethanol demand in his hypothetical scenario, Wisner adjusted several things in the model such as boosting average corn yield 2 bushels higher because there would be less marginal acres planted and less continuous corn planted. Total acreage was dropped and usage for exports and livestock feeding adjusted higher. Plugging all that into the corn usage chart, he predicts the $2 per bushel corn prices seen in 2004 through 2006 would be even lower, at $1.60 per bushel U.S. average farm price in 2008-'09. "Our conclusion is without the expansion, U.S. agriculture would be struggling with large excess capacity, large carryover stocks, high program costs and low prices and much less volatility in prices, of course," Wisner says.

In October, all eyes were on the financial markets, raising the question of what impact Wall Street's crisis will have on the corn and ethanol industries. "I've been wrestling with that question," Wisner says. "There's a linkage, and with the extreme moves we've seen in the financial markets, I believe that linkage is going to be stronger than it has been in the past. The No. 1 connection is that if you slow the world economy, you slow the growth in the demand for crude oil and that tends to put downward pressure on crude oil prices. That also causes liquidation by index fund investors in crude oil and other commodities. That affects crude oil prices and very directly affects ethanol. The potential impact on agriculture is larger than in the past because in agriculture we're now producing for two markets, one for food and one for energy. The energy market is more sensitive to what happens in financial markets—more sensitive than the food markets." At press time, Wisner says he believes there is some overreaction and panic that is depressing that market but over time that will subside. "There will be some moves by the U.S. government and some foreign governments to bring less volatility in those markets and, as that occurs, the commodity markets will begin to stabilize and focus more on longer term fundamentals—the need for corn land for ethanol, the need for soybean acres for growing food demand especially in China and other Asian markets, and the need for vegetable oil for biofuels," Wisner says. "I'm expecting by January or February these markets will show more stability than they have in the past couple of months."

Iowa State University ag economists have launched a monthly newsletter at www.agmrc.org/agmrc/renewables. They are compiling data from USDA, the Energy Information Agency and other sources, along with analyses done by colleagues in Iowa and neighboring states. An ethanol profitability spreadsheet is included showing the impact of corn and natural gas prices and other variables on a model ethanol plant. The spreadsheet allows ethanol producers to plug in specific values for overhead costs and debt service and see how the numbers play out.

Susanne Retka Schill is an Ethanol Producer Magazine staff writer. Reach her at sretkaschill@bbiinternational.com or (701) 738-4922.