The 2009 Corn Market Outlook

The ethanol industry faced steep challenges in 2008 as corn prices touched record highs. 2009 is providing a fresh start and the possibility of a return to normalcy.
By Darin Newsom | February 04, 2009
Many ethanol producers are hoping that this year holds a less volatile corn market than 2008. Last year's road was bumpy as corn prices hit all-time highs causing a flurry of problems for some industry producers and possible ulcers for others. However, if ethanol producers paid close attention to the markets in 2008, they are likely much wiser and poised to make smarter corn buying decisions in 2009.

Using 2008 as a yard stick for market volatility, several factors need to be considered to better understand the corn markets this year. First, the current demand structure for the corn market will determine whether it is still a demand-driven market. In addition, we need to review the basic corn market fundamentals, its viability as an investment opportunity for noncommercial (speculative) interests, and its seasonal trends. Last, we need to examine how ethanol producers should react to the inevitable market swings.

Driving Demand
Since the fall of 2006, corn prices have rallied on the idea that a demand-driven market has been established. A demand-driven market (as opposed to a supply-driven market) is a situation where new demand is pulling on either stable or growing supplies. This results in a higher expected price range over time rather than a short-lived spike in prices. That being the case, the demand-driven market created by the burgeoning ethanol industry has justified the higher prices we have seen over the past three years. However, it wasn't just commercial demand that drove the market into a higher price range. Noncommercial traders were interested in taking part in the rally as well and proved to be the key reason for the unprecedented volatility. Where markets may normally see a scare that causes a price spike once or twice per year (an idea we will come back to later), in this case the frenzy went largely unchecked for months on end.

So the question heading into 2009 is whether corn remains a demand-driven market as in the past few years, or has this been lost and the market is set for a return to "normalcy."

Looking first at the current domestic demand, the answer would seem to be the demand-driven market may be taking its last breaths. According to the January USDA supply and demand report, 2007-‘08 feed demand was pegged at approximately 5.9 billion bushels. In 2008-‘09, this demand is estimated to drop to approximately 5.3 billion bushels due to fewer cattle being placed in feed yards for much of the latter half of 2008 as a result of the higher prices of feed.

One needs to also look at U.S. corn exports. In the 2007-‘08 marketing year, the U.S. exported approximately 2.4 billion bushels of corn. For 2008-'09, USDA is projecting a decrease to 1.75 billion bushels, a number that could continue to fall as the marketing year progresses given the slow pace of demand as 2008 ended. If realized, this would be the lowest export demand number since the 1.59 billion bushels seen during the 2002-‘03 marketing year.

However, it needs to be remembered that corn is a global market and the reduction in U.S. exports does not mean that global demand has declined. On the contrary, the January world supply and demand report pegged global demand at 783.22 million tonnes, an increase of 11.1 million tonnes from the previous marketing year.

This reduction in U.S. exports, despite a growth in world demand, can be attributed to a number of factors. The easiest factor to target would be the global economy. Some say that if prices are higher and the U.S. dollar gains some ground, foreign countries have a harder time purchasing grain from the U.S. Others will say it doesn't matter because regardless of price, people still need to eat. Both theories have their merits and, although the U.S. is still the largest exporter in the world, other countries such as Brazil, Argentina, South Africa and China are also players that might be able to sell corn cheaper than the U.S.

This leaves us with the demand created by the U.S. ethanol industry. The global economic downturn has slowed demand for petroleum products worldwide, leading to a historic selloff in the crude oil and gasoline markets. Domestically, the drop in gasoline demand has also reduced demand for ethanol, therefore lowering the ethanol industry's demand for corn from lofty estimates earlier in the 2008-‘09 marketing year. This is key to the discussion of ethanol demand for corn going forward. While it appears that demand is decreasing, in actuality, demand for corn is still projected to increase from the 2007-‘08 number of 3 billion bushels to 3.6 billion bushels in 2008-‘09. The 3.6 billion bushels is a continued reduction from the 4 billion bushels projected in the fall of 2008. Some analysts are predicting further reductions as the ethanol industry continues to consolidate in 2009, with demand for corn possibly falling as low as 3.2 billion bushels. If the other demand categories remain unchanged from January estimates, total U.S. demand would then fall to only 11.5 billion bushels, a sharp reduction from the 2007-‘08 figure of 12.7 billion bushels.

Believe it or not, we are still in a demand-driven market. With world demand still growing, any hiccups in world supplies could spark increased buying interest in corn. However, continued growth in world ending stocks—pegged at 136 million tonnes in the January world supply and demand report—create a world stocks-to-use number (ending stocks divided by total demand) of approximately 17.4 percent, a figure that is higher than what was seen in the 2006-‘07 and 2007-‘08 marketing years (14.9 percent and 16.4 percent, respectively) but still well below the 25.5 percent average of the past 20 years. This indicates that although some might think prices will remain lower because of a dip in demand, the big picture illustrates that a demand market still exists and will justify the higher prices we could see in 2009. The current market deems the appropriate price range for corn at a low near $3 per bushel and a high near $6.

Seasonality, Market Reactions
Corn prices were near the low end of this price range in late December, the month the market typically sees some push from export demand. Since that is not necessarily the case in 2009, this would indicate that the market was still waiting for commercial demand to emerge to push market prices higher.

Seasonal trends generally help the market rally from January through early planting season and sometimes into early June. Much of this increase is attributed to pre-planting speculation and farmers beginning to shut their bin doors as they begin to focus on spring planting. This makes it harder for merchandisers to secure grain deliveries. Then May through June, factors related to the new crop begin to take hold on the market as speculation on planting progress begins. Based on a seasonal index, corn prices from the first week in January increase 25 percent by mid-June. That means if the season index holds true in 2009, ethanol producers should begin preparing for the possibility of $5 corn during the spring.

After spring planting, the market will react to factors related to the newly planted crop. A weather scare could push corn prices back to the $6 mark. Each year, traders get one weather-related scare that is then built into the market. Last year, the flooding in Iowa was the center of a media fire storm that escalated new-crop prices to near $8 per bushel (the December 2008 futures contract). In reality, only a small amount of acreage was affected and market prices quickly readjusted.

This is typical of a supply-driven market where prices react violently to weather-related news, but one must look at the larger picture. The commercial side of the market must quickly weigh out if the supply scare is real or headline-driven before making buying or selling decisions. Where speculative traders live for this type of market due to the large possible return and quick in and out, commercial traders have to factor in actual needs that could be affected.

2009 will remain a volatile year due to a demand-driven market. However, with the global economic downturn, noncommercial influence in commodities could be less than in years past. The market will most assuredly see sharp rallies as well as strong selloffs. Traders, both commercial and noncommercial, must plan for it. In doing so, the lessons from the past two or three years will certainly come into play as both sides evaluate the corn market. Ethanol producers cannot afford to be too cautious, because cautious can kill in the corn market. Be smarter in buying decisions through the summer for the best production value.

Darin Newsom is a senior analyst for DTN. Reach him at darinnewsom@dtn.com or (800) 328-2278.