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Is Speculative Trading Driving Corn Prices Up?

Posted: April 28, 2008 at 11:11 AM CST

Late last week, Texas Gov. Rick Perry asked the U.S. EPA for a partial national waiver from the U.S. renewable fuel standard, claiming that cutting back on corn ethanol is the “best, quickest way” to curb rising food costs.

While the ink on Perry’s request was drying, researchers at the University of Wisconsin at Madison released a study indicating that something other than ethanol — something artificial … something beyond the traditional supply/demand framework — is driving up corn prices.

The most probable culprit: speculative trading.

Both new and old crop futures have topped $6 a bushel now, and analysts say corn prices, globally, have risen nearly 140 percent over the past three years.

That’s serious stuff, but UW agribusiness professor T. Randall Fortenbery and graduate student Hwanil Park, who co-authored the report (“The Effect of Ethanol Production on the U.S. National Corn Price”) say it is “naïve and inaccurate” to place current price levels squarely on ethanol’s shoulders.

Fortenbery and Park said ethanol production has had “a significant and positive impact on corn price,” but it does not fully explain recent price level changes. In fact, they said that a 1 percent increase in ethanol production causes just a 0.16 percent increase in the price of corn in the short run. More importantly, the study found that ethanol production only accounts for a 41-cent-per-bushel increase in corn prices. If considered alone, ethanol’s effect on corn prices would still allow corn futures to fall below $3 per bushel, they said. The effect of exports, at the most, would add another dime to the cost of corn (which is debatable). That means speculative trading is most likely to blame for the historic jump in corn prices we're experiencing.

What’s going on? Well, more and more speculators may be taking long positions, at least for short periods of time, breaking away from the historical fundamental balance between price and market conditions.

The researchers don’t claim to have enough empirical evidence to pin $3 worth of blame on speculative traders — the study implies a correlation, not a cause — but they’re going to keep digging. “There does appear to be reason to study more carefully the impact of speculative activity on both price levels and volatility,” they said.

Now, Fortenbery and Park are going back to the drawing board to carefully research the impact of large increases in the amount of risk capital coming from the speculative side of the market.

The complete study is available online at:
www.aae.wisc.edu/pubs/sps/pdf/stpap523.pdf

-Tom Bryan