April 15, 2011

Corn Panic

Dennis Keeney

Dennis Keeney

Visiting Scholar

Center for a Livable Future

By Dr. Dennis Keeney, Visiting Scholar, Johns Hopkins Center for a Livable Future

corn-for-ethanolThe USDA 2011 Prospective Plantings Report was one of the most anticipated planting reports in several years. It came on the heels of a shocking Grain Stocks Report issued last month, which showed that corn stocks have come down 15% since March 2010. Ending stocks are projected to be only 675 million bushels, about 5% of the projected marketing year consumption, while consumption of the current marketing year corn was higher than in 2009 and well above projected consumption. Lowered stocks were also caused by a smaller than expected corn crop due to cold and rainy weather in the Corn Belt in 2010. Corn prices almost immediately increased by another $1 per bushel on the heels of a doubling of price during the past year. This dramatic price jump portends another round of world-wide food price increases, similar to those in 2008-2009. Already, some political uprisings in the Middle East have been blamed to some extent on rapid food price increases. In 2008-2009, yields bounced back to normal and the ethanol demand was much lower.

Why has this happened? Will it be alleviated by a bumper crop on more acres in 2011? Or has the grain commodity price structure started a trend towards a “new normal” of steadily increasing prices and more shortages?

The March 31 crop report indicated that farmers “intend” to plant 5% more acreage in corn, 8% more in wheat and 15% more in cotton while cutting soybean planting by only 1%. This adds up to 4 million more acres of cropland than there were in 2010.  One wonders where that extra land is coming from. Most likely, it is land being retired from the Conservation Reserve Program (CRP), and includes more fragile meadow and grassland. That is not good news for the environment. Just recently, a number of congressional members called for the immediate release of some of the 31.2 million acres of CRP for cropland.

I would like to explore what corn is used for and why the sudden drop in ending stocks surprised so many people, before presenting some scenarios that may play out in the near future.

Corn Consumption

First, why is corn, little of which is consumed directly in food products, such a big deal? Corn is the basis of all commodity grain. It is indirectly a major source of protein for much of the developed and the increasingly prosperous developing world because of its dominance as the animal feed of choice. Darrel Good and Scott Erwin, agriculture economists at the University of Illinois, estimate that in the U.S. about 5,200 million bushels of corn will be consumed as animal feed in 2010-2011, which is 39% of the total consumption of 13,500 million bushels. At 37%, ethanol is expected to be the second highest use for corn, followed by exports at 14% and other processing at 10%.

Good and Irwin have given some good insight into alternate production, consumption and price scenarios for 2011-2012. Key, of course, is corn production. This will in large part set the price, which in turn will affect where the corn is consumed. Some uses of corn are more inelastic than others. The demand for feed, for example, is most affected by price because livestock numbers can be adjusted if costs are higher than profits. However, based on the current high price of most animal products, it is likely that there will be strong feed demand in the coming year. And if corn prices get too high, other grains (like wheat) will be substituted.

Similarly, corn use for ethanol will likely remain high and probably be even higher in the coming year. The mandated ethanol blending is set to increase, and the high and rising price of gasoline will encourage more ethanol in gasoline blends because it will be profitable, even without the current 45 cents per gallon subsidy. Good and Irwin estimate that at the crude oil price of $110 a barrel (about the current price of oil), corn would have to be $9.78 a bushel to be unprofitable. Corn is currently selling on the futures market for about $7.70 a bushel. However, the “blend wall” (the point at which all gasoline is blended at 10% ethanol) is rapidly approaching and could be reached in 2012. This will require consume about 5 billion bushels of corn, over 40% of the projected production.

The demand for corn for food is mainly influenced by population growth. Thus, domestic consumption is the least sensitive to corn prices. Products are simply priced higher to reflect, at least in part, the increased cost of corn.

Finally, export demand for corn will be highly dependent on world prices. The United States has always been the residual supplier of corn on the world markets. Export demand will depend on many factors, especially the weather in Argentina (the other corn-exporting nation) and elsewhere, including China, where pent-up demand is causing greatly increased animal feeding. In fact, China has nearly doubled its imports this past year. This article by Bloomberg indicates that China’s demand may push corn over $10 a bushel. China and most other importing countries purchase corn on the world market, pushing up prices everywhere and affecting the price of other grains and foods.

Corn Production

The reason the Prospective Plantings Report is so important is that speculators and others must have some idea how much corn will be available in 2011-2012. The big unknown, as it is every year, is weather. And most agree that the uncertainties of global climate change are making it ever more difficult to predict production with much certainty.

Good and Irwin give boundaries on what might happen if the U.S. has trend line yields, good weather or poor weather. The trend line is the long-term average yearly increase in corn yields. This has been remarkably linear for 50 years, with fluctuations due to weather. Good and Irwin found that the average yearly increase in corn yield from 1960 to present (excluding the exceptionally low yields of 1988 and 1993) was 1.89 bushels per year. This equates to a 2011 yield of 158 bushels per acre. Remember, this is the national yield; some states, such as Iowa, will be higher, and others lower). They also analyzed a good and poor weather scenario by using high and low yields for 10 years above or below the yield trend line, normalized for yield increases. For the good weather scenario, they estimate a yield of 168 bushels per acre, while the poor weather yield would be 149 bushels per acre.

Good and Irwin projected consumption and ending corn price for each scenario. The trend line yield would result in little change in use from 2010-2011 and an average farm corn price of $5.75 per bushel. Under good weather (maximum likely yield), the corn price would drop to $4.75 per bushel and ending stocks would be nearly 9% of use, as compared to 5% for this year.

The real concern is the poor weather scenario, in which all uses would be less and the farm price would be at least $7 per bushel. They discuss policy changes that would alleviate the economic impact of low yield. These include restrictions on exports (a policy that always fails), opening up CRP lands to haying and grazing (which would have little immediate impact), and limiting ethanol production (which would be politically fraught with difficulty and hard to justify if oil prices remain high).

The authors feel that any short-term policy responses will be limited. But they urge readers that the time to discuss the scenarios is now, as these scenarios will very likely play out sometime this decade. The Southwestern United States, especially Texas, is in drought, and wet weather is inhibiting planting in the upper Midwest.

What this may mean

In the short term, the use of corn as a basis for food prices is troubling and fraught with danger. And it is out of our control-much like fuel prices, which are now causing major disruptions to the national economy. But high fuel cost is one thing; starving is another. We see before us a “developing” world, primarily China and India, growing rapidly in economic power and population. These nations are demanding resources at an unprecedented level. And corn is one of those resources. No matter how much we emphasize lower meat consumption and local and low-input foods, little will change world-wide. And as global climate change takes hold, prospects for crop disruptions magnify.

One obvious policy is to abandon grain-based biofuels world-wide. But that horse is already out of the barn and will only be corralled by economic necessity, which means ethanol will trump hunger. But opulent lifestyles also will trump hunger. Something will have to give.

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