Tag Archives: corn production

Energy Fork in the Road

One economic topic that isn’t getting the attention it deserves is the energy policy. The drought of 2012 along with the expiration of subsidies paid to ethanol blenders will make it nearly impossible to reach the Renewable Fuels Standards (RFS) as early as next year. The standards that were put in place to increase this country’s energy independence were based on protectionist interests and were only viable as long as ethanol produced by the U.S. was subsidized while Brazilian ethanol was simultaneously taxed.

The difference between U.S. ethanol and Brazilian ethanol is the source of their primary inputs. We use corn, which is slower to grow, harder to use and more expensive than the cane sugar Brazil uses as the feedstock for their ethanol production. It will be very interesting to hear how the Presidential candidates debate their renewable energy policies, especially as 40% of our primary crop is diverted from food to energy production. This year’s drought has created a political collision course between food costs and the Renewable Fuels Mandate as well as the Energy Independence and Security Act.

The corn market is about as American as you can get. The U.S. produces as much corn as the next two largest producers, China and Brazil, combined. Unfortunately, production will fall nearly 15% short of 2011’s 314 million tons. The current Renewable Fuels Mandate allotted 40% of last year’s corn to produce 13.95 billion gallons of renewable fuel and 2012 will require an additional 8% increase over 2011. This brings total renewable fuel sources to 15.2 billion gallons on total consumption of 134 billion gallons in 2012.

The drought has pushed corn prices to an all time high of $8.43 per bushel. While the market is now 14% lower at  $7.25, the rally has been more than enough to shatter the profit margins of ethanol blenders. The combination of expiring refining subsidies along with higher input costs is leading to the shut down of major ethanol blenders. This raises the capital market question of who’s going to be responsible for meeting the aforementioned production targets? Ethanol distillers are losing more than $.40 per gallon at the current prices.

The idea of diverting 4.7 billion bushels of an estimated 11 billion bushels in total U.S. production towards an inferior yet, more expensive product seems silly in the face of rising global food prices. This is exactly what would be required to happen to meet next year’s Mandate. Furthermore, reaching next year’s goals using the current 10% ethanol blend is nearly impossible given the current mix of gasoline and diesel motors. Diesel biofuels and biodiesels are given a 50% bonus in RFS for their lower greenhouse gas emissions as measured by the EPA. The friction this creates in meeting the Renewable Fuels Mandate is called the, “blend wall.” The blend wall is the physical limitation of production and blending facilities based on the most common 10% ethanol blend. The mandate calls for 13.8 billion gallons, 10% of expected 2013 US consumption. However, current facilities, assuming they were all open and operating at full capacity, can only produce 13.3 billion gallons of ethanol.

The candidates will have to address the subsidies that farmers and blenders are paid as well as their plan on handling imports. These are most likely, the easy issues to address. Developing a complete energy plan will also include a discussion on the much more economically friendly topic of our vast natural gas reserves which have the capacity to place us on a much more sustainable path.

This blog is published by Andy Waldock. Andy Waldock is a trader, analyst, broker and asset manager. Therefore, Andy Waldock may have positions for himself, his family, or, his clients in any market discussed. The blog is meant for educational purposes and to develop a dialogue among those with an interest in the commodity markets. The commodity markets employ a high degree of leverage and may not be suitable for all investors. There is substantial risk of loss in investing in futures.

Food or, Fuel?

Corn is facing unprecedented demand on all fronts. The USDA
reported that prospective corn planting for 2011 is expected to be 5% higher
than last year. That would make this the second largest crop planted since
1944. The 92.5 million acres is second only to 2007’s record of 93.5 million
acres. In spite of the growing acreage in corn and higher yields driven by
greater technology, corn stocks are still down 10% from this time last year. In
fact, the corn on hand versus this year’s expected demand, (stocks to usage
ratio), stands at 5%. This is the lowest number since 1937. There are currently
6.5 billion bushels of corn in storage versus global demand of 123.5 billion
bushels.

The government’s push towards ethanol was actually initiated
by Carter during the oil crisis of the 70’s. It was left dormant until the post
9/11 energy independence push. Corn was trading at $2.25 per bushel in 2001.
Cheap, clean burning corn made it a political win/win for energy independence
and the global warming, green energy crowd. This led to government mandates and
subsidies to increase ethanol production every year through 2015. This year, up
to 40% of the corn crop, at a price above $6.50 per bushel, will be allocated
to ethanol production. If we multiply the intended planting acreage times an
average yield of 155 bushels per acre, we can see that the cost of the corn
input of ethanol production will be more than $37 billion dollars.

The U.S. also exports more than 60% of the corn we produce. Our
exports have continued to climb even as the price of corn has nearly doubled in
the last year alone. Meat consumption has just begun to grow in Asian countries
as they’ve begun to prosper and develop their own middle class. This will not
only continue, it will accelerate. Global meat consumption is still only 20% of
the U.S. average. The demand for feed grains continues to outpace production by
1-4% per year. China is determined to have a self -sustaining hog industry by
2013. These factors help explain the continual decline in ending stocks in the
face of growing harvests.

The demands on the corn market from ethanol and food
production leave absolutely no room for weather related issues. This year’s
crop is crucial to restoring our reserves. Based on the current ethanol
policies, it would have to rally another $.50 cents per gallon just to catch up
with the current price of gasoline. Corn would have to reach $8.82 per bushel
for gas and ethanol to reach equilibrium at $3.15 per gallon. Ethanol/ gasoline
blenders also receive a federal credit of $1.30 per bushel. This pushes the break-even
corn price to $10.12 per bushel for ethanol producers.

The price of corn hit an all time high of $7.79 in June of
2008. Remember, this followed the largest crop ever harvested in 2007. We
already know that global gasoline demand will increase, as fuel must be
exported to Japan. We also know that Japan’s imports of all foods will be
higher than ever. China is doing everything they can to put the brakes on their
economy but it won’t derail the growing appetites of their people. Finally, the
continued decline of the U.S. Dollar will serve as double coupon day for global
shoppers as we remain the world’s supermarket.

This blog is published by Andy Waldock. Andy Waldock is a trader, analyst, broker and asset manager. Therefore, Andy Waldock may have positions for himself, his family, or, his clients in any market discussed. The blog is meant for educational purposes and to develop a dialogue among those with an interest in the commodity markets. The commodity markets employ a high degree of leverage and may not be suitable for all investors. There is substantial risk of loss in investing in futures.

Food Inflation is Here to Stay

Inflation is measured many ways. Government reports will talk about core inflation, inflation excluding food and energy, consumer price index, producer price index and so on. These measurements all exist in the academic world. Talking heads argue about it on TV. Real inflation, inflation that is felt throughout the world, is food inflation. Food inflation is here, it’s real and it’s here to stay.

The Food and Agriculture Organization in Rome tracks a basket of 55 commodities to measure global food prices. This month, it topped the June ’08 high due to regional production issues. Many domestic commodity markets are substantially below their ’08 highs. Remember $8 corn and $16 dollar soybeans? Lets not forget the input cost of $140 crude oil. The only reason prices didn’t sky rocket even more in 2008 is because the world was still reeling from economic meltdown. Savings rates were increasing and spending was declining. This kept fundamental demand in check. The 2008 rally was fueled by poorly timed commodity index fund buying coupled with rising fuel and fertilizer costs.

The commodity index funds were created to capitalize on the growing appetites of emerging markets. As foreign markets mature, their tastes will include a more western diet, which is heavily based on grain and meat consumption. For example, total United States meat consumption is approximately 250 pounds per person per year. China’s total meat consumption has nearly doubled in the last 10 years and is now around 100 pounds per person per year. This is still less than half of our consumption. Their population, which is four times larger than our own, could double their consumption again and still be below the average American’s.

The example above also translates into the grain markets. Think of soybeans in terms of vegetable oils and think of corn to feed the livestock. The USDA released their annual crop production report this week as well as their supply and demand reports. The United States planted and harvested more acreage than last year in corn and beans. The bean harvest was the second highest on record and rice did set a new record. Historically, these numbers would be seen as very bearish for the markets since they point to greater supply. However, looking deeper, we can see that ending stocks are near all time lows, which indicates exceptionally strong demand given the generous supply for 2010.

Food prices are beginning to soar. Just as decent nutrition is the most basic of luxuries in a developing economy, so is it the most primal of necessities. We are already seeing riots in many third world countries over the price of sugar and grains. Developing nations are faced with a two-headed monster of rising food costs in the open market as well as food that is moving to the black market. President Clinton’s primary focus in Rwanda was to safely transport food aid past the warlords and to the people. Algeria, Haiti, Bangladesh, Senegal and Indonesia have all experienced civil unrest due to rising food prices just in the last week. It is much more difficult to contract one’s appetite than it is to expand it. Any planting issues in the U.S. this spring would douse the global embers of unrest with gasoline.

The United States is responsible for nearly 40% of the world’s soybean production and approximately 70% of its corn. These are the staples that feed the world’s people and its livestock. Our crops yield five times the global average. The U.S. will export our agricultural intellectual property as Brazil, Russia and the Ukraine expect to grow their output by 30% over the next ten years. Fertilizer, seed companies and biogenetic engineering will become the next wave of global financial players as mother Earth prepares to deal with the strain of a swelling and hungry population.

This blog is published by Andy Waldock. Andy Waldock is a trader, analyst, broker and asset manager. Therefore, Andy Waldock may have positions for himself, his family, or, his clients in any market discussed. The blog is meant for educational purposes and to develop a dialogue among those with an interest in the commodity markets. The commodity markets employ a high degree of leverage and may not be suitable for all investors. There is substantial risk of loss in investing in futures.