farmgate: How High Can Ethanol Demand Drive Up The Price Of Corn?
Rising corn prices attributed to ethanol demand. Higher feed costs for livestock producers competing with the ethanol industry for corn. Millions of more corn acres expected in 2007 to satisfy the demand. Higher prices for other commodities competing with corn for acreage. Where does it all end? How high does ethanol push up corn prices to a level when agriculture becomes unbalanced and the foundation cracks? $3 corn is rare, but we’ll even push higher to get some answers.
Quite a few headlines were made last week when economists from Iowa State University said $4.05 was the magic corn price ceiling for the ethanol economy. But how did they really come up with that, and what are the other impacts on agriculture from $4 corn?
The Iowa State research first examines the profitability of ethanol production and the incentives for investors to fund these facilities, then uses a broad model of the world agricultural economy to evaluate the likely impact of U.S. ethanol production on agricultural markets. The economists worked backward from the price of crude oil, which determines the price of gasoline, which has to compete with the price of E-85, which determines the top price of corn that can be paid for refining it, which will stop investors from building ethanol plants above that corn price. Whew!
That corn price and the acreage needed to produce enough corn to generate that price were determined by the Iowa State and University of Missouri consortium, the Food and Agriculture Policy Research Institute, which evaluated: prices of energy and dried distillers grains with solubles, bio-fuels production, release of Conservation Reserve Program acres, corn and oilseed yields, and public policy.
Beginning with a $60 price per barrel of crude oil, which translates to $2.07 gas, the Iowa State researchers used a 66% energy equivalent for ethanol, placing its value at $1.38. Add in the 51¢ tax credit provided to blenders and the price of ethanol becomes $1.89 per gallon. With additional assumptions about the cost of ethanol refining, the amount of ethanol and DDGS per bushel of corn, the economists determined “The ethanol plant earns $5.67 for the ethanol produced from one bushel of corn; it also receives $0.66 per bushel for the DDGS co-product. The total cost of processing this bushel is $2.28 ($1.56 for variable costs and $0.72 for fixed costs). We can subtract total costs per bushel from total revenue per bushel to arrive at the break-even price for corn. This equals $6.33 minus $2.28 or $4.05. This means that the plant can pay as much as $4.05 for corn.” The bottom line is that ethanol production will stop about the time corn prices reach $4.05 per bushel.
Remember, the assumption began with crude oil at $60 per barrel. If it rises to $70, then ethanol production would halt when the price of corn reaches $4.74 per bushel. The corn price ceiling would by $5.43, if we operate in a world with $80 oil, and those figures are based on continuation of the 51¢ per gallon tax credit. If the tax credit is eliminated, the corn price ceiling would be $2.52 at $60 oil and $3.21 with $70 oil.
If the price of corn approached $4, how much corn would you produce to meet the demand and what would that mean to other crops, other consumers of corn, and the cropping patterns in other nations? The Iowa State researchers expect, “U.S. corn area increasing by 21% and U.S. ethanol production increasing so that corn use in ethanol production exceeds 11 billion bushels. These adjustments allow the U.S. ethanol industry to expand to 31.5 billion gallons.” Of course, 31 billion gallons is well beyond current and planned capability.
But assume we were on track to achieve that level, how would the soybean crop be affected? The economists say, “High corn prices will provide an incentive to plant more corn acres and an expansion of DDGS production will create competition for soybean meal. The results show a slightly lower soybean price with higher soybean oil prices being offset by lower soybean meal prices and a 9-million-acre reduction in soybean area. This adjustment can be achieved if approximately half of corn-soybean producers switch from a corn-soybean rotation to a corn-corn-soybean rotation.” For wheat, there would be a 3% decline in acreage, a 20% increase in price, a near doubling of wheat feed to livestock in lieu of corn, and 16% reduction in wheat exports.
What about the livestock producer in this entire economic maelstrom? Livestock specialist John Lawrence at Iowa State believes “If we increase the corn price from $1.85 to $4.05 this increases corn costs per hog from $27 to $58 and increases total pork production costs by approximately 31%. U.S. pork production will need to decline by 10% to 15% to allow the industry to pass this cost increase on to the wholesale market.”
At the outset of the research, many assumptions were made, but just how important is one variable over another. The Iowa State economists say, “The results are most sensitive to the price of crude oil and to the tax credit that is provided to ethanol blenders. The results are not particularly sensitive to the import tariff alone, the release of Conservation Reserve Program acres, or to the prices of DDGS and natural gas.”
So who wins and who loses?
Winners: landowners with higher corn prices and cash rent; farm operators until cash rents become too high; dairy and beef producers with close access to DDGS.
Losers: pork and poultry producers who are not investors in ethanol plants; employees depending on jobs in those shrinking industries.
Summary:
Watching corn prices climb because of ethanol demand causes one to realize there are many effects of the current phenomena, not only the impact of higher feed costs for livestock producers. As ethanol expansion continues, and demand drives up prices, the $4 level becomes an economic ceiling for economic production due to current oil prices and continued favorable tax treatment. The higher price that ethanol plants can pay for corn will subsequently diminish US soybean and wheat acreage, reduce pork production, and raise cash rent prices.
Posted by Stu Ellis on November 13, 2006 1:24 AM to farmgate