farmgate: What Impact Would A Drought Have On The Ethanol-Based Corn Market?
You have wondered about the impact of a drought on the tight corn market. So let’s talk about that scenario. We already have $5 corn resulting from ethanol demand, export demand, and hungry livestock. What happens to the price if La Nina brings a short crop? Remember, there are federal mandates that require minimum levels of ethanol production, and that is the elephant in the room.
Getting a good handle on the issue requires consideration of many variables, such as planted acreage, yield, export demand, gasoline prices, and capacity of the ethanol industry. Those issues were analyzed by Iowa State University economists Lihong McPhail and Bruce Babcock in their report on the corn market. They say the corn market has been linked to the gasoline market through ethanol, with the goal being less dependence on foreign oil.
Federal energy policies have continued to raise the target for corn ethanol production, which now stands at 15 billion gallons by 2022, but at the end of 2007, the ethanol industry was halfway there. That has pushed corn above the $5 level with increased market volatility and the latter affects the decisions of players in the marketplace. The corn market had been used to supply shocks of drought or acreage setasides, but market shocks now come from export demand, ethanol production and the price of gas. And today the price of gas determines the price of ethanol and that affects the price of corn.
The Iowa State researchers say current corn prices are sensitive to planted acreage and yield because stock levels are relatively low and the demand for corn is strong, helped by the declining value of the dollar. Estimating a 90 million acre corn crop in 2008, a $4.97 corn price, 82% ethanol production capacity, and a continuation of the 51¢ blenders’ credit for ethanol, the researchers applied that baseline to the potential variables. They found:
1) The federal ethanol production mandate increased the average corn price to $5.32, with an average ethanol price of $2.37 per gallon.
2) Corn price volatility is directly correlated with the volatility of gasoline prices.
3) With the prospect of a La Nina drought affecting 2008 production, a 113 bu. national yield (1988 style drought) would push corn prices to $6.42 and only 27% of the ethanol plants could operate and the ethanol production mandate would not be met. If the mandate was enforced, corn prices would reach $7.99 and ethanol plants would require a $6 billion subsidization to continue operating.
4) A 169 bu. national yield would mean a $4.06 corn price and 99% of the ethanol refineries would be operating, producing more than the target amount of ethanol.
5) Removal of the 51¢ tax credit reduces the price of ethanol by 51¢ and corn prices average $4.15 per bushel, but only 54% of the ethanol plants can afford to operate and the ethanol production target would not be reached. If the 51¢ tax credit was replaced by a variable credit that encourage ethanol refiners to produce the target amount of ethanol, taxpayers would not pay as much to subsidize ethanol production.
Summary:
The relationship between corn, ethanol, and gasoline prices has resulted from the federal ethanol production mandates, and they will have an impact on corn prices particularly if a short corn crop results from weather issues. The reduction in production will raise corn prices to levels that ethanol refineries cannot afford to operate, and either the ethanol production mandates will have to be relaxed or refineries will have to be heavily subsidized to be able to buy corn at nearly $8 projected prices.
Posted by Stu Ellis on March 13, 2008 12:41 AM to farmgate