farmgate: How Much Further Will Corn Prices Drop?
Whether you think December corn futures put in a double bottom on the charts Wednesday or just underscored $3.85 on its way further down, its $4 decline since July has been a classic chart pattern demonstrating that bear markets move faster than bull markets. The question in every Cornbelt coffeeshop and elevator office is, “How low will corn prices go?”
Iowa State University economist Bruce Babcock rhetorically asked the same question, but unlike most of the rest of us, he arrived at a plausible answer. In the new issue of Iowa Ag Review Babcock says the declining corn market is a boon for livestock producers, a bust for corn growers, and difficult for everyone who needs to make financial plans. He says predicting the market is foolhardy, but it is reasonable to examine the market dynamics.
Babcock says a lot of the corn market volatility stems from the impact of ethanol, as well as livestock producers, the industrial market, and the export market, all of which have maximum prices they can pay for corn. And he says when there is a plentiful supply, corn prices can drop because few users have a maximum corn price that is relatively low. The corn users will vary from year to year in their maximum price and it is not possible yet to predict which industry will have the lowest maximum price during 2009. Combined, the livestock, industrial, and export industries will need 8.7 billion bushels of corn and have a high maximum willingness to pay for corn.
However, the ethanol market has a level that will cause it to lose money when corn prices exceed it. Ethanol plants will sell ethanol and DDGS, but that income has to cover corn, energy, and labor costs. Babcock says if ethanol is priced at $1 per gallon, then the breakeven price of corn is $3.15 per bushel. That rises to $5.07 when ethanol prices are $1.50, and then to $7 per bushel when ethanol is at $2 per gallon.
In the marketing year that just ended, the livestock, industrial, and export industries used about 10 billion bushels of the 13 billion produced, and ethanol used the balance. If the first three had high maximum levels they could pay, that meant ethanol was the marginal user and its ability to pay determined the price of corn. If that is the case, then the market price of corn will be the breakeven price for the ethanol industry. So what is that breakeven price?
That price is determined by the market price of ethanol, and because it is a substitute for gasoline, it closely follows oil prices. But even so, it does not track it perfectly. Babcock says typically the price of ethanol is 68% of the price of gasoline, since it has only 68% of the energy value, plus the blenders’ credit that will drop from its current 51 cents per gallon to 45 cents in January. But he says that formula has over-predicted ethanol prices by 8% since June. Based on that formula, Babcock predicts $70 crude oil to imply a $3.24 corn price, and $80 crude oil to imply a $3.77 corn price. Corn would climb to $4.30, if crude oil goes to $90 per barrel. He says corn farmers should be alarmed if oil prices fall to $50 per barrel, because corn prices would fall to $2.18 per bushel, and that will not cover costs of production and insufficient supplies of corn would be produced to meet the 13 billion bushel demand.
Under the current federal mandate for renewable fuels, the 2009 corn crop must produce 11.5 billion gallons of ethanol, and to do that as well as meet the demands of the other industries, the US will have to grow 12.9 billion bushels of corn. At a 154 bushel per acre trend yield, that will require 90 million planted acres, and Babcock says that will not happen if corn prices are $2.15 per bushel. He says it will take $3.50 to $4.00 corn to induce farmers to plant that much.
The Iowa State economist notes that the ethanol mandates put an effective price floor under the corn market, which also protects the price of soybeans from falling further. So he believes the ethanol mandates will determine acreage and any post-planting price action will be a function of the size of the crop and other demand fundamentals.
Summary:
The seeming free-fall in the corn market has created concerns about how low prices will go, but the price of corn is so closely tied to the price of crude oil, one only needs to look at ethanol production economics to predict the price action for corn futures. The mandates for ethanol production will require 90 million planted acres in 2009, to produce the corn needed by the ethanol industry, as well as for feed, exports, and other industrial uses. For farmers to plant sufficient acreage, the price will not be able to go much lower than $3.50 to $4.00 per bushel, which will also shield soybean prices from going much lower.
Posted by Stu Ellis on October 23, 2008 12:24 AM to farmgate