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November 13, 2006
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 at November 13, 2006 1:24 AM | Permalink
Comments
This is the best break down of how the economics work on ethanol plants production. $4.05 is pretty high for corn which i dont think it will stay at for a long period of time if it gets there at all. $60 oil is another thing. If Bush starts to get things settled in Iraq we could see oil down to $40-45 and that would change the corn price break-even dramatically.
--Rick
Rick:
You have hit the nail on the head with regard to the fluctuation in oil prices having an impact on ethanol profitability, and eventually corn demand. However, many folks would question if oil prices would decline much below current levels.
--Stu
Posted by: Rick at November 13, 2006 8:24 AM
I am a wheat farmer and cattle producer in Texas. It looks to me like as high as the wheat market is going that it will not be feasible to feed wheat to cattle. Wheat can only be fed at a 40% rate in the ration because of the gluten factor. What is your prediction of wheat prices next May and how do you see the wheat market in the next five years. Enjoyed your article. thanks
Don:
Thanks for reading. You make a good point about the limitations of wheat feeding. Not having a clear crystal ball, it is hard to predict the wheat market in either the near or distant future. We have certainly seen expansion of wheat acreage this fall to meet the price-driven demand, and one might expect it to balance out. However the bull in the pasture is ethanol-driven corn demand and it may be forcing the acreage issue for years to come.
--Stu
Posted by: Don Welch at November 13, 2006 9:28 AM
This is an interesting analysis, but you don't talk about the cattle producers. Won't excess capacity of feedlots be an increasing problem as cattle stay on grass to heavier weights? Will grass become more valuable (less of a premium for lighter weight calves) as feedlot cost of gain increases? Will higher in weights for feedlots add to the increase in slaughter weights, or if costs of gain for last days on feed exceed the selling price of fats, will carcass weights decrease? Will increased utilization of DDGS move the feeding industry back to Iowa, etc.? Thank you.
Mike:
We are just passing along the essence of the report. You ask some excellent questions. The drought in the Plains pushed some cattle into feedlots early, only to create higher production costs because of the increasing cost of corn. If cattlemen can get forage anywhere, they may delay feedlot placement as long as possible.
Your question about the location of the feeding industry vis-a-vis the DDGS points to a structural change in Cornbelt agriculture that was the focus of
Posted by: Mike Goldwasser at November 13, 2006 9:36 AM
I am a poultry farmer in India. Your article makes a very interesting reading. For poultry feed we depend on corn. It appears that in time to come, US may buy corn from other countries for Ethenol, thereby increasing the corn price in the globe. Your comments on future international market of corn will be highly appriciated.
RS
Mr. Singh--
I appreciate your perspective, and think it ironic that you have concerns about the price and availability of corn, when India just exported its first shipment of corn in 20 years. Your commodity system decision makers must be taking advantage of the price.
--Stu
Posted by: Rajendra Singh at November 15, 2006 12:47 PM
Thank you very much for the reply. I am happy to note that India is exporting corn for the second time this year. It was in the year 2003 that India exported corn for the first time in so many years. I am not worried about the availability, we have enough to meet our requirements. In fact it is the after-effect of the Bird Flu scare that has put the poultry industry in trouble, now we have come out of the crisis.
Can you please tell me the kind of direct or indirect subsidy the US Government is giving for Ethenol production from corn in the US?
My request for your comments on global scenario on corn, i.e., shifting of demand and supply from one continent to the other, has failed to draw your attention.
I am also concerned about the reduction in Soya cultivation area, which is likely to be substituted by corn. I wonder what will the effect on the price of Protien vis-a-vis energy be so far as the animal feed is concerned, due to the making of Ethenol from corn?
RS
Mr. Singh:
The US government provides certain incentives for the petroleum industry to blend ethanol into gasoline, but while corn is the primary feedstock for US ethanol production, the benefits are not directed at corn itself.
Regarding soybean acreage in 2007, that is a question which will not be decided until planting time. The market will determine the balance of acres, between corn and soybeans, and until then, the ratio of protein vs. energy values will have to remain in question.
--Stu
Posted by: Rajendra Singh at November 19, 2006 12:30 PM
Stu,
A question about ethanol production from GMO corn and what that will do to the prices of corn, ethanol, and meat from beef rationed with distiller's grains:
Japan and the Western European countries don't accept US meat from animals rationed on GMO corn. Yet more and more ethanol is being made with GMO corn, and those distiller's grains are then being used as animal feed.
Ethanol plants haven't yet started keeping track of which feedstock is GMO and which isn't so that cattle feeders who buy DG will know whether or not they are feeding GMO grain products to their cattle?
If ethanol plants have to begin differentiating between GMO and non-GMO corn and which kind of distiller's grains they are offering to cattle feeders, won't that drive their operating costs up?
Regards,
Gary Dikkers
Madison, WI
Gary:
Great observation. The major wet millers certainly test incoming corn, because the gluten meal remaining from the ethanol refinery will still be detectable as GMO material if it winds up in a European port. While I am unaware of the practices of the dry millers (some may be testing as well) the DDGS would also certainly be a GMO material.
Those plant managers either know all of their DDGS will be consumed domestically by livestock or don't want to know what it contains, and that violates risk management principles. So you are correct that GMO corn poses a costly handling issue, if the plant needs to address that question.
--Stu
Posted by: Gary Dikkers at November 21, 2006 10:51 PM
I am wondering why the powers to be have chosen to use corn rather than use the cellulose-conversion method developed and tested by the Dept. of Ag. back in the late 70's. Corn stalks now have no market value but could yeald 50% of the yeald produced by corn, leveaing behind a good cattle feed by-product. Sources of celluose producing materals are far more plentiful and would not impact the food demands for corn. It is clear that the poor are going to be hurt by your decission with food cost rising near 50%. As you are fully aware oil is not going to remain in the sixty dollar range, we will be luck if it doesn't exceed eighty dollars.
Posted by: William Gorgus at May 5, 2007 1:41 PM
Gentlemen:
Regards using corn stalks for conversion to fuels, the old saying goes like this: waste not; want not!!
Posted by: Russ at December 22, 2007 3:41 AM
The "winners" and "losers" categories are intriging.
In a world of $70, $80, $90 oil - the energy associated expenses of $5 to $6 corn prices may consume the increased farm revenue. No winners. We would be handling more dollars, but keeping the same (or fewer) in our pocket. Most inputs at the farm level have a significant energy component and their price will be affected as quickly and at a similar rate as the "profitability" of ethanol production.
Would another "loser" be the consumer as tax payer? Tax revenue used by a small group of politicians to appease ethanol enthusiasts for a short term solution to fossil fuel costs. There may be a longer term solution to the issue of our Saudia friends control of our destiny.
I wonder what was unseen during the last 35+ years (old enough to remember the gas crisis of the early '70's) that prevented research into energy sources. I think about the estimates on the cost of the current conflict over seas and wonder how much real energy development might have been achieved with these same dollars invested.
How much ethanol do I need for my solar powered tractor?
Posted by: John Berry at December 27, 2007 11:47 AM
What type of corn is needed for the production of ETHONOL.If we have a clear informantion like type of corn,quantity of corn and is it available in India And where?sa that we can try to export the corn if required.
Posted by: sumit at March 11, 2008 10:30 AM