Ah, its one of those years! “Instances of substantial shortfalls in the size of the U.S. crop when stocks were low and demand was strong have been rare (1974 and 1995), but years with the potential for such an occurrence have been more numerous. The current year is one of those years.” And with that bit of introduction, let’s find out what history can teach us about the risks of a shortfall in corn production...

Corn stocks were large coming into this year, but demand was bigger, and Cornbelt farmers are in the driver’s seat. The road is a bit unfamiliar, so agricultural economists
Darrel Good and Scott Irwin at the University of Illinois have refreshed our memory about this “road less traveled,” in a new Marketing and Outlook Brief. What is the setting in this scenario?

1) Rapidly expanding consumption due primarily to increasing quantities of corn used for ethanol production: In 2004-05 the US refined 1.323 billion bushel of corn into ethanol, a demand that rose to 1.603 billion bushels in 20050-06, and is expected to reach 2.15 billion bushels during the current marketing year. Next year, USDA says it may hit 3.4 billion bushels. The 118 refineries in production have a 6.1 billion gallon capacity, and 79 more plants are in the construction stage.

2) Declining inventories: Corn stocks that hit a 17-year record of 2.114 billion bushels 20 months ago will be whittled down to 937 million at the end of August. During the current marketing year, consumption will exceed 11.5 billion bushels, which is a record and one billion bushels more than was produced last year.

3) High prices: corn prices moved sharply higher beginning in September 2006 to a high of $4.60 in February 2007. Although prices have faded, new crop futures remained near $3.70 in mid-May, at the extreme high end of the historical range of prices for this time of year.

4) Reported intentions to increase planted acreage: Corn growers promised the market they would plant 90.5 million acres this year, 12.1 million more than planted in 2006. Planting progress has regained its normal pace, but any substantial shortfall in production would not only result in a further reduction in domestic inventories, but could require some reduction in the anticipated level of consumption.

And therein lies the rub, as the Bard said about something else, but in this case, the risk in not producing enough is the difference in what is needed, versus what we do produce. What has been our history in that regard, and what can we learn from it. Economists Good and Irwin looked as far back as 1970 to calculate the probability of meeting the expected production. They determined, “Actual production was larger than expected production in 22 years and smaller in 15 years. Actual production was within 10 percent of expected production in 25 of the 37 years (67.5%).” The largest discrepancies were in 1974 and in 1988 when there was a 40% shortfall. The largest positive difference, 16.7%, was in 1979. Most of the differences between expected and actual production was a factor of the yield and not of the harvested acreage.

So what does that allow economists Good and Irwin to project for 2007, given the USDA’s expectations of 90.545 million planted acres and a trend yield of 148.6 bushels? With production estimated at 12.29 billion bushels, the economists applied the 1970 to 2006 model and found, “Based on historical distributions, there is a 67.5% probability that the 2007 crop will be between 11.06 billion and 13.52 billion bushels, or within 10% of expected production. There is an 18.9% chance of a crop smaller than 11.06 billion bushels, which would require substantial rationing of use, and a 13.5% chance of a crop larger than 13.52 billion bushels, which would likely lead to a build-up of inventories during the 2007-08 marketing year.” Based on the expected 12.29 billion bushel crop, Good and Irwin looked at the impacts of crops that were at that level, 10% above, as well as 10% and 20% below that level.

10% above expectations: A crop 10% larger than expected would likely result in lower prices, increased consumption, and larger carryover stocks. We project larger use in each category except non-ethanol processing uses (Other) of corn. A crop of 13.519 billion bushels could result in total consumption of 12.9 billion bushels, year ending stocks of 1.566 billion (12.1% of projected use) and a 2007-08 marketing year average price near $2.60.

Even with expectations: A crop of 12.29 billion bushels would allow for a substantial increase in consumption of U.S. corn during the 2007-08 marketing year, including up to 3.4 billion bushels for ethanol. Corn exports will likely decline from the 2.2 billion bushels expected this year due to large competing supplies in South America. Feed and residual use of corn will also likely decline from the level of the current year as byproduct feed from the ethanol industry provides more competition. Total use might be near 12.55 billion bushels, 975 million more than expected use for the current year, leaving year ending stocks at only 692 million bushels, or 5.5% of expected use. Under that scenario, the 2007-08 marketing year average price of corn might be near $3.30.

10% below expectations: A crop at 11.061 billion bushels, would force consumption of corn for all purposes to be slightly less than during the current marketing year and use would be limited to 11.55 billion bushels and year ending stocks reduced to 463 million bushels. Prices would have to be high enough to ration use of the crop. The estimates by category in the balance sheet reflect the following percentage reductions: Feed down 11.5%, Exports down 10%, Ethanol down 3%, and Other down 3%. Good and Irwin say, “While these projections by category reflect the general pattern expected, actual use by category could deviate substantially from these projections. The important point is that total consumption would be restricted to a total of only about 11.55 billion bushels. There are no historical observations on which to base the average price forecast, but an average near $4.25 is projected.”

20% below expectations: The need for rationing would expand from the 10% under scenario. A crop of 9.832 billion bushels and year ending stocks of 414 million (4 percent of use) would allow consumption of only 10.37 billion bushels, 17.4% (2.18 billion bushels) less than consumption with a crop of 12.29 billion bushels. Use by category is forecast to decline as follows: Feed down 22.6%, Exports down 20%, Ethanol down 10%, Other down 10%. As in the previous scenario, consumption by category could deviate substantially from these projections, but total consumption would be limited by available supplies. A period of extremely high prices would be required in order to force such a large reduction in use. The average farm price for the year would likely exceed $5.00 per bushel and is forecast at $5.25. The economists believe, “The high prices would force a substantial reduction in livestock numbers, increasing meat supplies in the short run, but resulting in much smaller supplies after that. Meat production could eventually decline 10 to 15 percent, resulting in escalating retail meat prices. The high prices would have significant negative financial implications for livestock producers, forcing some to discontinue production entirely.”

Other implications: If a shortfall occurred, would the market be allowed to allocate the corn, or would there be government intervention such as in the case with the 1973 soybean crop, when exports were embargoed. The economists say, “The potential negative impact on longer-term trade relationships would make an embargo a very unpopular alternative. The financial implications of high corn prices for livestock producers might evoke intervention in the allocation of supplies between domestic livestock producers and processors of corn.” Good and Irwin make the point that the market and policy makers should keep in mind the potential for a shortfall in the environment of strong market demand and have alternatives in mind in the case a shortfall materializes. And with the strong expansion of the ethanol market, that scenario needs to be kept in mind for several years to come. Additionally, the economists suggest that farm programs need to be carefully crafted to not over emphasize biofuels production at the expense of other crops, and the concept that a corn reserve might be needed to buffer any shortfall.

Summary:
With the increasing demand for corn outpacing supply, there are legitimate concerns that a shortfall could occur based on recent history when 1988 fell 40% short of the demand. The demand-based market exacerbates the potential for crop shortfalls, and if one happens price rationing will occur with ethanol production, livestock feed, and exports all impacted. While the market has been able to sort out such instances recently, 1973 brought about a government mandated soybean embargo. The current demand market will exist for several foreseeable years, and both the market and policy makers should beware of the potential for a shortfall in production that would require alternatives.