The financial future of the Cornbelt farmer is rooted in the price of corn, which is rooted in the price of ethanol, which is rooted in the price of oil. But your profitability depends on the implications of the implications of the implications of economic variables for which you can only hope and pray. On this Thanksgiving, we’ll connect the dots, and try to draw a conclusion, instead of a turkey.

This is Part 2 of the farm gate’s great ethanol adventure, exploring a new academic work by the University of Illinois Department of Agricultural, Consumer, and Environmental Economics. Agricultural economists Darrel Good, Bob Hauser, and Gary Schnitkey delved into the economics of the ethanol sector to help you connect the dots of price relationships.

More corn is being used for ethanol production than for exports, and the industry will nearly double its capacity when planned refineries come on line. While that will produce 14 billion gallons of ethanol, it will also require nearly 5 billion bushels of corn, nearly what is currently being allocated for livestock feed. But there are politically-charged incentive subsidies necessary for that to occur, along with a favorable sale price for the DDGS co-products, and affordable construction costs, an affordable price for corn, and an affordable cost of energy. (In other words, the dots need to form a line.)

Dot 1: Ethanol prices. With 2.8 gallons of ethanol produced from a bushel of corn, a 10% change in the $2.25 price of ethanol implies a 63¢ change in the price of corn. But if corn is $3.75 per bushel coming in, a 10% change is 37.5¢; and DDGS is $130 per ton going out, a 10% change would be 11.5¢ per bushel of corn. With natural gas costing $7 per 10,000 BTU’s, a 10% change alters the operating margin by 7¢ per bushel of corn. But instead of pricing ethanol with a formula of corn, DDGS, and energy, ethanol is priced by the going price of unleaded gasoline. In 2006, if unleaded gas averaged $1.94 per gallon, ethanol would have to be priced at $1.30 per gallon because it has only 66% of the BTU value. But adding the blender credit of 51¢ makes the price $1.81 per gallon for ethanol. Its average price was really $2.58 because of its environmental benefits that could become moot when alternatives disappear. Currently, ethanol is priced at a 45¢ discount to unleaded gas, and since that reduces the operating margin of an ethanol plant the expansion of refineries would decline sharply.

Dot 2: Ethanol and corn prices. The Illinois economists say if ethanol can be sold by the manufacturer at $1.50 per gallon, then it can pay up to $3.65 per bushel of corn and still break even. But they add, “The break-even corn price is particularly meaningful in the case of ethanol because (1) it is considerably higher than traditional corn prices, (2) a relatively large amount of corn production is used for ethanol, and (3) the amount of ethanol produced has very little effect on gasoline price.” The economists believe that if corn prices continue under $3.50, then ethanol production capacity will increase, but it will fall if corn prices remain above $3.50. The price of corn not only determines the growth of refining capacity, but also determines how much corn will be grown. But with the expected price of soybeans at 2.5 times the price of corn, the price of soybeans determines how many acres of corn will be planted.

Dot 3: Production and Consumption shifts. The economists hypothesize there will be significant impacts on consumption if the breakeven price is at $3.75 because of oil prices and federal policies, and if corn users did not have alternative feedstocks. Since the livestock industry is the largest corn user, “In our opinion, a large, long-term increase in ethanol demand would ultimately cause higher retail prices at the meat and dairy counter and higher livestock prices, but a relatively small reduction in livestock production.” Further, they say that most of the exported corn is also for livestock feed, the foreign demand for meat will determine the quantity demanded for export. In total they believe 13% of a fixed amount of corn would be all that is diverted to ethanol from other uses of corn. However, corn production can expand as the price demands, particularly from soybean acreage and what the producer loses is the profit from corn production, vis-à-vis corn yields.

Dot 4: Ethanol Yield per acre of corn. The ethanol yield per acre is a combination of corn yield, and how much ethanol can be produced from a bushel of corn, which is currently about 2.8 gallons, and has increased over time. But seed genetic improvements can raise that number with more starch and starch that is easily obtained. An increase in the ethanol yield will reduce the corn acres needed for ethanol. In recent years, the trend yield of corn has also increased, and at an accelerated rate. While technology has resulted in some of the increase, a more benign weather pattern in the past decade has also helped stabilize and increase corn yields.

Dot 5: World response to increasing crop prices. The higher US price for corn resulted in increased acreage in 2007, and the economists believe that as long as ethanol production expands, prices will remain strong and corn acreage will remain high. But they say the bidding war depends on the price of ethanol and how the world responds to higher crop prices in both consumption and production. Higher corn prices would result in higher prices for corn and alternative crops, particularly for Brazilian soybeans, and that would result in lower prices for US beans and less acreage. Continued high prices would lead to productivity gains in many countries.

Dot 6: Corn price risk. The corn prices important to both the producer and the ethanol refiner are a function of weather driven yields. In the past decade they have been more stable than in the prior 20 years. Shortfalls have existed, but the 1 shortfall in 5 years that occurred from 1970 to 1990 has diminished to 1 in 10 in the past 12 years. However, the potential for a major shortfall has kept corn prices volatile, particularly with the low level of stocks on hand.

Summary:
The ethanol economy has become a dominant factor for Cornbelt agriculture, but its stability relies upon corn yields and prices, oil prices, government policies, alternative crops, and how the world responds to production and consumption changes because of the demand for corn. That combination of factors determines whether corn prices will be above or below a breakeven point for ethanol refineries, and that in turn determines the long range support for corn prices.