The soybean market has been hot this spring, thanks to supply issues linked to the drought in Argentina. But while beans were climbing the charts with the help of supply fundamentals, the corn market has been locked in a sideways channel for the past six months with no clear direction for marketing plans. There is a strong argument for the interconnection between the corn and the oil markets, so will learning about the oil market provide a lesson for corn marketing?

Economists who studied the relationships between corn and ethanol, and between ethanol and the oil market, all indicate there is about a 90% correlation between them, which links the price of corn to the price of oil, because ethanol has to be priced in relation to unleaded gasoline. Consequently, knowledge of the oil market may provide a head start on corn marketing.

Members of both Houses of Congress last week gathered in the Joint Economic Committee to hear authorities analyze oil prices and the US economy. Among them was Economist James Hamilton of the University of California at San Diego, who observed that four big increases in the price of oil for the past 35 years have all been followed by global recessions. We are in number five, and Hamilton says the latest surge in oil prices was an important factor that contributed to the current recession. However that surge resulted from a combination of declining oil production, increased Chinese demand, and a heated global economy, all of which pointed to a rise in oil prices to ration the supply.

Hamilton says the $4 price for a gallon of gasoline got the attention of US consumers, and the abrupt change in spending patterns disrupted certain key economic sectors, such as a plunge in sales of light trucks and SUV automobiles, which took 125,000 jobs out of the economy. But the economist also said paying $1 more for each of the 140 billion gallons of gasoline sold in the US takes $140 billion away from consumer purchasing power. Hamilton says the biggest economic effects of an oil price increase are not seen until 3-4 fiscal quarters after the price rises.

The University of California economist suggests that speculation in the oil commodity trading pits were partially involved, and says that may have benefited from the Federal Reserve action to reduce interest rates early in 2008. He favors an emergency plan to reduce petroleum demand that can be implemented on short notice in the wake of any future oil crisis. But Hamilton notes the long term challenge is a “booming world petroleum demand in the face of stagnant world oil production.”

Retail gasoline prices have climbed 50 cents per gallon since the December low, which is $70 billion dollars taken from consumer spending power. Hamilton says there are many other dynamics now at work in the recession, which are more important than oil prices; but he says the recent price increase in gas indicates the challenges ahead. “Even if we see significant short-run gains in global oil production capabilities, if demand from China and elsewhere returns to its previous rate of growth, it will not be too long before the same calculus that produced the oil price spike of 2007-08 will be back to haunt us again.”

Based on Hamilton’s analysis, the gasoline market will be climbing, helping ethanol to return to higher levels, and that could take the corn market upward with it.

Dr. Daniel Yergin, Chairman, IHS Cambridge Energy Research Associates, also testified to the Congressional Committee and agreed that the surge in oil commodity prices was a significant contributing factor to the current recession. But Yergin says the oil industry is increasing its capacity by 2 million barrels per day at the same time demand is declining by 2 million barrels per day, putting downward pressure on oil prices. However, the cost of producing new oil fields has remained high, and despite lower oil prices, oil exploration remains costly.

With such high production costs, the new capacity may not materialize, and projects to find more oil may be postponed or cancelled. How soon that will occur, Yergin says, depends on oil demand and the recovery from the global recession, as well as the implementation of green climate change policies.

Summary:
With the corn and ethanol market closely linked to the gasoline and crude oil market, corn growers may be able to plan long term, based on the future of the oil industry. Economists have told Congress that while capacity is up slightly, demand has fallen by a like amount. However world demand should return, and with it, higher prices for gasoline. Will those become a factor in ethanol prices and corn demand? If recent history is any value, corn prices should rise along with the oil market.