A fair number of U.S. growers, including many from the South, are hooking their wagons to corn, betting that prices for ethanol and ethanol feedstocks will remain high into the next decade.
Not only are southern producers shifting large acreages from cotton, rice and soybeans to corn, but they are also reported to be trading in cotton pickers for combines with corn headers and building long-term storage.
What are farmers basing these decisions on other than the excitement generated by $4 and higher Chicago Board of Trade corn futures? How real is the corn “boom,” and can growers count on high returns for corn lasting beyond the next few months, experts are asking.
The answers to those questions depend on a number of factors ranging from weather to tax policies to oil prices, say economists at the Food and Agricultural Policy Research Institute, which recently released the 2007 agricultural economic baseline that it prepares annually for Congress.
The baseline, which is prepared by FAPRI centers at the University of Missouri-Columbia and Iowa State University, Ames, says high corn prices are expected to cause major shifts in crop production in the next two years, bringing an additional 8.4 million acres into corn in 2007.
It would mark the first time U.S. farmers have planted 85 million acres of corn since 1949. The FAPRI projection of 86.7 million acres in 2007 falls in the middle of the range of trade projections. FAPRI is projecting almost 90 million acres of corn in 2008. (The Mid-South could plant an additional 1 million acres of corn in 2007, according to Extension specialists.)
In the FAPRI baseline, expected corn use for ethanol almost doubles — to 3.16 billion bushels — in the 2007 crop year from the 2005 crop and exceeds 4 billion bushels or 32 percent of the nation's corn crop in 2009-10.
Increasing ethanol production drives the corn price from a $2-per-bushel average in the last two crop years to slightly above $3 per bushel in every year of the 10-year baseline, which runs from 2007 to 2016.
Chicago Board of Trade corn futures currently are running above those levels, exceeding $4 per bushel as far out as 2009. “Those prices are higher than our projections, as the market encourages producers to plant more corn to feed the growing ethanol industry,” said Pat Westhoff, the FAPRI analyst who heads up the preparation of the baseline.
“But we're also seeing some weakening in the demand for ethanol,” he said in an interview at the FAPRI offices in Columbia. “Last year, ethanol manufacturers were netting about $1.50 per gallon over operating costs. But falling ethanol prices and rising corn prices will sharply reduce net returns in 2007-08.”
In fact, the FAPRI baseline shows the value of ethanol declining in each of the years through 2016, from an average of $2.03 per gallon in 2006-07 to $1.58 per gallon in 2016-17. Net operating returns for ethanol manufacturing are expected to decline from 61 cents per gallon in 2006-07 to 28 cents in 2007-08 and to 20 cents in 2016-17.
Some weakness in ethanol demand has also been showing up on the Chicago Board of Trade where ethanol futures dipped below $2 per gallon late last year. The market has recovered some of the decline in recent weeks.
“Futures have been 30 to 40 cents off for the further out contracts, which is usually a sign of a potential weakening of demand,” said Westhoff. “They have since regained some of the decline, but the outlook still isn't as strong as it was in 2005 and 2006.”
Looking forward, Westhoff says, oil prices have been “all over the board,” ranging from as high as $55 to as low as $49.99 per barrel on the New York Mercantile Exchange or NYMEX. “In November, during our initial review of the baseline numbers, we heard comments that our prices were too low. But then they went even lower.”
A number of factors have contributed to the dips in oil prices. Last year, China, India and the United States were factors in driving energy prices up. Now the Chinese economy appears to have begun a correction, and oil supplies have not fallen as much as predicted.
“The OPEC countries said they would cut production, but it's not believed to have been by as much as they said they would,” said Westhoff, who worked on the staff of the Senate Committee on Agriculture, Nutrition and Forestry before joining FAPRI.
But even if OPEC members continue pumping oil at higher-than-anticipated levels, a host of uncertainties in the oil markets could make U.S. consumers hostage to less than friendly governments in Nigeria, Iran and even Venezuela.
“So much depends on the price of petroleum,” says Westhoff. Missouri University FAPRI uses a baseline assumption that the oil price falls to $50 per barrel in 2016. (Forecasts on oil, interest rates and other macroeconomics come from the private forecasting firm, Global Insight.)
To try to develop the best picture of the factors determining corn demand, FAPRI economists analyzed 500 different outcomes using the computer models it maintains for the U.S. agricultural economy. The computer run shows prices can be much higher or much lower than averages in the baseline, depending on weather, oil prices and other factors.
Petroleum prices, which averaged around $60 per barrel during 2006, have a 90 percent probability of running as high as $80 per barrel and a 10 percent probability of dropping to as low as $30 per barrel over the next 10 years, according to the model. The average of the 500 outcomes put the price near $50 per barrel.
U.S. ethanol production could reach 8 billion gallons and then level off if oil prices begin a lengthy decline; 12 billion to 13 billion gallons if prices remain in the $50- to $60-per-barrel range, and 18 billion gallons if oil prices climb to $80 per barrel and remain there.
The future of tax incentives could also play a major role. “Current tax policies that support biofuels are slated to expire in 2008 and 2010,” says Westhoff. “If the credits expire, the results could be sharply lower biofuel production, corn and soy oil demand and crop prices.”
Farm policy will also continue to play a role in the availability of corn for ethanol, says Abner Womack, professor of agricultural economics at the University of Missouri and FAPRI's director.
The current farm bill allows cotton farmers to receive a cotton-based direct payment of 6.7 cents per pound and a counter-cyclical payment of 13.7 cents per pound and plant corn. Corn producers, on the other hand, are not expected to receive a 2007 counter-cyclical payment because of currently high corn prices.
“The decoupling is the big factor here,” says Womack. “Using average yields, the farm programs add about $94 an acre to the amount a cotton farmer can receive above the returns from the corn market.”
The current outlook for ethanol depends on the price of corn not becoming too high, removing profits from ethanol plants, most of which are located in two or three states in the Midwest. Consumer preferences may also be a key ingredient.
Much of the increased demand for ethanol of the last two years came from the decision to phase out methyl tert-butyl ether or MTBE from gasoline. “We've done that,” says Westhoff. “Now the demand depends on how high oil prices go.
“We assume you have to drop ethanol prices to get people to consume it — since ethanol has two-thirds the energy value of gasoline,” he notes. “But it may be that motorists are willing to pay a little bit of a premium for the higher octane of E-85 or other ethanol blends.”
“We also have to have places like Memphis be willing to put in the infrastructure and use ethanol blends in their cars,” said Womack. “Demand for ethanol has to move out of the Midwest and into other parts of the country.”