The national average corn yield was the main focus of cash and futures market traders in the Oct. 8, 2010, World Agricultural Supply and Demand Estimates (WASDE) report. Many market analysts consider this report a “game changer.”
The resulting price rally in crop markets has people beginning to ask if this could be a repeat of the 2008 price spike.
No one knows for sure. There are similarities. However, there also are some very important differences.
The corn ending stocks estimate of 902 million bushels is arguably the most important number in the October WASDE report. The corn stocks-to-use ratio, which is a percentage measure of reserves, is forecasted to be a near-record low of 6.7 per cent. The drought-reduced 1996 crop resulted in a five per cent stocks-to-use ratio, which is the lowest ratio in the past 35 years.
Very small projected reserves increase the uncertainty. It also causes end users to carefully re-evaluate how much they can afford to pay. The three largest uses of corn are animal feed (approximately 40 per cent) ethanol (approximately 35 per cent) and exports (approximately 15 per cent). How much can each of these sectors afford to pay for corn? What changes can they make to adjust to higher corn prices?
Although corn is the preferred feed for most livestock species, the U.S. livestock sector has proven to be very creative in using alternative feed sources when corn prices increase. However, prices for the alternative feed sources also increase as corn prices rise. These increases usually are based upon the relative feed value of corn.
The first alternative for a livestock producer facing rising corn prices is to switch from feeding corn to using a substitute feed. The next alternative, as feed prices continue to increase, is to cull underperforming feeder and breeding stock. The final alternative is to exit the livestock enterprise if feed prices increase dramatically and financial losses persist.
Unfortunately, the dairy, pork and poultry sectors are just beginning to recover from a period of sustained losses. It is likely that any planned expansion of the livestock herd has been delayed by the increase in corn prices. It is unclear how much higher corn prices can rise before the livestock sector begins a second round of industry contraction.
The ethanol industry also is recovering from a period of financial stress and industry restructuring. Corn makes up 65 to 70 per cent of the total cost of producing ethanol, so corn prices have a significant impact on the profitability of an ethanol processor. The relationship between ethanol prices and corn prices is a key element in determining how much an ethanol processor can pay for corn profitably.
In 2008, rising corn prices were matched by rising energy prices, including ethanol. As long as ethanol prices rose faster than corn prices, ethanol processors could afford to pay for the increased cost of corn. However, the current price relationship between corn and ethanol makes it difficult for ethanol processors to bid for corn aggressively. This suggests that ethanol processors may begin cutting production.
The mandatory use of ethanol for motor fuels, required by the Renewable Fuels Standard, places a floor on the blending and use of ethanol. However, ethanol and gasoline prices will need to remain strong to entice ethanol processors to produce above the minimum mandatory levels.
Changes in corn export levels, due to rising prices, are the most difficult to predict. The relatively low value of the U.S. dollar is making it easier for international buyers to purchase U.S. corn.
In 2008, most market analysts expected corn exports to drop off as corn prices increased. However, this did not happen because the relatively low value of the U.S. dollar eased the price increases. The U.S. dollar index varied between 70 and 75 during the first half of 2008. The U.S. dollar index is now trading between 77 and 80.
While higher corn prices are possible, it is unlikely that prices will reach the levels seen during the 2008 peak. The ability of the key users of corn to pay those prices has changed.