The livestock industry and others that use corn as key input are calling on Congress and the administration to modify or suspend the ethanol mandate for the 2012 corn crop.
Pressure for modifying the mandate is also coming from a hunger community that is fearful that a further rise in corn prices will trigger an increase in the number of food insecure people as it did in 2008 when over 200 million were added worldwide to the rolls of the food insecure.
Corn farmers, on the other hand, are concerned that a change in the ethanol mandate may collapse prices just when they are facing a reduced crop. At this point we have a better idea of the size of this year’s crop than we do about how the ethanol mandate debate is going to shake out. What we are certain about is how we got into this pickle.
There are two parts to the story and they both hinge on the same policy change.
The export boom of the 1970s began with a decision by policy-makers in the Soviet Union to import grain rather than reduce their domestic grain demand by reducing the size of their cattle herd. By 1975, U.S. corn exports had tripled to 1.7 million bushels. Meanwhile the price of corn doubled putting pressure on cattle producers.
Fast-forward to the drought of 2012 where the projection is for the corn yield to fall for the third year in a row to 123.4 bu./ac., 16 per cent below the 2011 yield and 25 per cent below 2009. 2012 farm gate corn prices are projected to be more than double their 2009 farm gate average of $3.55.
Now to the second part of the story. Beginning in 1998, the farm gate price of corn fell below $2 for only the second time in the prior 25 years. And unlike 1985, it stayed there for four years. Even with the emergency payments, corn farmers were desperate. They were told that the problem was overproduction and the solution was to get involved in non-food-related demand enhancement.
And so they began to cast about for uses that did not involve food products. They looked at converting cornstarch into clothing fibres. They funded research into using corn to make glues. And they looked at ethanol.
That corn could be used to make ethanol was a no-brainer. Whiskey makers had been doing it for centuries. And, unlike the other non-food products, the production of ethanol as an automotive fuel oxygenate could be ramped up very quickly.
Corn farmers began to organize meetings to set up ethanol plants. To fund the ethanol plants, we saw farmers plop down a $10,000 investment in shares of an ethanol co-op for the right to sell 10,000 bushels of corn to the co-op at a two- to five-cents-per-bushel premium over the local market.
It looked like a fool’s investment, but, with sub-$2-per-bushel corn, their backs were up against the wall.
It did not take long for non-farmer investors to see the money that was to be made in ethanol production and soon the use of corn for ethanol production went from a number close to zero to five billion bushels a year.
What policy instrument do both parts of this story have in common? Grain reserves, well more precisely, the lack of grain reserves.
For more than three millennia, people have known that agricultural production is highly variable from year to year while the demand for food is very stable. Ancient Egyptians and Chinese implemented the use of government-organized reserves to buy grain during periods of high production and then sell the grain when crops failed.
In the U.S., the use of grain reserves was successfully implemented during the Depression and used off and on over the next five decades. By 1961, corn reserves were 65 per cent of annual utilization and policy-makers decided that they had to empty out the larder. Want to guess when Old Mother Hubbard’s cupboard was bare?
It was the early 1970s, just when we needed the grain. By the 1977 crop year, with prices two-thirds of their recent levels, reserves were back in favour.
Once again, in the late 1980s reserves fell out of favour and were effectively eliminated in the 1996 Farm Bill.
And what happened two years later? The government lacked the ability to purchase reserves to stabilize prices — exports were supposed to do it — as a result prices plummeted. The result was an ethanol industry that developed at a much faster rate than it would have in the absence of extremely low corn prices.
In 2012, like in the early 1970s, we find ourselves with a drought-reduced corn crop and no reserves to fill in the gap.
There is more to this story.
In the late 1940s, the U.S. accumulated significant grain reserves and policy-makers were looking for ways to reduce them. But before the government could get rid of them, there was a sharp increase in demand. Uncle Sam got involved in the Korean War and needed grain reserves to feed hungry soldiers.
We had significant yield and production problems with corn in 1983 and 1988. In 1983, production dropped by 49 per cent, yet the total utilization (sum of domestic and export corn uses) declined by only eight per cent. Similarly, in 1988, U.S. corn production declined by 31 per cent from the previous year, while total utilization declined by only six per cent.
In both years, it was the presence of reserves that made the difference. In 1983 and 1988, total beginning stocks brought into the marketing years exceeded 3.5 billion bushels with well over half being non-commercial reserves stocks. Today — without such stocks — total utilization must track production declines nearly bushel-for-bushel.
What about the years ahead? Will the shortfalls of 2012 reset corn’s demand base?
Demand destroyed may take time to reconstruct. In addition, the current high prices may trigger increases in production that could result in extremely low prices in the future.