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Corn Flakiness

The historic drought this summer across most of the United States has severely damaged this year’s corn crop.  According to the U.S. Department of Agriculture, corn production is expected to be down more than 10% from last year.

Not surprisingly, corn prices have surged.  What may be surprising is how much they’ve surged:  up to record levels exceeding $8.00/bushel, up 60% over the past few months.  

Since prices have risen (60%) far more than volumes have fallen (10%), this is great news for corn farmers.

Of course, what’s good news for corn farmers is not necessarily good news for corn consumers.  The two biggest consumers of corn are livestock farmers/ranchers and ethanol production plants, and these twin pillars of corn demand are butting heads. 

Yes, this is another manifestation of the “food vs. fuel” debates so prevalent a few years ago.

By various measures, 28-41% of U.S. corn supply is used for ethanol production.  In turn, ethanol production is strongly influenced by U.S. energy policy — specifically, the Renewable Fuels Standard (RFS) implemented as part of the Energy Independency and Security Act of 2007, passed under the Bush Administration.  In 2012, the RFS stipulates that 13.2 billion gallons of ethanol must be produced and blended into gasoline for automotive use.

Without the RFS policy, it’s pretty clear that ethanol production would fall considerably under current market conditions.  Even with the RFS setting minimum levels, ethanol production is on the ropes, simply because the cost of the corn feedstock has risen much more than the price of ethanol has risen.  Put another way, ethanol margins have dramatically deteriorated — and in many cases are now negative.  In response, marginal ethanol plants are being idled.

Even with these adverse conditions, it’s widely expected that the ethanol quantities stipulated by the RFS for 2012 can still be met.  Pre-existing inventories of ethanol can be drawn down, ethanol exports from the U.S. can be reduced, and there are leftover Renewable Identification Number (RIN) credits from last year that can be applied to this year’s requirements.

Although financially bleak for this year, the ethanol markets won’t break.  Same with the livestock markets, but that isn’t stopping farmers/ranchers from raising objections:  they are pressing the U.S. EPA to at least temporarily relax the RFS to help alleviate the upward pressure on corn prices.  In the past few weeks, 156 House members and 25 Senators have written EPA Administrator Lisa Jackson seeking intervention.

A waiver on the RFS is probably not gonna happen right now, both because of economics and politics.

A recent study by Bruce Babcock of Iowa State University entitled “Preliminary Assessment of the Drought’s Impacts on Crop Prices and Biofuel Production” indicates that eliminating the ethanol mandate of the RFS would only reduce corn prices by $0.28/bushel, or less than a 5%.  In short, it doesn’t seem that relaxing the RFS will have that much beneficial impact on corn prices, as livestock interests are assuming. 

Representing the ethanol industry, the Renewable Fuels Association released a statement arguing that there is no need to waive the RFS requirements in the face of a tough corn crop.  The Obama Administration seems to be on the same page:  USDA Secretary Tom Vilsack continues to staunchly support the ethanol market.  Corn farmers do too — and there are a lot of voting corn farmers in swing states like right here in Ohio.

Given that it’s politically controversial during an election season and doubtfully effective anyway, it seems unlikely that Obama will relax the RFS.  And then, by November, a lot of the pressures caused by ethanol on the corn markets will have eased, since the demand for fuels peaks in the summer.

Now, if we have another serious drought during the 2013 growing season…?  The Dust Bowl years of the mid-1930’s tell us that unpleasant scenario is not unprecedented.