Corn: Commodity Perspective – January 7, 2008

The bidding war for U.S. corn acreage is clearly under way, with March corn futures prices now approaching $4.66 per bushel. January soybeans futures are approaching $12.49 per bushel, a remarkable level by any standard. This implies a soybean-to-corn price ratio of 2.68—a clear signal for farmers to plant more soybean acres in 2008.

But how large will the shift in acreage be? Even as we approach March, there are still several risk factors that will ultimately influence the size of the acreage shift. One early indicator of the potential shift in acres will be the USDA's Winter Wheat and Rye Seeding report, scheduled for release on January 11. Given high wheat prices this past fall, a significant increase in wheat acreage is expected. In addition, high nitrogen prices and potential supply problems could intensify the shift from corn to soybeans. But a larger-than-expected South American soybean crop or a slowdown in Chinese soybean imports could take some of the edge off soybean prices.

Corn Demand Remains Strong

Despite relatively high corn prices in the United States, demand remains strong. When ethanol prices fell to $1.60 per gallon in the early fall of 2007, ethanol margins narrowed to around $0.20 per gallon. Since then, crude oil prices have increased, driving up nearby ethanol futures to $2.30 per gallon. And with corn futures at $4.66 per bushel, that still generates a positive return over variable costs of nearly $0.45 per gallon of ethanol produced.

Exports plus outstanding sales also continue to surge well above last year's pace. A weak dollar has offset some of the runup in U.S. corn prices, making U.S. corn exports attractive to foreign buyers. Mexico, Egypt, and South Korea account for much of the increase in corn's export demand.

One of the biggest risk factors for U.S. exports is China's expanding livestock sector, and its conversion from backyard to commercial production. Typically, commercial enterprises utilize more feed-efficient rations, which include more protein (i.e., soybean meal), reducing the overall feed required per pound of gain and thus the need for feeding quite as much grain per pound of gain. Subsequently, the growth in corn feed demand has not been nearly as dramatic as the growth in soybean meal demand. As reported by the USDA, China's overall demand growth has been outpacing its production, but it has drawn down domestic stock levels to compensate and even continued to export corn. For many years, analysts have speculated on when China might become a net importer on a more permanent basis. If USDA data are correct and the current slowdown in Chinese corn exports in not just production driven, China becoming a net importer of corn may be eminent.

Why Are Corn Prices So High?

Some might suggest that the only reason for high corn prices is the demand from ethanol, and certainly that has a great deal to do with high prices. But there are two other compelling drivers that have further exacerbated the situation. First, China had a poor crop in 2007, resulting in less exports from China, and which must be directly offset by U.S. or Argentinean exports. The weak value of the dollar has allowed the United States to capitalize on the situation.

Second, the 2007 shift in U.S. crop acreage away from soybeans dramatically reduced the nation's soybean stocks. South America's soybean production response is expected to be sluggish due to the high value of the real and weak price transparency back to farmers in Argentina. For example, Brazilian soybean prices (in Brazilian reals) increased by 34% from November 2006 to November 2007, while U.S. soybean prices (in U.S. dollars) increased nearly 60%. As a result, South America has not responded as much as expected, and U.S. soybean prices have skyrocketed above $12 per bushel, pulling corn prices higher as the commodities compete for acres in 2008.

Corn Price Volatility Will Continue

What is clear is that we should expect continuing volatility in commodity prices, especially with corn prices now linked to the crude oil price through ethanol. Most of the current fundamentals suggest that corn prices will continue to increase through the planting season in an effort to limit some of the shift to soybeans. If more acres of corn were planted in 2008 than was expected, a pronounced slowdown in corn used for ethanol would occur due to weakening crude oil prices. Or if U.S. corn export demand slowed, corn prices could fall precipitously.