HUNTIN' DAYLIGHT -- CORN PRICE SURGE A GAME CHANGER

by: Wes Ishmael

Now you see it, now you don't.

Rather than a magician's mantra, that phrase describes USDA projections of this year's corn harvest.

Through September's Crop Production report USDA was estimating a new record corn crop of 13.2 billion bu. Then came October's staggering and surprising estimate that was four percent lower (12.7 billion bu). Despite more acres planted to corn than previously estimated, and despite the accelerated pace of this year's crop development and harvest, average yield projections declined dramatically due to late planting and the atypically cool, wet growing season across much of the Corn Belt.

In fact, yield estimates declined 6.7 bu/acre to 155.8 bu/acre. According to Darrel Good agricultural economist at the University of Illinois, “The decline from the September forecast was record large, eclipsing the 4.3 bushels of 1974 and the 4.5 bushels of 1995. Yield forecasts declined by 14 bushels in Illinois, 10 bushels in Indiana and Iowa, and 9 bushels in Missouri and Nebraska.”

More significant, October's World Agricultural Supply and Demand Estimates (WASDE) lowered domestic corn ending stocks to 902 million bu. Globally, ending corn stocks were lowered 6 million tons.

“The corn stocks-to-use ratio, which is a percentage measure of reserves, is forecasted to be a near-record low of 6.7 percent,” explains Frain Olson, extension crops marketing economist at North Dakota State University. “The drought-reduced 1996 crop resulted in a five percent stocks-to-use ratio, which is the lowest ratio in the past 35 years.”

“We consider a five percent stocks-to-use ratio, as experienced in 1995-96, to be a minimum carryover level,” Good says. “The USDA expects the 2010-11 marketing year average farm price to be in a range of $4.60 to $5.40, well above the previous record of $4.20 during the 2007-08 marketing year.”

Spun differently, any other shock to corn supply or demand will have exponential prices effects.

Corn futures jumped 30¢ on the Friday the October corn forecast came out, and nearly that the following Monday.

Keep in mind corn prices were already holding to loftier levels than fundamentals suggested, between runaway wheat prices earlier in the summer, due both to non-commercial fund buying, as well as the more fundamental drought in Russia and surrounding former countries of the Soviet Union. Those nations announced a ban last summer on exporting wheat, the situation was so dire.

The recent surge propelled corn prices to levels unseen since the commodity bubble in 2008. Understandably, it has prompted plenty of wonderment about the potential for a price spike similar to that suffered then.

“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,” Olson explains. “There are several indicators that can be used as signals for changes in the ability to pay higher corn prices. For the livestock sector, it is meat prices. If retail meat prices strengthen, a portion of the increased price can be used to pay for corn. For the ethanol sector, it is gasoline prices. If retail gasoline prices strengthen, ethanol can be used as a replacement for gasoline rather than a mandated additive. For exports, it is the value of the U.S. dollar. If the value of the U.S. dollar remains low, it moderates the impact of higher domestic corn prices.”

Fed Cattle Prices Up

As corn prices and cattle feeding breakeven increase, without increasing consumer beef demand, the value of calves and feeder cattle necessarily decline.

“Projected feedlot cost of gain has risen from $75/cwt. to $85/cwt. If corn prices continue to rise, and if we get in another battle this winter/spring for corn versus soybean acres, that rise could easily be well above $6 corn, then feedlot cost of gain will move into the $90/cwt. plus range,” says Dillon Feuz, professor of applied economics at Utah State University, in the October 12 In the Cattle Markets. “Spring contracts for Live Cattle have also rallied in the last three days, under the assumption that there will be fewer cattle placed on feed. However, I doubt that the present economy will support prices much higher or even the current levels. That would mean if corn continues higher, then feeder cattle prices will likely decline further from the already discounted levels.”

Part of that stems from the fact that consumers are only now coming to grips with retail beef prices moving into record high territory.

“The retail price so far this year has averaged $4.37 per pound, exceeding the previous record of $4.29 for the same period in 2008,” says Chris Hurt, Purdue University Extension economist. “Early forecasts of retail prices in 2011 are $4.60 to $4.65 per pound, an increase of about six percent over the 2010 record price.”

Compare that to average retail price of $3.84/lbs. for 2002-2006 before feed prices increased so dramatically, Hurt says. He adds that some analysts miss the fact that higher feed prices eventually are reflected in higher meat prices.

So, fed cattle prices will likely grow to record high levels, but all else being equal, higher retail beef prices will make domestic demand more challenging. Calf and feeder cattle prices get squeezed.

Waiting…waiting…

Even before the October USDA Crop Production report, cow-calf returns for 2010, though positive, were still too paltry to encourage industry-wide expansion. October's shocking corn production report will likely delay any herd expansion for even longer.

“…calves and feeder cattle still face the price-depressing burden of high feed costs. In the longer run, current high feed prices will keep the industry in a liquidation phase, and smaller beef supplies in coming years will be positive for returns for years to come,” says Hurt.

According to Hurt, the cattle industry continues to adjust to high feed prices not only from the last three years, but also from the most recent increases in corn, distillers, and soybean meal costs. The longer-term adjustments continue to play out in the reduction of cow numbers, he explains.

“The most recent surge in feed prices will likely keep producers from expanding until feed prices moderate. That will not be until the 2011 U.S. crops are assured, which is still at least 10 months away. This means cow numbers will not likely expand until 2012 and that beef supplies will not start to grow until 2014,” Hurt says.

Again, this is in the absence of other shocks to the corn market, such as those related to ethanol. You likely saw that the Environmental Protection Agency granted a waiver in October to allow five percent more ethanol (15 percent total) to be blended into gasoline for cars and light vehicles manufactured in 2007 and later. The confusion that would result from offering multiple grades at the pump, as well as further testing on how the higher blend affects vehicles manufactured from 2001 to 2006 (possibly allowing the higher blend for those vehicles, too) delayed shoving the market around on those counts.

As analysts pointed out in the October 18 CME Group Weekly Ethanol Outlook, “…The EPA's decision will not result in any significant increase in ethanol demand until at least the second half of 2011. There are still serious issues to address such as whether legislation is needed to enforce auto warranties when an owner uses E15. In addition, most retailers are not likely to sell E15 because they are concerned about misuse by consumers, liability, whether their pumps are UL-approved for E15, and the likely cost for installing new pumps. Progress on selling E85 has been glacial and E15 is likely to face the same hurdles. Still, the EPA has started down the road of allowing more ethanol to be used in 2007+ vehicles that represent one-third of U.S. fuel consumption, which at least opens the door towards an eventual increase in U.S. ethanol consumption.”

In the meantime, Feuz says, “No ethanol apologist will convince me that that industry is not negatively impacting the livestock and dairy sectors and ultimately raising consumer food prices. You cannot inefficiently use a third of the corn crop to run cars and not ultimately raise food prices. I am not opposed to ethanol; just government mandated and subsidized ethanol.”







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