Ethanol’s impact on corn prices

The recent history of U.S. ethanol for fuel can be divided in two periods: the last decade of the 20^th century and the first decade of the current century. During these two decades, ethanol production grew by 60 and 780 percent, respectively. Estimated production in 2011 was 13,900 million gallons of ethanol. According to the Renewable Fuels Association (RFA), U.S. farmers harvested in 2011 almost 12.4 billion bushels of corn. In the same publication, the demand for ethanol production was estimated at 40 percent of the crop or roughly five billion bushels.

During a recent news conference held by the RFA, however, it was suggested that this 40 percent does not take into account the distillers grains co-product, which goes back into the marketplace as animal feed, and that ethanol only utilizes 14.5 million acres of the total 88.2 million acres of corn planted, ending up with 16 percent net corn acres used up by ethanol.

During the last decade, corn prices have increased by nearly three-fold. Other factors that influenced corn prices were energy prices, exchange rates, and adverse weather.

Dairy cow rations

In the U.S., diets for dairy cows in confinement consist largely of forage and concentrates. Before the recent expansion of the corn-to-ethanol industry, diets were formulated to contain approximately 50:50 forage-to-concentrate ratio on a dry basis. Alfalfa and corn silage have been the forages of choice, mainly because of their adaptability to the U.S. climate and their potential to sustain higher milk production. More than half of the cows in the Midwest are fed these two forages at variable concentrations in the diet.

Corn has been by far the most popular grain (93 percent of the cows) because of its high energy density and yield. Corn grain, because of its high starch content, allows formulation of energy-dense rations required by high-producing cows.

Soybean meal and whole cottonseeds complete the list of most popular feeds and were fed to 90 and 38 percent of the cows in the Midwest, respectively.

Supply and demand

Modern economic theories state other factors beyond supply and demand affect price, such as government regulations, speculation, as well as modern techniques of marketing and advertising. Even acknowledging these, a quick look at ethanol production and corn prices shows the noticeable relationship of supply and demand that unarguably operates in free markets.

If there is such a tight relationship between supply and demand, why didn’t corn prices increase between 2002 and 2004? Why are the graphed lines between ethanol production and corn prices diverging between 2002 and 2004 in spite of ethanol production increasing by 60 percent? This is again explained by supply and demand. Corn harvested for grain during that period increased by five million acres and corn production in million bushels by almost 24 percent. (See figure 1 on the next page.) From 2005 to 2009, ethanol production started to grow exponentially and we also had an increase in corn from roughly 11 to 13 million bushels, or 18 percent, which was reflected in corn prices around $4 per bushel. From 13 million bushels in 2009, corn production dropped to 12.4 and 12.3 million bushels in 2009 and 2010, respectively.

The U.S. is a major world food supplier, and any significant changes in its crop market impact the rest of the world.

According to the United Nations’ monthly Food Price Index released Aug. 9 this year, food prices jumped 6 percent in July, after three months of declines. Corn price was the main driver behind this increase with a 23-percent surge in July alone, topping $8 per bushel at the Chicago Board of Trade. There is no question that this sudden increase has to be attributed to the drought and prospects of a reduced corn crop. Nevertheless, a 23-percent increase in corn prices due to the drought would have a different impact in the U.S. and worldwide if corn base prices were lower. Corn prices were at $4.20 per bushel right before the drastic surge in ethanol production (figure 2) and a 23-percent price increase due to the drought would have put corn at around $5, not $7.60 as it is currently or $8 as it was this summer.

Impact on feed prices and income over feed costs

The basic law of supply and demand is the most important aspect of modern economics theory. As demand for an item increases, its price rises — it works for corn grain, corn distillers grains, ethanol, and so on.

Figure 2 on this page shows that from 2008 to 2009 ethanol production jumped from 6.94 to 10.94 billion gallons, whereas corn prices actually dropped from $4.06 to $3.55 per bushel, the reason being an exceptional corn crop with 11 more bushels per acre for the U.S. as a whole (from 153.9 to 164.7). The following two seasons — 2010 and 2011 — had more “average” corn crops with 152.80 and 147.20 bushels per acre and, as a result, corn prices jumped again to $5.18 (2010) and $6.20 (2011) per bushel.

What this shows again is that the corn-ethanol interface is in a very delicate equilibrium that once broken by increased supply (i.e. more bushels per acre) or demand (i.e. lower crop yields due to weather) immediately results in a modification of the price per bushel.

Conclusions

The corn/ethanol interface is extremely vulnerable as it not only depends on internal but also external factors. Market globalization has resulted in higher price volatility of dairy inputs and outputs. Dairy production needs to be economically competitive if there is going to be sustained growth and secured dairy product-based foods in the future.

At the moment, there seem to be two long-term strategy options that could be pondered. One would be to change the current U.S. dependence on corn as a feed for livestock and prioritize corn to ethanol. With our current knowledge, this approach will more than likely reduce livestock production, increase food prices, and threaten food security. The other approach is to link corn prices to animal products. In the current economic environment, dairy producers cannot afford anymore to have a set milk price and a floating feed price.

Alvaro Garcia is a professor and extension dairy specialist at South Dakota State University.

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