February Crop Market Update Department of Economic Analysis

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1 Corn Price ($/bu) and Ethanol Price ($/gal) February Crop Market Update Department of Economic Analysis In this edition: Energy Update: Matt Erickson, Economist Crop Update: Todd Davis, Senior Economist Recommended links: AFBF Economic Podcasts The Economics of Harvesting Corn Cobs for Energy Purdue Agricultural Economics Report, December 2010 Next Market Update: Livestock Market Update: released on February 22, 2011 Energy Update: A Strong Demand for King Corn It should come as no shock that more corn acres are being dedicated to ethanol. USDA reports that 4.9 billion bushels of the 2010 corn crop were dedicated to producing ethanol, or 39% of the total corn crop. With about a third coming back into the food supply as distiller s grains, approximately 24% of the U.S. corn crop is mandated to ethanol. There is no doubt that rising corn prices have been driven by increased demand, creating tighter supplies. From farm to fork, corn plays an integral role in providing food, fuel, and fiber to the world. Let s see how the increasing demand for corn and ethanol are affecting the current market situation. Walking the Stocks-to-Use Tightrope The January 2011 World Agriculture Supply and Demand (WASDE) report indicated the stocks-to-use ratio was approximately 5.5%, the lowest it s been since 1995/1996. However, the recent February 2011 WASDE indicated the stocks-to-use ratio decreased to 5%, the same as in 1995/1996. Furthermore, corn used for ethanol is projected to be 50 million bushels higher at 4.95 billion as compared to last month s WASDE at 4.9 billion. Relating to production, EIA reports that current ethanol production is approximately 900,000 barrels per day, or a slight 1% weekly decrease. With the tight stocks-to-use ratio for corn, corn and ethanol prices have increased. With the February $7.00 $6.00 $5.00 $4.00 $3.00 $2.00 U.S. Monthly Corn Price and Corn Stocks-to-Use Ratio ( Present) Feb 2011 Jan 2011 R² = Corn Stocks-to-Use Ratio (WASDE)

2 Jun 04, 2010 Jun 11, 2010 Jun 18, 2010 Jun 25, 2010 Jul 02, 2010 Jul 09, 2010 Jul 16, 2010 Jul 23, 2010 Jul 30, 2010 Aug 06, 2010 Aug 13, 2010 Aug 20, 2010 Aug 27, 2010 Sep 03, 2010 Sep 10, 2010 Sep 17, 2010 Sep 24, 2010 Oct 01, 2010 Oct 08, 2010 Oct 15, 2010 Oct 22, 2010 Oct 29, 2010 Nov 05, 2010 Nov 12, 2010 Nov 19, 2010 Nov 26, 2010 Dec 03, 2010 Dec 10, 2010 Dec 17, 2010 Dec 24, 2010 Dec 31, 2010 Jan 07, 2011 Jan 14, 2011 Jan 21,2011 Jan 28,2011 Feb 04,2011 Ethanol Production (Thousand Barrels Per Day) Commodity Price Ethanol Price ($/gal) 2011 WASDE reporting stocks-to-use at 5%, monthly ethanol prices averaged near $2.30 per gallon. Putting this into perspective, one year ago (February 2010) WASDE reported stocks-to-use at 13.1%, and ethanol prices for the month of February averaged $1.69 per gallon. Now at 5%, nearby corn prices are above $6.50 per bushel and ethanol prices continue to climb around $2.30 per gallon demand is high and demand is strong. $3.00 $2.50 $2.00 $1.50 Weekly Ethanol Price and Quantity Relationship (June Present) R² = Is Corn Becoming the True Golden Commodity? $0.50 So it seems. With increasing demand and tightening supplies for corn, prices are $- beginning to hit marks similar to From the first of June last year, nearby corn futures Ethanol Production (Thousand Barrels ) prices have increased approximately 87%. And there is no doubt that ethanol remains one of the forces behind the increased demand in the corn market. Currently, ethanol production is approximately 900,000 barrels per day. From the first of June last year, ethanol production has increased over 7%. In fact, the ethanol industry was operating at virtually 100% capacity when weekly ethanol production reached 922,000 barrels per day in the third week of January according to the Renewable Fuels Association and the CME Group. The slight, weekly decrease of ethanol production from the third week of January to the recent February level is a result of short-term production not being able to grow further due to lack of new capacity under construction. Along with increased corn prices, input costs have increased. It seems that one cannot discuss markets without the mention of crude oil. For 2011, projections for crude oil prices remain bullish. From the first of June last year, WTI spot crude oil prices have increased approximately 18%. Nevertheless, natural gas prices have moved in tandem with other energy and commodity prices. Since the October low of last year, natural gas prices have increased by 36%. Why is natural gas important when discussing ethanol? For starters, it takes a lot of Ethanol Production vs. Various Commodity Prices (June Present) $7.00 $6.00 $5.00 $4.00 $3.00 $2.00 $- Ethanol Production Corn Price ($/bu.) Natural Gas Price ($/mmbtu) Ethanol Price ($/gal)

3 01/08/10 01/22/10 02/05/10 02/19/10 03/05/10 03/19/10 04/02/10 04/16/10 04/30/10 05/14/10 05/28/10 06/11/10 06/25/10 07/09/10 07/23/10 08/06/10 08/20/10 09/03/10 09/17/10 10/01/10 10/15/10 10/29/10 11/12/10 11/26/10 12/10/10 12/24/10 01/07/11 01/21/11 02/04/11 Ethanol Margin ($/gal.) natural gas to run an ethanol plant. An ethanol plant needs steam to liquefy corn starch and heat to distill alcohol and dry the leftover distiller s grains. Following corn, natural gas is the number two input expense for most ethanol plants; an Iowa report estimates that annual production of more than one billion gallons of ethanol accounts for about 16% of the state's demand for natural gas. 1 Ethanol Margins Ethanol operating margins have been slightly negative for the past couple weeks. The rate of increase between corn prices and ethanol prices are the main cause for this decline. As previously mentioned, corn prices have surged 87% since June During that same time span, ethanol prices have surged 47%. With corn being the number one input expense and ethanol being the number one source of revenue for ethanol plants, corn prices outpacing ethanol prices will only tighten profit margins. Currently, weekly ethanol margins over total costs are approximately -$0.07 per gallon. Last week (week ending January 28, 2011) weekly ethanol margins over total costs were approximately -$0.01 per gallon. However, returns over variable U.S. Weekly Ethanol Margins ( Present) costs (week ending February 4, 2011) were approximately $0.18 per $0.80 gallon and $0.24 per gallon the week prior. Now, does this mean that $0.60 every ethanol plant is experiencing negative margins over total costs? $0.40 Not necessarily and not the point to this exercise. $0.20 The key message should dictate that profit risks will continue to remain high for ethanol $- producers if corn continues to rally as such $(0.20) over the price for Returns Over Total Costs ($/gal.) Returns Over Variable Costs ($/gal.) ethanol. Crop Market Update We are in the lull between the January 12 th WASDE report where the final 2010 production numbers were revealed and the March 31 st Prospective Plantings report where the first 2011 production information gets factored into the market. So it is not a surprise that the February 9 th WASDE report did not make any changes to the Supply and Use Balance Sheets for soybeans, cotton and wheat. The U.S. marketing-year average prices for soybeans, cotton and wheat are projected to be $11.70 per bushel, $0.815 per pound, and $5.70 per bushel, respectively. I will spend the rest of this column focusing on the corn market as this is the commodity that is driving the other crop markets. I will discuss the latest changes to the Supply and Use Balance Sheet. 1 Researchers Help Take Natural Gas Out Of Ethanol Production. Science Daily; 2006

4 Then we will talk about what acreage the corn market needs to meet the expected demand for the marketing-year to both maintain ending-stocks and to grow ending-stocks. Finally, we will discuss how the Supply and Use Balance Sheet for Corn might look like for varying 2011 U.S. average harvested yields. Corn Update The February WASDE report showed continued tightening to the projected ending stocks for the 2010 corn crop. The February 9 th report increased the projected corn use by an additional 70 million bushels (50 million for use in ethanol, 15 million for HFCS, and 5 million for industrial starch use). The market has been keeping a close eye on the use statistics to see if demand is slowing due to much higher prices. The February report did not reflect any reduction in demand for feed or exports. As a result of the increase in use, the projected ending stocks for the marketing-year was reduced to 675 million bushels. The stocks-use ratio has reached 5% for the marketing-year which is about 18 days of inventory. The stocks-use ratio has reached levels last seen in the marketing-year. The tight supplies at that time were caused by a short crop. Because it was caused by a supply problem, one large crop was enough to rebuild stocks to calm that market and reduce corn price. In contrast, this marketing-year is a result of very strong demand for corn both in the domestic and export markets. Demand for corn is growing as total corn use for the 2010 crop is projected to be 434 million bushels greater than the previous year. As a result, one record crop is not going to build stocks to a level that would greatly reduce corn price. The U.S. Average Farm Price is projected to range from $5.05 to $5.75 per bushel which is a record price. These high prices are serving two purposes: 1) bidding for additional corn acres in 2011, and 2) rationing demand for the 2010 crop to ensure corn is available throughout this marketing-year. We can expect even higher prices if demand isn t reduced or if there is a production problem with the 2011 corn crop. How Many Corn Acres Does The Market Need? Using the February WASDE report, we can calculate the acreage needed to maintain or even increase stocks at the end of the marketing-year. This exercise requires a lot of assumptions but it illustrates the production levels needed to meet the growing demand for corn. Let s look at Table 1 where we have two scenarios: Maintain Stocks and Grow Stocks. The Maintain Stocks scenario is where ending stocks in 2011 is at the same level as the 2010 marketing-year (Line 1). Assuming that total use in 2011 (Line 2) is the same as in 2010, this implies that a total supply of 14,175 million bushels is needed (Line 3). If imports remain the same (Line 4) and we add the beginning stocks (Line 5), we will need to produce 13,480 million bushels in 2011 (Line 6). If we harvest a yield that is near the trend yield (Line 7), we will need to harvest 83.2 million acres (Line 8). Assuming average abandonment of 8% (Line 9), this means we need to plant 90.4 million acres (Line 10). This is an additional 2.2 million acres over 2010 (Line 12). Of course, maintaining stocks at a historically low level would not calm the uncertainty in the corn market especially as demand continues to grow. The Grow Stocks scenario assumes that ending stocks will increase to 1,000 million bushels at the end of the marketing-year. Given the expected use assumptions, 1,000 million bushels is only a 7.4% stocks-use ratio which is relatively tight by historical standards. As you work through the

5 arithmetic, you can see that the 2011 planted acreage needs to be 92.6 million acres 4.4 million more than Given the profitability of alternative crops and limitations on the total amount of cropland available in the U.S., we may not get an additional 4.4 million additional acres of corn. However, the example shows that the market fundamentals are very strong to support corn prices at higher levels for the next couple of crop-years. Table U.S. Corn Acreage Needed to Maintain or Grow Ending Stocks. Line # Maintain Stocks Grow Stocks 1 Ending Stocks (mil. bushels) 675 1,000 2 Total Use (mil. bushels) 13,500 13,500 3 Total Supply (mil. bushels) 14,175 14,500 4 Imports (mil. bushels) Beginning Stocks (mil. bushels) Production (mil. bushels) 13,480 13, Average Yield (bu./acre) Harvested Acres (million) % Abandoned 8% 8% Planted Acres (million) Planted Acres (million) Change from 2010 (million) What If There Is A Production Problem? The above analysis assumes that we achieve trend-yields and that the level of abandonment is the same as the previous five years. In other words, it assumes that we do not have any production problems. What happens to 2011 ending stocks if we have record yields? Alternatively, what happens to stocks if we have below average yields? Table 2 describes the effect of record, average, and below average yields on the corn Supply and Use Projected Balance Sheet. Assuming that 91 million acres of corn is planted with an 8% abandonment, million acres of corn are harvested in With a record yield of 165 bu./acre, the 2011 crop is 13,814 million bushels and the ending stocks increase to 1,009 million bushels. This will provide some relief to the corn market; however, the stocks-use ratio is still 7.5% which is relatively tight. If we obtain trend yields of 162 bu./acre, ending stocks are about the same at 758 million bushels and stocks-use is at 5.6%. However, if we have a below average yield of 160 bu./acre, ending stocks decline to 590 million bushels and stocks-use fall to 4.4%.

6 Table 2. Effect of U.S. Average Yield on Ending Stocks for Corn. Record Average Below Average Yield Yield Yield 2011 Planted Acres % Abandoned 8% 8% 8% 2011 Harvested Acres Yield Million Bushels Beginning Stocks Production 13,814 13,563 13,395 Imports Total Supply 14,509 14,258 14,090 Total Use 13,500 13,500 13,500 Ending Stocks 1, Stocks/Use 7.5% 5.6% 4.4% The message from Table 2 is that the 2011 corn crop will require everything to go right throughout the entire crop-year as we have no inventory to withstand a production shock. Another message is that it will take more than one record crop-year to rebuild corn stocks. The higher price levels will be maintained throughout this marketing-year and into the next marketing-year. American Farm Bureau Federation