Finding a new use for any product will make its price go up. That’s just what ethanol has done, and grain producers especially in the U.S. are currently cashing in.

University of Missouri economist Ron Plain predicts that because of ethanol, U.S. corn prices will average over $4 per bushel for the foreseeable future.

Plain studied corn prices over the last 100 years and found two other periods when there was a sudden jolt of new demand. In both cases, prices stepped up, basically creating a new trading range.

Strong domestic demand in the U.S. following the Second World War drove average corn prices 62 per cent higher. Three decades later, new export demand for U.S. drove corn prices an average 88 per cent higher.

Now a generation later, the corn-for-energy market is the demand driver, lifting average prices to $4.15, roughly a 75 per cent increase over the last step.

Of course, nothing in agriculture happens in isolation. These higher corn prices also impact the price of other crops. “Over the long term, soybeans have been priced at 2.5 times the price of corn. There is also a price relationship between wheat and corn. So as corn prices rise, the prices of other commodities also rise,” says Plain.

Good times come to end

While growers are celebrating this windfall in crop prices, Plain warns that high margins are short term only and will be threatened by higher production costs.

“Growers will see good money for a while,” Plain predicts. “However, over time the price of a commodity will equal the cost of production.”

Besides, growers must consider that ethanol demand has been largely driven by government policy. Plain says that a change in policy, such as the ending of the tax incentives could quickly drop his predicted average corn price by 50 cents a bushel.

Changing the flow of corn

“If you go back a decade, you find a very different agribusiness landscape,” says Kansas State University economist Daniel O’Brien. “Ethanol is changing the direction and flow of grain.”

Traditionally, much of the grain grown in the Midwest was moved by train and barge to port for export. New investment in ethanol plants did not follow this flow. Ethanol plants are typically built in areas of corn production where the cost of corn is cheaper. As a result, O’Brien says many new market areas are bidding up the price for grain so it will flow away from traditional markets. Not only has ethanol increased the national price of corn, it is also resulting in even higher premiums being paid in local rural areas where ethanol plants have been built.

Studies have shown an average 5.9-cent-per-bushel improvement in local basis, creating a cash price benefit for growers living within a 150-square-mile area surrounding an ethanol plant. But better prices aren’t the only benefit.

“Ethanol is not a silver bullet. This is a business that survives on the margin between the prices of corn in and energy and DDGs out,” says O’Brien. “While there can be good profits, the markets for both corn and ethanol are volatile and plants need to be well managed to survive.”

What about livestock?

Good times for grain growers are often bad times for beef and hogs. The ethanol boom has been no exception. “The increasing corn prices are very hard on livestock producers,” says Plain. “In order to keep the same margins at higher corn prices we will likely see a smaller livestock industry.”

Lee Meyer at the University of Kentucky agrees meat production will decline. “My take is that the livestock sector will shrink and change unless there is dramatic change in ethanol policy,” Meyer says.

Yet Meyer says the outlook for continued high grain prices will also lead to pasture and hayland being converted to cash crops.

Bruce Babcock at Iowa State University has calculated the $2-per-bushel increase in the price of corn and $90-per-ton increase in soybean meal between April 2010 and November 2010 increased the cost of producing a pound of chicken by seven cents, a pound of pork by 15 cents, a pound of beef by 24 cents and a dozen eggs by 12 cents.

Steve Amosson, agricultural extension economist with Texas A&M, expects corn price to range between $3.50 and $4.50 f.o.b. feedlots in the High Plains region. Amosson says a rule of thumb is calf prices drop $1.50 per cwt for every dime corn prices rise. It is this drop in cattle prices which has led to the recent drop in cow numbers. Amosson believes we are now at the point where supply numbers are in line with costs and returns. However, he expects there to be lots of volatility.

Food prices versus ethanol

The most vocal critics of ethanol are those who oppose the use of food crops for fuel. As an argument in a world where millions of people are short of food, it strikes a lot of consumers and politicians as overwhelming.

However, very little of the recent food cost increase can be tied to ethanol. In fact, some studies suggest food prices would actually have shot up even higher if corn-based ethanol hadn’t displaced gasoline.

It isn’t a simple comparison to make. Large numbers of variables need to be considered in the analysis, including that consumers eat byproducts of corn, not the whole corn itself, so there are many indirect effects involving processing, transportation, and even substitution of other grains into foodstuffs.

In his 2008 paper, Ethanol and Food Prices — A Preliminary Assessment, Richard Perrin at the University of Nebraska found “ethanol is responsible for no more than 30 to 40 per cent of the grain price increases of the last 18 months. This implies that ethanol is responsible for a one to two per cent rise in U.S. food prices.”

The impact is much bigger in poor countries, however. In the developing world, says Perrin, ethanol has driven food prices up by 12 to 15 per cent because direct grain purchases are a much higher portion of the food bill in those countries.

Perrin concludes that much of the increase we have seen in food prices has been the result of the increasing energy costs of production and transportation of food, speculative purchasing of grains, and increasing food demand in developing nations.

Where to from here?

Without question, ethanol has led to an increase in grain prices. But the consensus among economists is that at best, these higher prices will result in a relatively short period of good profit margins for growers.

Increased production of corn, coupled with rising production costs due to farmers competing for land, fertilizer, other crop inputs, and costs of new technology will quickly eat into that profit margin and growers will once again be caught in another cost-price squeeze.

Growers need to ask themselves if bidding up land and inputs for higher production and short-term profits is really worth it if it simply means the profit margin is lost due to overproduction and high costs over the long term.CG