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Let Them Eat Rice

Washington's unedifying ethanol food fight.

12:00 AM, Jul 25, 2008 • By DAVE JUDAY
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A cheap dollar also pulls up prices through export demand. That is certainly happening now. Normally, $6.00 per bushel corn would not be exportable--the cost would be way too high. But with the dollar so devalued, exports continue. Indeed, total U.S. exports are up--a full 13 percent from the 2003-2007 average, which amounts to an extra 258 million bushels exported. Ethanol's use of corn, however, grew almost four times faster--by one billion bushels from last year to this. Overall, USDA projects exports will account for 2.1 billion bushels of corn this year, while ethanol will account for 4 billion bushels.

And what about the impact of the Chinese livestock and meat complex, alluded to by Senator Grassley? According to China expert, Darrell Ray, Director of the University of Tennessee's Agricultural Policy Analysis Center, "China has not been importing corn to grow her livestock industry. China continues to export more corn that she imports. With regard to grains, China has been taking care of China as if it were a planet on to its own, completely independent of what is happening elsewhere. . . . To attribute today's international grain prices to China essentially assumes that beginning two years ago the market decided there may be a need for China to become a net importer of some corn in the future, say 2012, and so bid-up the price of corn by double."

Finally, there is the skyrocketing cost of oil. Certainly, high oil costs push up the cost of producing corn, a very energy-intensive crop. Oil prices, however, are not keeping pace with the rate of increase in corn prices, believe it or not.
According to an authoritative study conducted by the Department of Agriculture in 2003, it takes 49,753 BTU's to produce a bushel of corn. That is inclusive of all energy inputs--from manufacturing and applying pesticides, to operating irrigation, to the energy used in providing custom labor work, etc. Considering that each barrel of oil has 5.8 million BTU's, it takes less than one percent (0.86 percent) of the total energy in a barrel of oil to make a bushel of corn. Even when oil hit $147.02--its record close on July 11--that amounts to $1.25 of energy costs per bushel of corn, which was priced at $6.39 on that same day.

Percentage-wise, that is roughly 19 percent of the cost of a bushel of corn. Relatively, that ratio is low compared that ratio over the past couple of years since the RFS was enacted. Look back to April 2006--immediately before the major influx of ethanol came on-line. Corn was $2.20 per bushel; oil was $69.44. That yielded a ratio of 27 percent of the price of corn being attributable to energy costs. Since November 2007, when oil broke $90, the ratio of energy costs as a percent of the price of bushel of corn has dropped from 23 percent to the high teens. In short, corn prices are rising faster than oil prices, and that renders doubtful the argument that energy costs are somehow pushing corn beyond its market worth.

In summary, monetary policy, energy costs, export demand, and exchange rates are all catalysts--and can be powerful in their role--but the fundamental longer term trend driving commodity market bullishness is the ethanol mandate. In 2001-2002, ethanol comprised about five percent of the corn crop use; in 2008-2009, because of the RFS, ethanol will comprise 33 percent of total corn use. Moreover, federal law mandates that the use of corn-based ethanol grow from the current nine billion gallons to 15 billion gallons--a 67 percent increase--over the next six-and-a-half years.

The market has seen spikes of high corn prices over the past 10 years, but the food processing industry (or the livestock industry) often absorb short run high price spikes in commodity prices. Ethanol, however, is driving corn prices for the long run--there is a minimum guaranteed demand for corn-based ethanol that will increase year over year for the next seven years, and will remain constant for at least another seven years after that thanks to the RFS. That upward pressure will get pushed into food costs for the long run.

Moreover, the worst is probably yet to come. Indeed, a majority of the corn that is in the food products and meat we are currently eating was purchased out of the crop harvested in the fall of 2007, at an average price of $3.50 to $4.00 per bushel. Most of what we will be eating next year will come out of a harvest that would be priced somewhere between $6.00 to $6.75--based on a normal harvest from this spring's planting. Once the flood damage to the Midwest is assessed, those prices could be significantly higher. Food and beverage prices in April 2008 were 10.18 percent higher than they were in April of 2005 before the RFS was implemented--and corn prices are still climbing.