The FarmPolicy.com News Summary

Neil King Jr., Chip Cummins and Russell Gold http://online.wsj.com/article/SB119932015772763671.html?mod=todays_us_page_ one  reported in today’s Wall Street Journal that, “The surging price of oil, from just over $10 a barrel a decade ago to $100 yesterday, is altering the wealth and influence of nations and industries around the world.”

The Journal indicated that, “No one can say for sure whether sky-high oil — part of a price boom in a wide range of commodities, from gold to wheat — is here to stay. But most in the industry agree that a 20-year stretch in which oil was consistently cheap is long gone. The global thirst for oil shows little sign of retreating, and large new discoveries are few. Some in the industry say prices could go far higher; others suspect that speculators — or an economic slump in the U.S. or China — could send prices falling in the near term.

“Yesterday, with a single trade, crude-oil futures hit an intraday high of $100 a barrel, a record for the U.S. benchmark. For the day, they rose $3.64 to a record close of $99.62 a barrel. Crude is still shy of the inflation-adjusted peak of $102.81 a barrel set in April 1980, amid political turmoil in Iran and unrest elsewhere in the Middle East. The 1980 peak in nominal terms was $39.50 a barrel.”

More specifically with respect to ethanol, the Journal article went on to explain that, “Pricey oil and a quest for ‘energy independence’ have led to an ethanol boom, but higher corn prices now pinch that industry’s profits. Historically, ethanol sold at a premium to gasoline; today there’s so much ethanol available that it’s selling at a discount.

“Even in abundance, ethanol is a tiny factor in the U.S. fuel market, displacing a little more than 200 million barrels of crude oil annually, according to the Renewable Fuels Association. The blend of 85% ethanol and 15% gasoline called E85 is available at only bout 1,400 of the roughly 170,000 U.S. fuel stations. And though ethanol is blended into most U.S. gasoline, at up to 10%, calls to dial up that percentage have sparked controversy because of concern this might increase certain forms of air pollution.”

Although President Bush just signed a new energy bill last month http://www.farmpolicy.com/?p=573 , Wall Street Journal writers Greg Hitt, Elizabeth Holmes and Alex Frangos http://online.wsj.com/article/SB119933328695164469.html?mod=todays_us_page_ one  reported today that, “Concerns about U.S. dependence on foreign oil are spilling into the race for the White House and fueling the clash between President Bush and Congressional Democrats.

“Presidential contenders yesterday pointed to the latest surge in the price of oil — which hit $100 a barrel for the first time — as fresh evidence of the need for more aggressive action by the government to increase the nation’s energy independence.”

The article noted that, “With the public mood dark, the energy issue has become a defining plank in the platforms for most major candidates, Republicans and Democrats alike. Wide bipartisan majorities backed legislation in December designed to ease the nation’s dependence on fossil fuel. The measure would raise vehicle fuel-economy standards to 35 miles a gallon by 2020, a 40% increase. The legislation would also increase production of clean-burning ethanol and other biofuels. But the impact of these moves won’t be felt for years.”

Meanwhile, an update posted yesterday at The Ethanol Report http://www.ethanolrfa.org/industry/conference/blog/2008/01/02/ethanol-group s-react-to-record-oil-price/  also cited the new oil price benchmark, stating in part that, “Renewable Fuels Association President Bob Dinneen issued the following statement on the unhappy milestone of the new year:

‘Oil’s unprecedented rise to $100 a barrel underscores our economic and geopolitical vulnerability to depleting oil reserves. While developing new oil reserves is proving more difficult and expensive, the American ethanol industry is rapidly developing new cost-effective technologies that will greatly reduce our nation’s reliance on imported oil from unstable regions often hostile to the United States.’

“‘Developing new petroleum sources requires more energy-intensive and environmentally-questionable practices, such as the extraction of oil from the tar sands in Canada. Conversely, next generation ethanol technologies will improve ethanol’s already green footprint and allow for greater ethanol production from resources ranging from corn to switchgrass to wood waste and garbage.’

“‘The continuing volatility of world oil and energy markets highlights the importance of the energy legislation Congress passed late last year. By pairing higher fuel economy standards with the increased use of renewable fuels from non-traditional feedstocks, our country now has a policy and plan in place to begin mitigating the impact of volatile and ever-increasing world oil prices.'”

Oil Prices- Corn Prices and Ethanol Profitability

Recall that back in May, University of Illinois Agricultural Economists Gary Schnitkey, Darrel Good and Paul Ellinger indicated (“Crude Oil Price Variability and its Impact on Break-Even Corn Prices”) http://www.farmdoc.uiuc.edu/manage/newsletters/fefo07_11/fefo07_11.html that, “For the 2006 ­ 2007 marketing year, 2.15 billion bushels of corn, accounting for 11 percent of total U.S. corn consumption, will be used to make ethanol. More corn is projected to be used in ethanol production over the next several years. If corn remains the predominant feed stock, nearly 4.5 billion bushels of corn could be used annually in ethanol production beginning in 2007-08 or early 2008-09 marketing years.

“Increasing use of corn in ethanol production holds the promise of increasing corn prices such that average corn prices in the future will be higher than average historical prices. However, ethanol production may not reduce corn price variability. As corn use in ethanol production increases, corn prices will be more influenced by oil prices. Like corn, crude oil and gasoline are commodities and are subject to price swings as a result of supply and demand changes.

“Once Federal mandates for use of biofuels are reached, ethanol’s primary use will be as a substitute for gasoline. As such, the ethanol price will have to be competitive with the gasoline price so that consumers will buy ethanol-blended fuels. Because corn is the major production cost for ethanol, the price an ethanol producer will be willing to pay for corn, hereafter referred to as the break-even corn price, will be directly related to the ethanol price. As the ethanol price increases, the break-even corn price increases. Moreover, ethanol price will be directly related to crude oil price. Therefore, break-even corn prices will be positively related to crude oil prices. As crude oil price increases, the price of gasoline will increase leading to higher ethanol and break-even corn prices. Conversely, decreases in crude oil price will lead to a lower gasoline price, a lower ethanol price, and a lower break-even corn price.”

The paper went on to state that, “For a range of crude oil prices, two corn break-even prices are calculated. The first break-even price is the price that would allow the ethanol producer to just recover variable costs of production. As long as corn can be purchased below this price, existing ethanol plants will find it economically advantageous to produce ethanol. The second break-even corn price is the price that would allow the ethanol producer to just recover all economic costs of production. As long as corn can be purchased below this price, there would be incentive to expand ethanol production capacities.”

Research results were then summarized in this table http://www.farmdoc.uiuc.edu/manage/newsletters/fefo07_11/table1.JPG ; note that based on this analysis from May, at a crude oil price of $100 per barrel, a break-even corn price is estimated at $7.93 (covering variable costs) and $7.38 (covering all costs).

Near the conclusion of the report, the authors explained that, “While corn prices may be higher than historical averages, there is little reason to believe that they will be less variable. Oil prices will have increasing impacts on corn prices. Historically, crude oil prices have exhibited variability. Moreover, options contracts indicate that oil prices will be variable. This variability may cause more corn price variability than has occurred in the past. This variability may be further exacerbated by corn production risks and low levels of stocks which may further contribute to corn price variability.”

The Center for Agricultural and Rural Development at Iowa State University conducted a similar analysis last year (“The Long-Run Impact of Corn-Based Ethanol on the Grain, http://www.card.iastate.edu/publications/DBS/PDFFiles/06bp49.pdf

Oilseed, and Livestock Sectors: A Preliminary Assessment http://www.card.iastate.edu/publications/DBS/PDFFiles/06bp49.pdf ,” November 2006) and concluded that when the market price of crude oil is $60 per barrel, the breakeven market price for corn would be $4.05 per bushel. Based on the inverse relationship between the price of a barrel of oil and the relative cost competitiveness of ethanol, the Iowa State economists found that the breakeven price of corn would fall to $2.67 when the price of oil was $40 per barrel and would increase to $5.43 if the price of crude oil rose to $80 per barrel.  (See summary of results here http://farmpolicy.typepad.com/farmpolicy/files/CARDOilCorn.jpg ).

Economists at Purdue University have conducted similar modeling simulations based on the relationship between the price of crude oil, the price of ethanol, and the price of corn. Based on their modeling, Chris Hurt, Wally Tyner, and Otto Doering (“Economics of Ethanol http://www.ces.purdue.edu/extmedia/ID/ID-339.pdf ,” December 2006) found that if the market price of crude oil was $60 per barrel, ethanol producers could pay up to $3.96 per bushel of corn and still breakeven. However, the model also incorporated the value of ethanol as an additive and estimated that with an oxygenate premium of $0.25 per gallon, ethanol producers could purchase corn at $4.82 per bushel and still breakeven at an oil price of $60 per barrel.  (See summary of results here http://farmpolicy.typepad.com/farmpolicy/files/PurdueOilCorn.jpg ).

The robust market price of oil, in conjunction with the newly mandated Renewable Fuels Standard will likely continue to impact the agricultural economy.  In fact, some farm policy observers have opined that the energy bill could overshadow the importance of the Farm Bill.

A Purdue University news release http://news.uns.purdue.edu/x/2007b/071221HurtEnergyBill.html  from last month stated in part that, “President Bush signed into law on Wednesday (Dec. 19) an energy bill that will have a larger long-term impact on U.S. agriculture than the pending farm bill, said a Purdue University expert.

“By increasing the Renewable Fuels Standard (RFS) to 36 billion gallons by 2022, the bill provides a road map for the production of renewable fuels from our nation’s farms and forests.

“‘This is not market driven,’ said Chris Hurt, Purdue Extension agricultural economist. ‘It’s policy driven with billions of dollars and it’s really going to change America.'”

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As the demand for corn to produce ethanol persists, and a multitude of other market factors take hold, prices for some program crops have ratcheted upwards.

Based on these higher than average prices, news and analysis has focused on spring planting decisions.

A Reuters news article from yesterday (via DTN http://www.dtn.com/forms/ag/try/dtnonline/) stated that, “With an eye to world prices, U.S. farmers will expand their plantings of soybeans and wheat by roughly 8 percent this year while paring corn seedings by 6 percent, say two projections by agricultural economists.

“Prepared separately, the projections by Agriculture Department chief economist Keith Collins and by American Farm Bureau Federation economists http://www.fb.org/newsroom/nr/nr2007/12-18-07/December2007MarketUpdate.pdf foresee a 10 million-acre (4 million-hectare) increase in wheat and soybeans. Corn plantings would fall by 6-6.5 million acres (2.5 million hectares).”

The Reuters article noted that, “USDA’s Collins said the high cost of nitrogen will contribute to smaller corn plantings. Record-high wheat prices will encourage larger sowings, he told USDA’s radio news service.”

The American Farm Bureau summary of projected acres is available here http://farmpolicy.typepad.com/farmpolicy/files/acresplanted.jpg, while the Reuters article included this summary table http://farmpolicy.typepad.com/farmpolicy/files/ReutersSummary.jpg of planting estimates from Farm Bureau and Dr. Collins.

Food Prices

As commodity prices rise, media attention continues to focus on the price of food.

Julie Jargon, David Kesmodel and Janet Adamy http://online.wsj.com/article/SB119932361635363833.html reported in today’s Wall Street Journal that, “With the rising cost of milk, eggs, meat and produce contributing to the biggest jump in food prices in 17 years http://www.ers.usda.gov/Briefing/CPIFoodAndExpenditures/ , consumers are starting to feel the pinch.

“Some shoppers, already dealing with falling home values and rising fuel costs, are finding creative ways to save, opting for cheaper ingredients and private-label goods and leaning more heavily on discount grocers. And restaurant diners, who have been eating out less frequently, will likely face even higher prices on menus.”

The Journal article went on to explain that, “Many of the price increases seem small on a per-item basis. The average retail price of a dozen eggs went up 38% to $1.86 in November from a year earlier; a gallon of milk rose 30% to $3.90; and whole-wheat bread rose 12% to $1.78 per pound, meaning a 24-ounce loaf of bread now costs, on average, $2.67. But the costs can add up on a weekly grocery bill. Overall, food prices as measured by the consumer price index rose at a 5.3% seasonally adjusted annual rate through November, compared with a 2.4% rise for all of 2006. That is the biggest increase since 1990.

“Food prices are rising for a number of reasons. A growing middle class in Latin America and Asia can afford more meat and milk, which has driven up demand for grain to feed cattle and hogs. A drought in Australia in 2006 reduced the supply of milk available to Asia, further pushing up the cost. Rising global demand for U.S. wheat and poor harvests in other wheat-producing countries caused wheat prices to soar to record levels last year.

“Demand for grain-derived ethanol, driven by government incentives, has helped push up corn and soybean prices, which in turn have raised the cost of many products derived from those crops, such as oils and high-fructose corn syrup, a sweetener used in everything from soft drinks to ketchup. To top it off, rising fuel costs are making it more expensive to transport food from the producers to stores and restaurants.”

The Journal article also included this helpful summary graph http://s.wsj.net/public/resources/images/PJ-AL572_FOOD_20080102214130.gif regarding food prices.

In addition, this recent audio report http://www.theworld.org/?q=node/14939 , which aired late last month on The World Radio program, provided an interesting angle on food price increases. A summary of the radio segment stated that, “Rising incomes in places like China and India have increased demand on the world’s food supply. Matt Sepic of KWMU in St. Louis explains how that’s putting a squeeze on US food pantries.”

And, a recent USDA Radio segment with outgoing Chief Economist Keith Collins (MP3 file available here http://audioarchives.oc.usda.gov/audio/features/mp3/OC-S-1623C-01-W_7976B30 B4B14473AB790BE21AE6D1871.mp3 ), also hit on the food price issue (among other topics).

Farm Bill

In Farm Bill news, Philip Brasher http://www.desmoinesregister.com/apps/pbcs.dll/section?category=PluckPerson a&U=2185bc81de004debacbdd061ab010ec2&plckPersonaPage=PersonaBlog& ;plckUserId=2185bc81de004debacbdd061ab010ec2  reported yesterday at The Des Moines Register’s Cash Crops Blog that, “Democrats are going to have a tough time as it is agreeing among themselves on a subsidy means test that is anything close to what the Bush administration wants. The means test is a powerful negotiating point for the White House, just because it’s about the only issue with the farm bill that will resonate with the public at large.

“The negotiations between the House and Senate are certain to take several weeks to complete once they start. Aides to the House and Senate agriculture committees started some informal discussions before Christmas, says Kate Cyrul, a spokeswoman for Iowa Sen. Tom Harkin. He’ll chair the House-Senate conference committee that will be charged with writing the final bill. Harkin, who is chairman of the Senate agriculture committee, also met with his House counterpart, Minn. Rep. Collin Peterson, and the senior Republicans on the two agriculture panels.

“The House isn’t due back in session until Jan. 15. The Senate is scheduled back a week later.”

Keith Good President FarmPolicy.com, Inc.
Journalism Fellow German Marshall Fund of the United States
(t) 217.356.2269 Champaign, Illinois