Speculators, ethanol, fundamentals: What's driving corn prices?

Speculators, ethanol, fundamentals: What's driving corn prices?

Sharp decline in corn prices attributable to a 2013 bumper crop and increased grain stocks, but ethanol effects still support current corn prices at about twice their typical level.

*Dr. Tom Elam is president of FarmEcon LLC.

A POULTRY industry leader recently forwarded me an email from a corn producer blaming "wealthy speculators" for lower corn prices.

He was also wondering what had happened to the price-boosting effects of the renewable fuel standard (RFS) mandate.

This article will show that current corn prices are consistent with both higher corn production and strong 2014 ethanol production. "Speculation" is not required to explain current prices.


Corn price drivers

Speculators, ethanol, fundamentals: What's driving corn prices?
Since 2005, there has been a fundamental shift in the demand/price relationship of U.S. feed grains. That shift is dominated by the increased use of U.S. corn for ethanol production and higher energy prices that have boosted the value of corn as a fuel. Absent that ethanol-induced shift, the underlying relationship between corn prices and the stocks:use ratio for total feed grains has not changed.

The corn price shift is starkly evident in the Figure, which shows corn prices versus the stocks:use ratio for total U.S. feed grains (corn, sorghum, barley and oats).

As shown, prior to the 2006 feed grain crop, there was a stable relationship between how "tight" ending stocks were and the season average farm-level corn price. From a very basic supply/demand balance viewpoint, this makes perfect sense. As feed grain stocks decline relative to total usage, corn prices are bid up, giving farmers incentives to plant more feed grains in the next year.

Increasing stocks relative to total usage indicate that less feed grain production is needed, so prices fall, and plantings and production decline.

The black line in the Figure represents the plot of a regression equation that best fits the corn prices and feed grain stocks:use ratios from 1990 to 2005. That predictable relationship between the ratio and corn price has obviously changed dramatically.

At all stocks:use ratios since 2005, the season average farm level corn price has been substantially higher than the 1990-2005 relationship shows. This change coincides precisely with changes in federal biofuel policies and an increased use of corn to produce ethanol for fuel.

While fuel ethanol has been produced from corn for well more than 40 years, only after the RFS was created in 2005 and increased in 2007 did corn use for ethanol production become a major factor in U.S. corn demand.

To estimate the impact of that increase in ethanol's use of corn, a threshold variable was calculated as ethanol production in excess of 4 billion gal. per crop year. The 4 billion threshold is due to the fact that ethanol production first exceeded that level in 2005, the year the original RFS was created.

Higher corn use for ethanol has also made corn prices sensitive to energy prices. In recent crop years, corn prices have been positively correlated to ethanol and gasoline prices. In contrast, from 1990 to 2005, the correlation between corn price and ethanol price was actually negative. The positive correlation between ethanol and corn prices emerged only as ethanol prices exceeded about $2/gal.

Including data for the 1990-2011 feed grain crops, a model was estimated to include the effects of ethanol production and price. Results are shown in the Table. The stocks:use2 variable is used because the relationship is not a simple straight line.

The R-squareof this equation is 0.94. All coefficients have the correct theoretical sign, and all are statistically significant. The intercept and two coefficients for the stocks:use ratio are essentially identical to the "pre-ethanol" regression model estimates for 1990-2005 shown as the black line in the Figure. That is, the underlying relationship between stocks:use and corn price has not changed since 2005. All of the 2006-13 increase in corn prices above the black line are due to ethanol production and price effects.

Every 1 billion gal. of ethanol production above 4 billion gal. is associated with an increase in corn prices of about 21 cents/bu. A $1/gal. increase in ethanol prices over $2/gal. is associated with an increase in corn prices of about $1.64/bu. In both cases, the effects are independent of, and additive to, any effects that increased ethanol production may have had on lowering the feed grain stocks:use ratio.

That is, not only has ethanol's increased use of corn caused feed grain stocks:use ratios to be smaller, but it has also further increased corn prices beyond what those ratios would have indicated based on the historical 1990-2005 relationship.

As shown by the green dots in the Figure, the equation can be used to forecast an average price for the 2013 corn crop. Using the U.S. Department of Agriculture's November 2013 feed grain stocks:use ratio estimate of 14.7%, 2013-14 crop year ethanol production of 13.5 billion gal. and an average Omaha, Neb., ethanol price of $2.25/gal., the estimated season average corn price is $4.59/bu. The midpoint of the USDA November corn price forecast is $4.50 — very close to the model forecast.

If ethanol production was under 4 billion gal. and ethanol prices were less than $2.00/gal., the model would forecast a 2013 corn price of $2.17/bu. at a 14.7% stocks:use ratio, about half the forecast that includes ethanol production and price effects. How much of that ethanol effect is due to the 2007 RFS mandate and how much would have happened anyway is highly debatable.



The sharp decline in 2013 corn prices is totally attributable to a 2013 bumper crop and the resulting increase in grain stocks. Higher prospective stocks have reduced corn prices to levels near those seen at similar stocks:use ratios from 2007 to 2009.

If these post-2006 higher levels of ethanol production and prices continue, they will support 2013-14 corn prices at about twice the level that the underlying pre-2006 relationship between stocks:use and corn price would indicate. On balance, for the 2013 corn crop, higher production and stocks have swamped the positive corn price effects of ethanol production and prices.

We do not need to resort to blaming lower corn prices on "wealthy speculators." Neither do we need to ask what happened to the corn price effect of higher ethanol production and prices. Those ethanol effects are still with us, supporting current corn prices at about twice the level they would otherwise be at the forecasted 2013-14 marketing year-ending stocks:use ratio.

Editor's Note: Dr. Elam discussed his outlook for 2013-14 corn and soybean production in a recent edition of the "Feedstuffs in Focus" podcast that is posted at www.Feedstuffs.com.


Regression for season average corn price and 1990-2011 feed grain stocks:use ratio













Stocks:use ratio




Stocks:use ratio2




Ethanol production, over 4 bil. gal.




Ethanol price (Omaha blender), over $2/gal.




Sources: U.S. Department of Agriculture, World Outlook Board, U.S. Department of Energy and Nebraska Energy Board.



Volume:85 Issue:48

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