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Ethanol's growth and implications for grain producers

Midwest agriculture is in the midst of a rapid shift from primarily a food producer to being a major source of energy as well. Exceptionally high world crude oil prices in the last three years have brought huge investments in ethanol plants throughout the Midwest and even in areas far from the Corn Belt.

In Iowa, combined corn processing capacity for ethanol and other corn products will soon be equivalent to more than half of the 2006 Iowa corn crop. If all planned plants are built, processing capacity would be equivalent to 133% of last year's crop -- within three to five years. At the national level, existing processing capacity and plants under construction or being expanded will likely boost total capacity to the equivalent of about 40% of last year's corn production -- within the next 15 to 18 months. If all planned and proposed corn-based plants in the United States were built, corn processing capacity would exceed the 2006 U.S. crop by at least one-fifth. Current returns for processing corn into ethanol are quite favorable.

Until the economics of converting corn to ethanol deteriorate through higher corn prices and lower ethanol prices, the expansion is almost certain to continue. Because of limited crop acreage, U.S. processing of corn for ethanol appears likely to reach an upper limit of about 5.5 billion bushels by the end of this decade. If crude oil prices were to fall sharply, the upper limit would be a bit lower. Crude oil prices have been drifting lower in recent weeks, but both the U.S. Department of Energy and the New York futures market expect the decline to end soon, with prices trending upward in the years ahead.

Another indication of pressure to increase corn acreage comes from current supply figures and demand prospects for the current marketing year. Last year's U.S. corn yield was the second highest on record. Even so, production was about 1.3 to 1.4 billion bushels below potential demand. Most of the production-use gap this year can be filled by drawing down the large carryover stocks to minimum levels needed for normal operations from August 31 until new crop supplies are available. However, the market also will need to ration away about 100 to 200 million bushels of demand through higher prices. This is the second consecutive season that production has fallen short of market demand. The 2005 U.S. crop was about 200 million bushels below total use.

For the 2007-2008 marketing year, beginning carryover stocks are expected to be about the minimum level needed by the grain trade, a very tight 3.0 to 3.5 weeks' supply. That means production will need to be large enough to fill the current production-use gap and also accommodate at least another billion bushels of demand, growth that is anticipated as newly constructed ethanol plants come online in the next 12 months. Feed demand also appears likely to remain large, but exports may decrease modestly next season if foreign crops are better than in 2006.

With rapidly expanding ethanol demand, the main job of the corn market through spring will be to keep corn prices high enough to encourage at least a 12% to 14% increase in 2007 U.S. plantings. Further increases appear almost certain to be needed again in the following two or three years. Acreage of grain, soybeans, and cotton nationally has declined by about 15 million acres in the last 10 years. Declining total acreage tells us that most of the extra corn acres will have to come from other crops. That means shifting soybean acres to corn, although a few extra corn acres may come from oats, hay, and pasture, as well as wheat in the eastern and extreme western parts of the Corn Belt.

In the main Corn Belt, there are 7.1 million acres in the Conservation Reserve Program (CRP), which includes buffer strips along streams and ditches, reclaimed wetlands, and reforested land. Realistically, a maximum of around 3.5 to 4.0 million CRP acres may be released from CRP for corn and soybean production over the next few years. There is speculation that some of these acres will be released for cropping in 2007, but at this time, no decision has been made. Much of the 37 million acres of CRP land is in the Great Plains, in areas too dry for corn. As the Soybean Belt moves farther west, displacing wheat, oats, and barley, some CRP acres in that region may be returned to wheat production.

The grain markets are sending a strong signal to farmers to consider shifting substantial acreages from soybeans to corn. In recent weeks, cash corn prices have been nearly double last summer's levels, while soybean prices have been up only 25 to 40 percent. Whether it makes sense to shift your rotations to more corn this year and in the future will depend on:

  • your soil types and topography;
  • the yield drag you expect with back-to-back corn acres;
  • impacts of shorter planting and harvesting seasons on your operation;
  • availability of best-yielding varieties of seed corn; and
  • available storage, drying, transporting, and unloading capacity on your farm and at local elevators.

Sizable shifts to more corn appear likely in the best corn-growing regions of the Midwest. However, some areas will not shift as much land to corn as in central and northern Iowa, southern Minnesota, central and northern Illinois, and areas of Nebraska where irrigation water is adequate for more corn acres. A very sharp increase in corn acres will be needed in the best corn-growing areas to push U.S. acreage up by 12% to 14% this year. Failure to reach this level of acreage and/or below-trend yields in 2007 would bring very strong corn prices in the next year.

Midwest agriculture is in the midst of a rapid shift from primarily a food producer to being a major source of energy as well. Exceptionally high world crude oil prices in the last three years have brought huge investments in ethanol plants throughout the Midwest and even in areas far from the Corn Belt.

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