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Multi-year market impacts of ethanol explosion

11/15/2006 @ 2:59pm

The past few weeks I've talked about the heady bullish indications we've been getting from our USDA Chief Economist, Dr. Keith Collins (see http://www.usda.gov/oce/index.htm and click on his Sept. 6 or Oct. 12 presentations), and also the Iowa State University preliminary study on ethanol plants (http://www.card.iastate.edu/, click on Nov. 6 report).

These were some pretty bullish market indications, including Collins assertions of the possibility that corn would run to new highs, the possibility that the ethanol demand was like the Russian grain demand shock in the 70's, and ISU's conclusions that at current price levels of crude oil and the ethanol subsidy, ethanol plants could pay $4.05 for cash corn and still cover all their costs (including investment costs).

These are some pretty interesting things, but there is another story here that is still untold, and that is the interesting numbers game to be played with S/D numbers into 2007 and 2008. In the 2006 market year, we had a pretty good corn crop and record large soybean crop yield wise, with pretty decent overall production numbers. Yet, corn carryout is still projected to fall 1 billion bushels. That billion bushels is about 6.7 million acres of harvested production, or about 7 million planted acres (at 150 bu/acre). So realistically, given the demand projected this marketing year we would have needed another 7 million acres of planted corn to keep carryout unchanged. Because we had 2 billion carryout to begin with, this first drop in carryout is not such a major concern (after all, we still have a billion bu or so left over at the end of the year).

As I believe the market has already looked forward to 2007, so must we look forward and see what the market is so concerned about to rally $1+ in just 2 months (yes, we are looking ahead to 2007 S/D today, and not waiting until next March/April to do so). If we only had to worry about demand equal to 2006, it wouldn't be as great a stretch to get 7 million more planted acres of corn to keep carryout unchanged. But the problem is that ethanol use will probably expand again aggressively in 2007. But how much?

Current USDA projections for ethanol demand are 2.1 billion bu to produce 5 billion gallons of ethanol in 2006. Currently there are 106 ethanol plants producing these 5 billion gallons, with another 48 under construction (some estimates as high as 62 under construction) and 7 expanding capacity. There also are estimates as high as 231 additional plants in the planning stages. Even if just the plants currently being built are completed, we still are looking at a significant expansion well into 2008. If even one-forth of the planned ones still go ahead, it expands well into 2009 and 2010.

From current USDA statements, Pro Ag's best estimates of ethanol production is 7 billion gallons in 2007, 8.5 billion in 2008, 9.5 billion in 2009, and 10 billion in 2010. The bushels needed to use for ethanol would expand to 2.85 billion in 2007, 3.4 billion in 2008, 3.8 billion in 2009, and 4 billion in 2010. The projected expansion in ethanol alone (and other demand unchanged) would mean we need an additional 5 million acres of corn in 2007 just to meet expanded ethanol demand (that we need to add to the 7 million to prevent losing another billion bu carryout like we did in 2006), an additional 3.7 million acres in 2008, 2.5 million in 2009, and 1.25 million acres in 2010.

That means an expansion of around 12 million planted acres in 2007 is needed to meet all demand and leave roughly 1 billion carryout (a comfortable amount). And we'd need additional acreage expansions in 2008-2010 of 7.5 million in addition to the acreage hike in 2007, or a net 19.5 million acre expansion in 4 years! That's a lot of acres, and almost everyone agrees the market is probably not capable of expanding corn acreage that fast - especially for the 2007 year. That leaves a lot of pressure on prices to cut demand somewhere to make demand equal supply.

For 2007, the market can probably take as much as 7-8 million acres from soybeans (about 280-320 mb less production than this 2006 year) and still have a comfortable soybean carryout. This is the most logical conclusion one can reach, as with 565 mb current soy carryout, there's plenty of room for lost acres here. Now 2007 soy carryout is down to 240 mb. But in 2008, we need another 3.7 million acres of corn to feed the additional ethanol demand for that year's new plants, so once again we may need to rob soybean acres to meet the ethanol demand. Now we cut soybean acres even further (say 420 mb from 2006?) and 2008 soybean carryout goes very negative - not possible in a food/feed environment. Somewhere along the line, we have a supply problem which needs to be worked out by the marketplace.

So there's the conundrum which puts as Collins said, "...a gleam in some corn producers' eyes but a frown on some corn users faces." Particularly in 2007, we have a corn acreage shortage of perhaps up to 12 million acres (maybe 9-10 million with some demand cuts due to high prices).

This shortage could be mostly answered by causing producers to shift 8 million or so of soybean acres (no small task to producers used to a 50-50 rotation). But then you create a big problem in soybeans for 2008 (negative carryout in beans if the acres go to corn, not enough corn if the acres stay or shift back to beans). Perhaps the biggest bidding war for acres might come in 2008, not 2007, as soybeans in 2008 will have to really bid for acres and not just tag along behind corn gains.

The market has a huge job to do in the coming few years, not just 2007, and one which will include huge price volatility/uncertainty and bumps and grinds around the issues. Corn should be the bull leader going into 2007, then we have the typical weather cycle (which could be huge if we have below trend yields), and then perhaps a more pronounced bidding war for acres in 2008 that includes soybeans. By the end of 2008, we should have a lot of problems solved, but where will prices be at? Is the market trying to cut demand now (while supplies seem plentiful) to reduce the adjustments later?

If everything works out as diagramed here, it could be a very interesting few years, indeed! And all caused by the little ethanol snowball that just keeps growing with time, and is becoming a corn market giant!

The past few weeks I've talked about the heady bullish indications we've been getting from our USDA Chief Economist, Dr. Keith Collins (see http://www.usda.gov/oce/index.htm and click on his Sept. 6 or Oct. 12 presentations), and also the Iowa State University preliminary study on ethanol plants (http://www.card.iastate.edu/, click on Nov. 6 report).