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What will slow ethanol development next year?

USDA Baseline projections for the next 10 years were released Wednesday, with some interesting projections included in it.

The ethanol demand is projected to increase 2x last year's rate for 2007/08, with 3.2 billion bu projected used for ethanol. That's up 1.05 billion from last year, or about 2x the 550 mb expansion in 2006/07 crop year, and even larger than the 1 billion increase projected by USDA Chief Economist Keith Collins in his Jan 10 testimony to Congress. So on one hand, USDA is admitting that ethanol development is much faster than anyone expected for the 2007/08 crop year.

Yet, in the baseline projections the increase for 2008/09 ethanol use growth drops to only 500 mb, or half the speed of increase for 2007/08. It slows further again for 2009/2010 with only 200 mb increase (3.9 billion), and slows again for 2010/11 to only 100 mb (4 billion bu total). These projections indicate USDA expects a rapid slowing down of the rate of expansion of corn use for ethanol, even after admitting that next year's growth is even larger than they thought it could be.

So what is slowing down the ethanol construction for the 2008/2009 marketing year? Somewhere in the next year, USDA seems to think ethanol plant construction will slow considerably for some reason, but usually that means the return on investment is much lower. Projected prices for corn don't look overly high to slow ethanol plant building, as cash corn averages are $3.50 for 07/08, $3.60 for 08/09, $3.75 for 2009/10, and go from $3.55 in 2010/11 and drop 5c/year into 2016/17, when prices are forecast to average $3.30 cash.

USDA projected corn cash prices to average from $3.30-$3.75 for the next 10 years! While these prices are all up considerably from the past decade, yet none of these prices are above the break-even price for corn ethanol plant development (calculated at $4.05 cash corn). There seems to be a big hole here in what is going to constrict the ethanol plant development over the next few years.

It almost implies that a mandate will come out preventing additional ethanol plant construction. Yet, politicians seem to have no intention of slowing ethanol plant/alternative fuel development. So, where will the mandate come from?

In order for these 'baseline' projections to be correct, something has to emerge to slow ethanol plant development in the coming year drastically! The growth must be half the current growth and continue to be cut in half the next 3 years (from each previous year), and it's hard to imagine anything short of very high prices (well above $3.50) to make ethanol plants unprofitable. The only other alternative would be to pull ethanol subsidies for new plants. But that wouldn't just slow construction, that would end construction of ethanol plants, and they didn't project that either.

So in the end, it doesn't seem that USDA has said much at all about how ethanol will impact agriculture in this report. They simply assume construction will slow considerably from the pace we suspect it is currently at, and therefore everything comes out smooth in the end. I know of very few markets that actually work that way.

On Wednesday, prices broke after seeing this report, as USDA's implied results are that ethanol plant growth will slow quickly from where it is, and therefore problem solved. The only problem with that assumption is that it may not occur unless something causes it to slow. Has the market done enough work to that effect today?

While projected ending stocks were left very low for 2007/08 (660 mb), they really aren't projected to rise much further at any time- staying below 700 mb all the way to 2012/13, and barely getting above 805 mb by 2016/17. This seems unlikely that tight stocks all that time will not bring some spikes in prices enough to slow demand growth, and thus ethanol growth, in the coming years. More likely than the USDA projections is that some problem will come along to spike prices, and until that happens ethanol plant growth may continue. Based on this indication, the spike in prices had better come quickly and cut ethanol plant investments in half, or we will have an even bigger problem further down the road.

It looks like a 'punt' to me in explaining how this ethanol corn growth/high corn prices will play out in the marketplace. But then again, perhaps it wasn't USDA's goal to explain how it will all work. Instead, it's the marketplace that will eventually answer these questions, not a 110 page report. But based on these numbers, there will be some fireworks needed in the marketplace to shut down ethanol plant growth, or the US will run out of corn in the not too distant future! And every other crop in the US will be impacted by it, as I note soybean prices are projected to average from $6.75-$7.25 for the next decade and wheat at $4.25-$4.55 for the next decade.

Those are much better prices than the last decade for national farm averages, so obviously USDA is also admitting the world grain demand/price picture has changed a great deal from last year!

USDA Baseline projections for the next 10 years were released Wednesday, with some interesting projections included in it.

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