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Ciptapangan Visitor
Corn Is Booming as Ethanol Heats Up
posted by admin on 06/11/06

Crops Fetch New Highs, Ranchers, Food Makers Fret; Silver Lining for Taxpayers?


By SCOTT KILMAN

November 4, 2006; Page A1

The booming ethanol-fuel industry is rewriting the rules of the Midwest economy with big implications for everyone from consumers and food executives to farmers.

Over the summer, the corn-to-fuel industry was experiencing windfall profits as the price of oil soared. Those outsize profits have since retreated to more moderate levels, cooling the fever for the stocks of producers such as Archer-Daniels-Midland Co. and snarling some initial public offerings.

But the ethanol industry's continuing expansion and its ravenous appetite for corn are helping ignite the biggest bull market for grain since the 1970s, when the former Soviet Union suddenly emerged as a huge customer.

[Chart]

The price for corn -- the nation's No. 1 crop and one of the most ubiquitous ingredients in the American food supply -- has jumped nearly 55% since mid-September, when U.S. corn farmers began harvesting their third-biggest crop ever. Grain prices usually slump to their lowest levels of the year during the harvest season. Yet the price of corn in recent weeks has shot through the rarely breached $3-a-bushel mark and appears headed higher.

"The consequences of ethanol are the biggest thing going on in agriculture today," says Keith Collins, chief economist of the U.S. Agriculture Department. "We are talking about a higher new benchmark for corn."

The prospect for a new plateau in corn prices represents a shift in the balance of power in the farm sector. It also portends headaches for global food producers, which have benefited for nearly a decade from an abundant and cheap supply of ingredients made from U.S. crops, such as corn.

Corn is used for everything from fattening pigs and chickens to making soda pop and breakfast cereal. The corn rally is hitting packaged food brands already coping with a sharp run-up in wheat and sugar costs this year. "It's just a story of commodities," said Kellogg Co. Chief Financial Officer Jeffrey Boromisa late last month when explaining to analysts why the breakfast-cereal company's third-quarter gross profit margin declined from a year ago.

The trend is bruising some livestock farmers. Dairy farmer Mike Aardema, who milks 4,000 cows near Burley, Idaho, says the corn rally is increasing his livestock feed costs by hundreds of thousands of dollars a year. He usually spends about $6 million annually on rations.

"I don't like this ethanol boom," says Mr. Aardema, who worries that he might have to cut production if corn prices continue to climb. A dairy cow must eat roughly 10 pounds of corn daily in order to produce milk. In the ranching industry, it takes six pounds of corn to produce one pound of beef.

This rally is the first in decades that isn't driven by crop disasters or surges in export demand, the effects of which have tended to fade quickly and leave the agriculture sector with a brutal hangover. To be sure, economists such as Michael Swanson at Wells Fargo & Co., worry that the ethanol industry is growing too quickly, and any shakeout could quickly deflate corn prices. Rising ethanol supplies and falling gasoline prices have combined to cut the spot price of a gallon of ethanol by 45% from its record high in the summer. A surge of Brazilian imports of sugarcane-derived ethanol has contributed to the price decline.

But the ethanol industry is still so profitable, thanks in part to federal tax incentives and state mandates, that analysts are beginning to calculate that it would take corn prices of $4 a bushel to quell the industry's demand. A level that high would send an inflationary ripple through many products in the American shopper's grocery bag.

"The price of corn will have to rally a lot if it is going to slow investment in ethanol," says Dan Basse, president of AgResource Co., a Chicago commodity advisory firm.

Wall Street analysts are beginning to cut their earnings estimates for food manufacturers, figuring that the higher costs will crimp their profits.

"We believe that we are in the beginning stages of major changes to agricultural markets caused by rapidly expanding production of biofuels," said Credit Suisse Group in a report issued Friday titled "Corn Conundrum."

David Nelson, a Credit Suisse analyst, lowered his ratings on meat companies Tyson Foods Inc. and Smithfield Foods Inc. to "neutral" from "outperform." In the case of Tyson, Mr. Nelson calculates that every 10-cent rise in the price of corn shaves a nickel from potential earnings per share.

Such a high price for corn at harvest will likely spur farmers to convert pastures and idled land into new cornfields next spring. That could lift sales by companies such as Deere & Co. of tractors and Monsanto Co. of genetically modified seed. Prices of soybeans, oats, sorghum and barley have climbed in recent weeks, too. Processors that depend on those crops are suddenly willing to pay more in order to discourage growers from shifting their farms to corn.

The rally in corn, which is helping to generate record trading volume in the agricultural pits at the Chicago Board of Trade, could have a silver lining for taxpayers. Last year the federal government sent roughly $8.9 billion in subsidy checks to corn farmers to compensate them for low prices. Rising market prices might reduce the government's subsidy obligations to the point that federal checks to corn farmers could fall to $2 billion annually by next year, according to government analysis.

While food executives have fretted for more than a year about the amount of corn being diverted to ethanol, the magnitude of this new competition is only now becoming clear.

With 106 ethanol plants already in operation, an additional 48 plants are under construction and seven are undergoing expansion, according to Renewable Fuels Association, an ethanol trade group. The U.S. Agriculture Department is predicting that the ethanol industry will consume 2.15 billion bushels of this year's corn crop, which is now in the process of being harvested across the Midwest. That amount represents 20% of the total U.S. corn harvest and 63% more corn than the industry used just two years ago.

Within a year or so the U.S. will probably be using more corn to make fuel than it ships to foreign customers. One result of that growth is that the food industry will have to become accustomed to far less corn laying around in storage as a hedge against crop disasters.

According to a monthly Agriculture Department forecast due to be updated Thursday, the expected corn harvest of 10.9 billion bushels is about one billion bushels short of demand in the next 12 months. That will help draw down supplies to the tightest level since 1995, when a summer heat wave devastated Midwest crops.

At the Lincolnway Energy plant in Nevada, Iowa, which started producing ethanol in May, the drop in ethanol prices is doing little to dissuade company officials from plans to build a second ethanol plant in nearby Des Moines. One reason: Even though rising corn prices make big profits harder to obtain, many of the plant's owners are also corn farmers. They are betting that any thinning of their dividend checks from the plant will be offset by higher corn income.

Write to Scott Kilman at scott.kilman@wsj.com


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