January 12, 2009

Corn producers have gotten a nice holiday gift in the form of higher futures prices, but that rally of more than US$1 a bushel is a lump of coal for one of corn's key customers, the ethanol industry.

 

Many producers were already in a precarious state prior to the rally, analysts say, and the industry has seen multiple plant closures. Corn's recent rally was quick, coming even as crude oil continued to sag, which has put even more pressure on ethanol margins.

 

"I think this market is going to be disciplined," said Michael Swanson, senior agricultural economist for Wells Fargo. Swanson and some other analysts say the rally was counterintuitive and counterproductive.

 

Corn has climbed from a low of US$3.05 1/2 cents in the nearby March contract on Dec. 5 to as much as US$4.29 on Jan. 6. It closed Thursday at US$4.06 3/4.

 

"If we rally, we're seemingly rationing demand farther," said John Kleist, broker/analyst with Allendale in McHenry, Illinois. "And that's what's counterintuitive. Why do we want to ration demand when you've got 1.5 (billion bushel) carryout and you're still going to have a pretty good amount of acres?"

 

Many analysts say there's no good fundamental answer. Technical chart momentum, dry South American weather and the need for the market to "buy" more acres in 2009 have been cited, but many analysts said poor demand isn't going away amid a worldwide recession.

 

As ethanol producers extract value out of each bushel of corn by selling the fuel and a byproduct, dried distiller grains, even the "very, very best" ethanol plants need 80 cents left over from that bushel to cover their chemical, labour, handling and depreciation costs, Swanson said. But corn prices are too high to allow even that, Swanson said. An average plant needs US$1.20 to cover those same costs, he said.

 

Marty Foreman, analyst for Doane Advisory Services, said that in the summer, ethanol was selling as much as US$1.75 higher than gasoline. Now the situation has reversed, and the gasoline premium is greater than the US government's 45-cent blending credit, reducing the incentive for blending, analysts said. The credit was reduced from 51 cents on January 1.

 

Crude oil is hovering around US$40 per barrel, while nearby Nymex reformulated gasoline blendstock for oxygen blending futures, or RBOB, are hovering around US$1.10 per gallon. February ethanol futures were around US$1.67 per gallon.

 

"It's a tough market to sell extra fuel into," Swanson said. "These farmers are thinking this is going in the right direction, let's rally another 30 cents. Well, if, they rally another 30 cents that 30 cents comes right out of the ethanol pocket. And they're not just going to run this plant just to lose money."

 

He added that ethanol plants have "a lot more discipline than everybody else" because they see the cash flow every day. He said one ethanol plant was recently offering US$2 per bushel for corn, basically saying "if you just have to get rid of corn, I'll take it."

 

Analysts say an increase in gasoline demand, which would be key to curing ethanol's woes, is possible. But some analysts, including Foreman, think corn will remain firm, bolstered by concerns that producers won't plant enough acres in 2009.

 

Corn's recent rally also doesn't help export demand, which has been anaemic for months. Analysts point out the last decent weekly month of sales was in early December when sales finally picked up with prices around US$2.90.

 

Corn's short-term rally is not as detrimental to feed demand, although analysts say livestock producers are also hurting.

 

Ron Plain, agricultural economist with the University of Missouri, said that while there is a direct relationship between corn prices and livestock, there's a lag between them.

 

Corn's descent from near US$8 in July improved livestock profitability and caused livestock producers to want to expand production. Because of the growth cycle, livestock producers can't react as quickly to changes in their costs.

 

"You can turn an ethanol plant on and off," Plain said. "You can't go out to your pigs, and say hey, 'I'm sorry, corn's expensive, hang out for the next six months and I'll be back with some more feed." 

 

Foreman said that assuming the corn market doesn't explode higher, there is some reason for livestock producers to be modestly optimistic.

 

"Assuming we don't have a further financial market meltdown, there are some ideas that you can pencil out some renewed profitability in the cattle by spring," Foreman said.