FBA Issue 22: September / October 2008
Perspective: Corn - A harvest with considerable upside


by YANG Ling, with additional reporting by Eric J. BROOKS


There is another month to go before newly harvested corn from the main production areas in China's northeast are released into the market. At that point, as supply and demand reveal their respective positions, price volatility will increase. Up to now, there has been a set of fortunate coincidences keeping prices under control. First, releases from national grain reserves kept corn prices in check earlier in the year. Later, on the back of first, a seasonal rise in livestock demand and later, mid year floods in American corn growing regions, there were two minor price rallies.


With Beijing making earlier than usual shipments of corn to avoid transport gridlock, the resulting supply increase tamed price inflation and steadied prices through this summer. Better yet, July saw CBOT corn prices track oil prices down by 25 percent from its June record high. Unfortunately, for reasons explained below, there is considerable potential for an inflationary outburst after September's Autumn Festival.


Reduced corn planted acreage

According to the latest estimate by the National Grain and Oils Information Centre, total corn acreage for 2008 was 27.7 million hectares, some 350,000 hectares or 1.25 percent lower than the previous year, when total corn acreage was 28.5 million hectares. Lured by higher profits, many farmers have converted part of their lands to  soy planting. This is especially so in the key corn growing province of Heilongjiang.


Weather conditions in the final two months before harvesting play a critical role in determining the quality and quantity of the corn harvested. Unfavourable August weather will affect October's harvest and lower China's total corn output. Needless to say, this would unbalance the uneasy equilibrium between domestic corn supply and demand. However, even under optimal weather conditions, it would be difficult to increase productivity enough to make up for the reduced acreage planted.


Hence, it would be difficult for this year's harvest to equal or exceed last year's, when demand exceeded supply. For, we can safely assume that this year's aggregate corn demand is equal to or higher than last year's.



Hyperinflating labour and fertiliser costs

Moreover, we can assume that high demand will be complimented by cost-push inflation: Leading the way are rising labour and fertiliser costs - particularly the latter, as corn requires more fertiliser than other grains. Despite government's restrictions on fertiliser exports enacted in April, prices are high and are continuing to rise amid very tight supplies.


In Jilin, prices of ammonia, a key fertilizer, zoomed upwards 108 percent from the previous year's RMB2,400/tonne to the current –and still rising –price of RMB5,000/tonne - and one must note that global fertiliser markets are suffering from considerably more serious hyperinflation than China's domestic prices. Global prices for key fertiliser compounds have tripled or even quadrupled. Despite export bans, it is difficult to say for how long the government can keep high international fertiliser prices at bay.


At the same time, farm labour costs skyrocketed by 60 percent in just one year - from RMB50 per day in 2007 to RMB80 per day in the third quarter of this year. With farm labour and fertiliser expenses both going through the roof, the average production cost per hectare jumped to RMB692.88. This is RMB148.25, or 27.2 percent higher than during the same period last year.


Nor are any other corn growing inputs providing any price relief. Average direct costs for seeds and machinery in 2008 jumped by 37.48 percent and 15.66 percent respectively. With all major inputs experiencing double-digit price increases, this is putting a very high cost floor on the price of corn.


High wheat prices undermine substitution effect

Meanwhile, high wheat prices are making it impossible to partially substitute wheat in place of corn. Newly harvested wheat prices, are higher than that of previous year.

Wheat's continual price increase has narrow the price gap between corn and wheat. Indeed, wheat prices may even surpass those of corn.


As it is uneconomical to use such high-priced wheat in place of corn, a reverse substitution effect occurs. Corn demand grows as the portion of feed once accounted for by wheat now reverts to corn. This tilts the market towards excess demand at a time when the corn harvest will either be stagnant or less than last years.



With all these factors strongly in favour of higher corn prices, much depends on the Autumn harvest. Prices will only track the overall inflation rate if the harvest exceeds 2007's amount - a possible but highly unlikely prospect.


More likely, a slightly smaller harvest than last year's will result in double digit price increases that outpaces China's already high inflation rate. If the corn harvest is 5 million tonnes less than last year's however, then severe supply shortfalls will strongly push up prices and create considerable market volatility. In that case, only another release of corn from dwindling national reserves or (assuming sufficient quantities are available), a sharp, sudden increase in corn imports could mitigate an inflationary outcome. 
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