Increasing Ethanol Demand and the Likely Price Implications for Corn

by: Naveen Musunuru

According to the March 31st prospective plantings report released by USDA, farmers in the U.S. intend to plant 86 million acres of corn in 2008. When compared to last year, this year’s acreage is estimated to decrease by approximately 8%.

High input costs associated with corn and relative soybean prices are encouraging farmers to reduce corn acreage and favor soybeans. The present estimated 86 million acres are still considered to be at high levels when compared to historical crop acreages. Also at the same time, the demand for corn is increasing at a faster rate than supply, creating an upward pressure on prices.

With an estimated yield of 150 bushels/acre (the average yield for the last five years), and adding the previous crop carryover, 2008 corn crop will likely produce at least 13 billion bushels of corn.

Data Source: USDA

If we look at corn consumption, the largest component for domestic use is for feed purposes. Higher corn prices in general and problems in the hog industry profitability may lower the demand in this area to around 5.5 billion bushels.

The demand for corn for ethanol is increasing rapidly for the last six years as evident from the graph. Corn for ethanol use may increase anywhere between 15 to 20%, when compared to last year resulting in an estimated use of 3.7 billion bushels of corn for this year.

If we expect at least 2 billion bushels in exports, the total domestic use is around 12.5 billion bushels. So we will have very tight ending stocks of 0.5 billion bushels or approximately 4% of total use.

Assuming these numbers held up well during the growing season, what are the price implications for the average investor? The 2008 December corn futures may reach an estimated high of $6.60 before expiration of the contract.

Data Source: USDA

Data Source: USDA

As of this writing, December corn is trading at $6.06 which implies that the current price is relatively undervalued.

Also keep in mind the other important factors which have the potential to influence corn prices. Any indication of short crop due to bad weather will put further pressure on prices and any positive deviation in corn acreage along with a bumper crop put a downward pressure on prices.

The first crop report for 2008/09 released by USDA on May 9th may reveal some important clues for the future direction of corn prices.

Disclosure: No position in corn