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Corn-based, federally subsidized ethanol production changes
everything.
It’s all about energy.
In the case of corn, you either consume it directly, convert it
to higher value protein by feeding it to livestock, or you drive
it down the street.
Deciding between
these options never seemed that difficult since World War II
until the government decided to tie the cost of the nation’s
food and its industrial fuel together tighter than a rusty fence
stretcher. That has occurred via a federal subsidy of 51 cents
per gallon of ethanol produced domestically, as well as a
federal tariff of 54 cents per gallon for imported ethanol.
All of this is part of the mandate to decrease fossil fuel usage
by 20% within the next decade, in part by requiring a minimum of
35 billion gallons of domestic alternative and renewable liquid
fuel production by 2017.
According to the
Renewable Fuels Association (RFA), the U.S. produced 4.855
billion gallons of ethanol last year (it was 3.9 billion gallons
in 2005) and has a current production capacity of 6.183 billion
gallons. In 2004, about 6% of all energy consumed, and about 9%
of total electricity production was from renewable energy
sources says the Energy Information Administration (EIA).
As for ethanol’s portended role in this national goal, “Under
current federal ethanol policy and current projections of crude
oil prices, U.S. ethanol production from corn is projected to
climb to 14.8 billion gallons by 2011. To supply this expanded
ethanol production, corn acreage is projected to increase to
almost 94 million acres. To induce farmers to plant this much
corn, season-average corn prices are projected to reach
approximately $3.40 per bushel.” That is according to authors of
a May-released study—Emerging Bio-Fuels: Outlook of Effects on
U.S. Grain, Oilseed and Livestock Markets—from the Center for
Agricultural and Rural Development (CARD).
USDA estimated 2007
corn acres early this spring at 87 million acres—8.7 million
acres more than last year—the most since 1946, for projected
production of 12.2 billion bushels. There were about 78 million
acres of corn planted last year for 10.5 billion bushels.
“Modest forecasts
suggest that ethanol production could increase to a total of
10-12 billion gallons in the next three to five years,” says
Derrell Peel, Ph.D., extension livestock marketing specialist at
Oklahoma State University. “This would require roughly 17
million more acres of corn production or more imported corn if
other uses of corn remain at current levels.”
Based on USDA
numbers, Peel explains U.S. corn acreage has averaged 72 million
acres for the past decade, roughly 23% of total crop acreage.
Add soybeans, wheat and hay and you’re talking 85% of all
planted acres. Cotton and grain sorghum account for another 9%.
According to RFA,
there are currently 114 ethanol bio-refineries nationwide with
the capacity to produce more than 5.6 billion gallons annually.
Another 78 ethanol refineries plus seven expansion projects
under construction would add a combined annual capacity of more
than 6 billion gallons. So more than double 4.86 billion gallons
of production in 2006. Ethanol production last year was 26.4%
larger than the 3.90 billion gallons churned out in 2005,
according to RFA statistics.
Welcome to the
ethanol world.
Cattle Dogma in
Flux
“When basic relationships change, as they have in the corn
market with the exploding demand in the industrial usage for
corn, trends change. The result is that the past may no longer
be a good predictor of the future,” explains Barry Dunn,
Executive Director of the King Ranch Institute for Ranch
Management in Kingsville, Texas.
“One of the
difficult challenges the cattle industry faces is that multiple
and critical price relationships have changed and are in the
process of re-establishing themselves, all within a relatively
short period of time. These would include: consumer demand, fed
cattle prices, transportation costs based on crude oil prices,
interest rates, and feed grains,” explains Derrell Peel.
For instance, basis
has changed for feed and cattle, based on the geographic
proximity to lower-cost corn co-products such as Distiller’s
Grains (DGs) and other alternative feeds.
Though there’s no wholesale migration under way—nor is it
fathomable that such could take place—cattle on feed numbers
this spring point to the fact that more cattle have been placed
in the Corn Belt and Northern High Plains than in recent ones;
fewer in the Southern High Plains, further away from corn and
corn co-products.
For that matter, it
changes buying patterns of both cattle and feed within regions,
too. As to the former, the odds-on bet is that feedlots must
combat the higher cost of corn by feeding heavier-weight cattle
that have spent more time picking up weight in the stocker
pasture. With fewer days on feed, average occupancy rates in the
feedlot—a key driver of feedlot economics—declines
significantly. It’s not that there are fewer cattle, but fewer
cattle days on feed. That would make cattle heading into the
feed yard worth even less.
Conversely, more
competition for pasture continues to pressure grass and hay
costs upward.
That’s before you consider details about whether carcass quality
would decline with fewer days on feed or whether any dilution
would be offset by the fact that cattle would be older entering
the feedlot. Likewise, the jury is still out on how feeding more
DGs and less corn at the feedlot will affect feeding and carcass
performance.
As for the buying
patterns of feed, increased ethanol production changes the
available mix of products, the regional availability and the
risk of leaving long-term supplies unsecured.
“In general, the impact of increased ethanol production is to
increase the relative supply of protein feeds and reduce the
relative supply of energy feeds for animals,” explains Peel.
“Thus, by-product feeds will compete more with protein feeds,
usually derived from oilseeds such as soybeans and cottonseed
than with energy feeds. Availability of distiller’s grains may
help offset potential reductions in soymeal production if corn
replaces soybeans in the total crop mix. Although the net impact
on protein feed supplies and prices is uncertain, there is
clearly a relative deficit of energy feeds which implies an
increased demand for other energy feeds such as grain sorghum
and possibly wheat, barley and oats. It is also true that
generally higher feed grain prices will increase the value of
forage and will favor production of cattle using more forage and
less feed grains.”
In the CARD study mentioned earlier, researchers explain, “Most
of this increased corn acreage replaces U.S. soybean acres,
which are projected to decline to 69 million acres. Soybean
prices are projected to average above $7 per bushel. In response
to permanently higher feed prices, livestock producers are
assumed to eventually reduce production to allow their higher
production costs to be passed onto consumers. Thus, livestock
production is projected to enter a period of slower growth as
these adjustments take place. Although U.S. exports of corn,
soybeans, wheat, cotton, and meat products are projected to
decline or flatten, the competitiveness of U.S. agriculture is
largely unchanged because most of the rest of the world’s
producers also face sharply higher feed costs.”
In the short-term
Dunn says logic suggests other supplements such as soybean meal
and cottonseed meal will become more available in areas that
aren’t located near ethanol production. If and when cellulosic
conversion—the next wave of ethanol production—becomes
widespread, though, there is liable to be a dearth of DGs, too.
“The initial
cellulosic production of ethanol won’t be from switch grass or
forest trash, it will be from Distiller’s Grains,” says Dunn.
He’s basing that prediction based on conversations with
researchers from the Agricultural Research Service who are
scurrying to find enzymes to digest DGs.
Now, toss the
current drought into that mix and things get real western. And,
that’s without considering what will happen when Mother Nature
throws a curve ball at corn production plans. Until now, corn
price has been driven by supply, now it’s fueled by demand.
Unsurprisingly, the
Food and Agricultural Policy Institute (FAPRI) continues to
project higher gain prices. In March, the organization
explained, “The world corn price increased dramatically in
2006-07, to $159.44 per metric ton, because of demand from
ethanol and livestock sectors and sustained exports. FAPRI
expects this increase in demand and price to continue until
2009-10, after which production growth catches up with growth in
utilization.”
“Over the next few
years, it’s not out of the question that we could see corn
priced at $4, $5 or even $7 per bushel. The old stand by rule is
that a 1 percent increase in the demand for or the supply of a
commodity results in a 5- 8 percent increase in price. If that
holds true, the price of feed grains could be higher than most
anticipate,” says Dunn.
Ironically, fed
cattle prices could set records during the next couple of years,
driven by shorter supplies. That’s prices, not profit. In fact,
though they didn’t break the all-time record set when the U.S.
industry was the beneficiary of Canada’s BSE situation for a few
months in 2003, fed cattle traded past the century mark for a
few weeks in April. The notion here is that cattle feeders will
be able to pressure calf prices to the point that cyclic
contraction will begin again. The wild card in that notion is
how much feeders will be able to hold a thumb on calf prices
with so much cattle feeding capacity already chasing a
relatively tight calf supply.
Either way, corn
prices have already driven up consumer’s food bills to the tune
of $14 billion per year, according to a study from the Center
for Agricultural Affairs and Rural Development at Iowa State
University (see Ethanol’s Consumer Pains).
Although consumer
beef demand has slipped some, it’s still considered to be
robust.
“In the last 15
years the annual carcass cutout price for beef has averaged
approximately $116 but has ranged from approximately $95 in 1998
to approximately $142.50 in 2006,” explains Dunn. “In eight
short years the average carcass cutout value has increased by
approximately 50 percent. When put in context of increasing
supplies, disease concerns, and issues of access to foreign
markets, this bullish demand is even more remarkable.”
As long as the
industry continues to focus on the consumer, Dunn sees no reason
to assume faltering consumer beef demand will further complicate
the new math fostered by ethanol.
“Ultimately, the changes in consumer demand, fed cattle prices,
transportation costs, interest rates, and feed grains will
collectively determine the retail price of beef,” says Dunn.
“The new price equilibrium achieved amongst and between these
variables is difficult if not impossible to predict, but it will
ultimately impact the inventory of cattle and the profitability
of all segments of the industry.”
All of these
factors comprise a just a short list of the combination of
forces thrust into play by the nation’s zest for ethanol. That’s
why it’s impossible to predict how ethanol will ultimately
impact the industry, or if it can grow as projected, then last.
Ethanol Speed
Bumps
As an example, what are the odds that ethanol production in this
nation is sustainable? The rampant growth of the industry has
been predicated upon one basic notion: oil prices will remain
high enough to make ethanol production economical. That and the
fact that the government will continue to subsidize ethanol
production at levels at least equal to current ones.
In January,
Cattle-Fax expected crude oil to trade mostly at $50-$60 per
barrel this year. With the tax credit, the breakeven purchase
price of corn for ethanol production would be worth $3.36-$4.05
per bushel, according to research by Dermot Hayes at Iowa State
University. Take that tax credit away and the breakeven purchase
price of corn would be $1.83 to $2.52 per bushel, based on the
same level of crude oil prices.
Remove that tax
credit and peg oil prices at the most recent five-year average
of $31.84 (basis composite acquisition cost/ Energy Information
Administration) and you’re talking a breakeven purchase price
for corn in ethanol production of less than $1.14 per bushel
based on Hayes’ figures.
For that matter,
assessing whether the world is in danger of running out of oil
is like determining if global warming is a product of man or
dumb luck and the epochal forces of nature.
As recently as last
summer the folks at the American Petroleum Institute explained
there was no shortage of global oil supplies, just a bailiwick
to work through in matching refining capacity to oil grades.
Furthermore, many industry estimates predict global oil
production will plateau in the next 50 years or so. That’s based
on proven reserves, not new sources and technologies coming on
line. Plus, much of the increase in recent global demand has
come from countries with no recorded history of political and
economic stability over the long haul.
Cynically, you also
have to ponder how much market share OPEC countries might be
willing to lose before lowering oil prices to the point that
ethanol production becomes a horribly expensive alternative.
Even if ethanol and
other bio-fuels are the wave of the future, growing the raw
material is only one challenge. There are reasons to doubt that
ethanol production can expand as fast as predicted simply
because of the infrastructure necessary to store and haul
materials around the country.
Last fall, Roger Ginder, an economics professor at Iowa State
University analyzed the impact of shifting more soybean acres to
corn in that state. He figures a bushel of soybeans equates to
the need for 60 bushels of storage capacity; another 120-160
bushels worth is needed for each acre of corn. Projected
increased corn production in Iowa by 2010 means just the extra
storage capacity necessary is larger than all of the storage
capacity that currently exists in the state. Other dominos lined
up with equally exponential challenges include grain drying
capacity, rail cars and truck hoppers.
Ginder concludes,
“The rapid increases in ethanol production capacity will put
heavy pressure on existing grain transportation and storage
infrastructure. Little has been done to add to the existing
storage and transportation infrastructure to accommodate the
planned expansions in ethanol production capacity. Significant
additional investment in infrastructure is needed for the
planned expansion in capacity to be economically viable. Low
margins in the grain elevator sector will make it difficult to
expand commercial storage as rapidly as the ethanol production
sector is expanding. Lag times to manufacture and build the
infrastructure also are a barrier. Planned increases in
production could easily outstrip the capacity to manufacture and
build the rail cars and storage facilities needed to accommodate
the growth. If not addressed, these infrastructure limitations
can be expected to slow the rate at which ethanol production can
grow.”
If you go by
projections from FAPRI, ethanol production, or at least the rate
of expansion, may be self-limiting to a degree, anyway.
According to the
organization, “Following a large price increase in 2006 for
ethanol, FAPRI expects the world ethanol price to fall to $1.50
per gallon in 2007 in response to a 2.4 percent decline in the
price of crude oil, and with declining U.S. ethanol net imports.
Projections show the ethanol price continuing to fall throughout
the decade, dropping to $1.35 per gallon by 2016 as production
growth outpaces growth in consumption. Global net trade is
projected to increase by 26.4 percent over the decade,
approaching 1.3 billion gallons by 2016.”
Best case scenario,
these impacts will be part of the business landscape for at
least the next several years. Randy Blach, Cattle-Fax executive
vice president pointed out earlier this year, “In the 1990’s we
had a supply bull market in corn. This is a demand bull market.
Bull demand markets have a longer tail. We will not fix this in
one year or in two years. We’ll be in this situation for some
period of time.”
Members of the
National Cattlemen’s Beef Association (NCBA) passed a resolution
at their annual meeting recommending that ethanol tax credits be
phased out, as well as tariffs on imported ethanol
($0.54/gallon). That recommendation goes to a vote of the entire
NCBA membership. However that turns out, bending the ear of
every political and organization representative you have in
support of that notion could be the most profit-positive thing
you do for your operation this year.
“The growing demand
for corn for ethanol represents a fundamentally new direction
for U.S. agriculture. Use of agricultural resources for energy
production is pitted against traditional food and fiber
production resulting in a complex and sweeping set of changes
and tradeoffs in agricultural input and output markets,” says
Peel. “Little can be said with certainty about the net impacts,
both short and long run, except that markets will be dynamic and
risky during the transition.
“Agricultural
producers will see new opportunities (especially in the crop
sector) and new threats (especially in the livestock sector).
Producers will need to be increasingly nimble and vigilant in
order to take advantage of opportunities or mitigate the threats
in volatile markets. Many fundamental price and value
relationships are likely to change and must be constantly
evaluated to manage risk and increase the odds of financial
success.”
Ethanol’s
Consumer Pains
If you’re producing anything that consumes corn,
value-added may be the most likely source of future
profits. At least this non-commodity approach seems like
sound advice given the fact that ethanol-fueled corn
prices have already catapulted U.S. retail food prices by
$14 billion annually.
And, that’s a conservative estimate according to a May
study from the Center for Agricultural Affairs and Rural
Development at Iowa State University.
The study evaluated
two scenarios. First, researchers looked at crude oil prices at
$55-$60 per barrel, which the study projects would result in
U.S. ethanol production reaching about 15 billion gallons
annually. That serves up the $14 billion increase in retail food
prices.
If crude oil prices
move to $65-$70 per barrel—the second scenario researchers
considered—the study projects the potential increase in U.S.
ethanol production at nearly 30 billion gallons annually. That
pegs corn prices at about $4.42 per bushel, and the increase in
annual retail food prices at $20 billion.
The study did not
expressly project the impacts of higher federal mandates on
renewable fuels production and use. But the ethanol production
levels evaluated in the two crude oil price scenarios roughly
mirror some legislative proposals being considered in Congress.
“We recognize the importance of the United States diversifying
its energy sources to enhance energy security,” said J. Patrick
Boyle, president and chief executive officer of the American
Meat Institute, one of the study sponsors. “But this study
clearly shows that we are reaching a tipping point, and that
over-reliance on corn-based ethanol to meet stringent government
mandates would further drive up retail food prices, reduce
domestic meat and poultry production, and erode our vital meat
and grain export markets.”
Other survey
sponsors included the Grocery Manufacturers/Food Products
Association, National Cattlemen’s Beef Association, National
Chicken Council, National Grain and Feed Association, National
Pork Producers Council and National Turkey Federation.
The study projected
the following U.S. commodity impacts if season-average corn
prices over a 10-year period ending in 2016 increased to $4.42
per bushel:
Pork: Production
costs would increase by 36.8%, production would decline by 9.2%,
retail prices would increase 8.4% and exports would decline by
21%, reversing 15 consecutive years of pork export growth.
Poultry: Broiler
exports would decline by 15%, while turkey exports would fall by
6%. Wholesale broiler prices would increase by 15%, retail
prices would increase by 5% and domestic consumption would
decline by 4%.
Beef: Retail beef
prices would increase 4% and production would decline by 1.6%.
Significantly, since the study projects that the price of dried
distiller’s grains with solubles will closely track increasing
corn prices, the impacts of such price increases are nearly as
significant for beef and dairy as they are for hogs and poultry.
The study indicates
that corn yield gains would ultimately provide sufficient
additional corn stocks to moderate grain price increases if
corn-based ethanol production peaks at 14-15 billion gallons
annually by 2010, when existing ethanol plants and those already
under construction come online. The study projects that under
this scenario, corn prices would peak at about $3.43 per bushel
in 2009 before leveling off at $3.16 per bushel by 2016. Ethanol
production at that level would equate to approximately 10% of
U.S. gasoline consumption.
Cellulosic-based
ethanol will likely provide little relief, predicts the study.
It says the vast majority of ethanol growth for the foreseeable
future likely will come from corn. Specifically, the study found
that neither corn stover nor switch grass planting as
replacement feedstocks for ethanol makes economic sense on U.S.
acres capable of growing corn. It concluded that because of high
conversion, handling, logistics and capital costs and
constraints, cellulosic ethanol would be viable economically
only if the U.S. government paid approximately $270 per acre in
subsidies to entice producers to convert from corn to switch
grass.
The study also
examines the impacts of removing some acres from the
Conservation Reserve Program (CRP), and eliminating the current
tariff on ethanol imports. As the largest source of available
U.S. tillable acres, the study suggests CRP acres could help
alleviate some of the financial stress on livestock producers
during the early years of rapid ethanol growth; these acres
could mitigate short-term disruptions in grain supplies, too.
Still, the study finds that shifting 11 million of the 36
million CRP acres into crop production would only mildly temper
the impact on long-term constrained supplies of basic
commodities, adding just over 1% to corn supplies and reducing
long-term corn prices by 2.2% (7 cents per bushel) under the
low-price crude oil scenario.
For the complete
study:
http://www.card.iastate.edu/publications/synopsis.aspx?id=1050 |
