Plant More Corn?

The USDA's January 12 corn production and carryover estimates for 2006-07 were described as "shocking" by many analysts. Although the trade expected some reductions in production and carryover, the magnitude of the cuts was not expected. The reports trimmed harvested acres and reduced 2006 average corn yield by 2.1 bpa to 149.1 bpa. The total production estimate of 10.535 billion bushels was down 210 million bushels from the previous estimate and below the range of pre-report trade estimates. Probably even more surprising was the 2006-07 corn ending stocks estimate of only 752 million bushels!

The tight corn carryover estimate is in sharp contrast to the abundant corn supply situation of less than two years ago. It represents the lowest ending stocks since the 1995-96 carryover of 426 million bushels when corn prices soared to record highs. Some analysts have been quick to note other similarities with 1995-96. Back then carryover plunged more than 1.1 billion bushels and resulted in a stocks/use ration of only 5%. This year ending stocks are expected to decline more than 1.2 billion bushels resulting in a similarly low stocks/use ratio of 6.4%. The rapid turnaround from abundant supplies is largely due to reduced 2006 plantings because of high production costs and strong corn demand--especially for ethanol production. The question is, how high will prices have to go in order to curb demand and/or encourage producers to increase production enough to meet increasing use?

Growth in ethanol production has been rapid. Currently there are 113 ethanol plants capable of producing 5.4 billion gallons of ethanol annually. Approximately 70 new plants are under construction and eventually will almost double ethanol production capacity. The USDA projects 2.150 billion bushels of the 2006-07 corn crop will be used for ethanol production. Based on the number of plants under construction, more than 3 billion bushels of the 2007-08 crop will likely be used for ethanol production. However, expansion beyond plants already under construction could slow since fuel and ethanol prices have moderated in recent months. Much higher corn prices will cut ethanol profit margins.

So far, corn export demand has remained strong in the face of sharply higher prices. Since the United States is the world's largest corn producer, short domestic supplies result in tighter world supplies. Projected world corn ending stocks of 86.4 mmt are the lowest in more than 10 years. Wheat and other coarse grain supplies are also in tight supply worldwide. But at some point, higher prices can be expected to reduce export demand.

Hardest hit by high corn prices have been livestock producers. March 2007 feeder calf futures prices provide a mirror image of corn prices for the same contract month. As corn prices move higher, feeder calf prices have generally traded lower. Declining hog prices and higher feed costs point to "red ink" for hog producers. Most analysts expect continued high corn prices to result in cutbacks in the livestock industry and slowing of corn for feed demand. The fact that USDA lowered expected feed use in the January estimates by 75 million bushels supports these conclusions.

In view of the tighter corn supplies, most market analysts believe that 8 to 10 million more acres should be planted to corn than was planted last year. Although total U.S. area devoted to major crops has declined in recent years, some of these acres may be attracted back into production. While some are suggesting early release of CRP acres, at this point, additional corn acres will likely have to come from wheat, cotton, soybean, and other crops. But high wheat prices have already encouraged winter wheat producers to plant more wheat than last year. Soft Red Winter (SRW) wheat is up 13% or 1 million acres more than last year. This increase in SRW acreage represents some Corn Belt acreage not likely to be available for corn production. Shifts away from spring wheat or cotton could contribute to increased corn acreage. But, unless they are irrigated acres, corn yields in cotton or spring wheat production areas are often below the national average yield and would contribute somewhat less to total production. Some acreage may be shifted from other crops as well, but a large part of increased corn acreage needs to come out of soybean production. Although domestic and world soybean supplies are projected at record high levels, soybean demand is strong with biodiesel production just beginning to catch on. This raises questions about how many acres should actually be taken out of soybean production.

Other factors add to the risk and uncertainty relative to increased corn production. Several long range weather outlooks based on El Nino suggest favorable growing conditions in 2007, but long range weather forecasts are not very reliable. Poor growing conditions could produce disastrous results for both corn producers and users. Many have been concerned about large fund traders in the futures markets, especially the index funds. The most recent commitment of traders report identified the amount of index fund long positions and found they held a significant percentage of open interest in corn along with other agriculture futures markets. If these index funds, along with other fund traders, decide to add to or liquidate their positions, it could have significant impact on prices.

How high will corn prices go? That question, of course, is nearly impossible to answer. Corn prices are already at levels that seldom occur. There is little past history to base price projections on. While tight supplies and concerns about adequate production have occurred before, rapidly expanding ethanol production and index funds are among some of the factors that are "new to the ballgame." Now that $4.00 has been broken, some may target $4.50 (a nice round number). Others may target the previous highs of 1996. But prices may not reach these levels or, if they do, may not stay that high for very long. A seasonal corn price high usually occurs about March or April, which is near the March 31 USDA Prospective Plantings report. This year, the market is likely to anticipate this report more than ever. If intended corn acreage indicates the needed 8 to 10 million acre increase, then a market high could occur. If acreage intentions are disappointing, prices could surge higher to further encourage producers to make last minute changes. The June 30 USDA Acreage report and/or summer weather conditions may provide additional positive or negative market news. The market will also continue to watch whether higher prices will begin to slow ethanol expansion or curb export demand throughout the year. Any signs that use is slowing could result in a quick market turn around. This suggests a volatile and high risk market in the months ahead.

So, should Missouri producers plant more corn this year? Current new crop futures prices (December 2007 corn, November 2007 soybean) heavily favor corn. Although current new crop prices suggest that soybean production could be profitable, corn futures prices near $4 appear to offer much greater returns. As a rough guide, a soybean/corn price ratio of about 2.2 appears to be the breakeven for many Missouri producers. In other words, when soybean prices are 2.2 times the price of corn, the net returns for producing corn or soybeans are about equal. Currently this ratio for new crop futures prices is much lower at about 1.9. If corn prices remain at current levels, this suggests that soybean prices would need to increase more than $1 per bushel to equal the breakeven ratio of 2.2. The futures market is saying, "Plant corn!"

Cash prices, production risk, and expected yields could make corn production less favorable than futures prices suggest. Corn and soybean basis varies considerably at different locations across the state and can result in a cash soybean/corn price ratio considerably different from the futures price ratio. Higher corn production costs along with production risk (corn yields are more variable in some areas of the state than others) may limit the amount of corn that same may want to plant. Still, although it's nearly impossible to predict the high, it appears that corn prices will determine which is the most profitable crop. The decision to plant more corn should include careful budgeting and planning using prices, yields, and expected costs that are appropriate for the producer's operation. The use of crop insurance and a disciplined approach to marketing also appear to be essential, especially if a producer incurs the increased costs, production and marketing risks associated with increased corn acreage.

Marketing is challenging in volatile markets. Market factors and uncertain conditions makes pulling the "sales trigger" difficult. Currently there is a negative carry for new crop corn futures (December futures prices less than March-July futures prices). New crop basis may be weak and often weakens more as futures prices soar higher. The combination of negative carry and weak basis can make new crop cash delivery contracts less attractive when compared with current old crop cash bids. Using the futures market can avoid the weak basis temporarily, but the potential for wide price swings creates the potential for large margin requirements on hedge positions. Option premiums can also be expected to be quite expensive in volatile markets, increasing marketing costs and reducing net price received. In spite of these challenging conditions, the potential for rewards is significant. It may require a combination of marketing tools and discipline to follow through with sales. Remember that the objective should not be to "get the high," but take advantage of profitable price opportunities, especially for those additional corn acres.