Shrinking Corn Crops, Rising Ethanol Production Make for Volatile Prices

People who monitor agricultural commodities are calling last week's government report on corn -- the nation's largest crop -- a game-changer. According to the Department of Agriculture, American corn production for October is forecast at 12.7 billion bushels, 4% lower than the September forecast and down 3% from 2009's record production of 13.1 billion bushels. Corn prices jumped following the news.

There are apparently a variety of factors in play here. Bad summer weather at home reduced U.S. corn production. Meanwhile, a severe heat wave and drought in Russia, one of the world's largest exporters of wheat, prompted Moscow to issue a temporary ban on grain exports. That ban, in turn, has led more foreign markets to purchase U.S. corn for livestock feed. About 20% of the U.S. corn crop is already exported annually.

And then there's corn-based ethanol. Nearly a third of this year's U.S. corn crop will be converted into fuel ethanol, and that percentage is expected to rise in the near future. The Environmental Protection Agency has also announced it would allow the amount of ethanol used in gasoline blends for newer vehicles to increase in volume, from 10% to 15%.

Earlier this week, a coalition of farm, restaurant and food associations issued a joint statement warning that American consumers would end up paying at the supermarket for the EPA's move. The E15 ethanol blend, they say, might lead to "dramatic increases in the portion of the U.S. corn crop used to make fuel rather than food and, when fully implemented, could result in more than 40% of the nation's corn crop being diverted to ethanol production."

Tackling One Problem But Creating Another

Individual food sectors used the coalition statement to make their cases. National Meat Association CEO Barry Carpenter said the ethanol change "barely puts a band-aid on the oil dependency it is intended to alleviate, yet negatively impacts food security by further raising food and feed prices. Higher feed prices will eventually be passed on to consumers in higher meat and poultry prices. This is not a good decision for either consumers or U.S. agriculture."

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Analysts for Barclays Capital are also sounding alarms, saying in a new report that while U.S. corn production may be pushing record levels, growing domestic and international demand could lead to very low reserve supplies.

"Anytime you start fiddling with a ... system too much on one side or the other, you get unintended consequences," says Dr. Bruce Hutton, dean emeritus at the University of Denver's Daniels College of Business. "While we chose corn as a solution to one problem -- gasoline -- it created other problems. So every time we as a country, or as a company, decide that you're going to think about solutions to problems without thinking about the interdependency, about the affect of that move on other systems, we get what we do."

Dr. Hutton also notes that the economic downturn is influencing the price of corn and ethanol. "If the economy's going down and people don't have enough money, then they end up not driving as much," he says, "and they don't use as much gasoline, so there's not as much need for ethanol."