Ag revolution being driven by ethanol

The current agricultural revolution is being driven by ethanol, and no matter what commodity you're trading today, you have to get corn right, says Mark Welch, economist with Texas A&M University

“Corn demand is real and growing,” says Welch. “But demand is based more on public support than market forces. The greatest risk is from loss of political support, including the 51-cent tax credit and 54-cent import tariff. Every ethanol plant that opens and every flex-fuel vehicle sold add to the ethanol constituency.”

World corn production and consumption has been increasing in the last five years, he says. “World corn consumption has increased by 19 percent in the past five years and by 6 percent from last year through this year. To this point, production has pretty well kept up with that rate of consumption,” he says.

Looking at the U.S. supply situation, the USDA estimates a 13-billion bushel crop, so production numbers have increased, but domestic use has increased very little — in fact, it's flat, says Welch.

“We're seeing a few more exports, and we're actually building ending stocks in this time of rapidly increasing corn demand. The sorghum situation is similar to corn — on a much smaller scale but much larger percentages,” he says.

The U.S. sorghum crop is about one-half billion bushels in size, says Welch, but that is twice the size of last year's crop. “The interesting thing with sorghum is that domestic use is flat, ending stocks are flat, and we're exporting all of that extra production. A lot of that is going to the European Union. They had problems with their wheat harvest, and they're using a lot of their domestic corn for ethanol. They don't want U.S. corn because it's contaminated with GMO influences, so they're buying sorghum,” he says.

In the United States, ethanol production is about 6.8 billion gallons per year, says Welch. When all proposed plants come on line, it'll increase to about 13.5 to 14 billion gallons of production, he adds.

“Will that be enough? The current renewable fuel standard ethanol market is 7.5 billion gallons. The Senate has asked, in its version of the energy bill, for 31 billion gallons of ethanol, with 15 of that coming from corn. They're expecting the remainder to come from cellulosic sources. Some states are implementing standards that are a little higher. In 2007, at about 6.5 billion gallons, we're covering estimated usage for now.

“If we can maintain this, we can insure that market forces might start driving this. At this point, it's political forces in the form of public support,” he says.

Gross returns on a per-gallon basis for a 15-million gallon ethanol plant are about $1.75 to $1.85 per gallon, he says. As crude oil has gone up to $80 per barrel, corn prices have gone up to $5.13 per bushel, says Welch. “As the price of gasoline goes up by 16 cents per gallon, the price of corn goes up by 28 cents per bushel. On the farm, that's a big deal,” he says.

The big question now, says the economist, is whether or not the tax credit for ethanol needs to be maintained. “With concerns being raised about the price of grain, of food, and given our enthusiasm to invest in ethanol production, do we need to maintain that tax credit?

“A policymaker may think that $4 per bushel for corn is a fair price. You can make the argument that with $80-per-barrel oil, we don't need the 51-cent tax credit — we have $4 corn without it. Some are talking about some type of cyclical tax credit. As oil prices go up, we would see a lower level of tax support. At $60 per barrel, without the tax credit, the break-even would be $2.50.”

If market forces are to support ethanol production, there's the problem of where to buy it, says Welch. “Nationally, less than 1 percent of the filling stations in the country offer E-85 ethanol — that's 1,100 out of more than 170,000 stations. Looking from Texas east, an effort is being made to establish these stations along the I-35 Corridor. But you had better fill up in Dallas before going to Kansas City.”

In many states, the stations that offer ethanol are government installations, making them unavailable to most consumers. For the market to take over and for ethanol to be driven by consumer demand based on economic forces, we have a long ways to go.

It's interesting, says Welch, to look at the current direction of the European Union's corn and grain trade. “The EU has gone from exporting some 13 million metric tons down to less than 5 million. Imports of these coarse grains are increasing back up to about 10 million tons.

“China also bears watching very closely. Their exports have gone from about 13 million metric tons down to about 3 million in the current market year. China has announced a policy in which it has banned the use of cereal grains from fuel production and is encouraging the importation of corn. If China no longer exports 13 million tons and instead becomes a net importer of corn, that'll have a huge effect on the world market.”

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