Corn Prices

SwineCast 0463

• Iowa State's Roger Elmore discusses the crop progress in this important midwestern corn state. Watching for the frost...
• Link to Elwynn Taylor's Weather Tweet Sheet mentioned by Roger.

     The pig production business has always had its ups and downs but developments over the last few years have resulted in the structuralization of increased levels of price and financial risk.  By structuralization, I mean that these factors are now regular, recurring added risks that are no longer random, isolated events which no risk management process can adequately predict or mitigate effectively.  The factors include the predicted and now realized reduction in the average level of the stocks-to-use ratios for corn and soybeans placing feed prices in a continuing, annual, heightened state of price risk volatility.  Bob Wisner, retired crop extension professor from Iowa State University told World Pork Expo attendees that we will end up the soybean year with as little as 2.2 weeks of the supply remaining.  The cold, rainy corn belt conditions which delayed the corn planting period in the U.S.

As we watch the markets throughout the world plunge trying to find a trading range, we are witnessing the global market reset to economic fundamentals.  Before you think this is unambiguously bad (the reset) consider that this entire event spanning the last two to three years was set in motion by government policy actions and the flood of liquidity beginning after the September 11th attacks.  The market is simply correcting now what government policy actions have caused, a massive destruction of the mirage of paper wealth they created.

     It did not take very long did it? Remember our reference to commodity production being "margin" industries? Margin industries have a strong tendency to quickly revert to long-term returns over cost that reflect a fair return to the factors of production. This is because they relatively (at least) mirror competitive market outcomes.

Mark Greenwood
June 2008

Yellow Series is Corn Prices; Green Series Hog Prices 

     If you believe markets work and in agricultural commodity markets we have the closest thing to competitive market structure that is likely to be found, you believe that sustained higher corn prices due to Ethanol production will eventually work their way not only into food prices but into higher live hog prices.

     We have previously talked about his and how our commodity industries at the production level act like "margin" industries.  That is, if no fundamental factor effecting the normal return to these industries change (like sustained increased risk, new technology, or new barriers to entry or exit etc.), then input price changes will wind up initally lowering profits but then through a rather predictable set of economic adjustments, return the participants to approximately the same profit level before the change took place.  There are all kinds of things which might make the new profit level a little more or less than the past but essentially we are beginning already to see this phenonmenon working its way through corn markets where seed costs, fertilizer costs, fuel costs, equipment costs and soaring land rental and purchase costs are returning the margins to pre-ethanol levels for corn producers.

The rapid acceleration in new ethanol plants over the last couple of years has resulted in current production capability reaching levels approaching the 2012 targets of the government mandates. Those mandates were for 7.5 billion gallons. Current production is estimated well over 5 billion gallons. Refineries currently under construction and/or expansion will add another 6 billion gallons of capacity if they are completed and come on line as planned.

By the end of 2006 we had achieved about 1.5% oil energy independence because of ethanol substitution according to the USDA. By 2017, if the massive growth they have forecasted actually arrives, we will be up to 3.7% oil energy independent compared to current purchases. This doesn't take into account the foreign oil used to produce ethanol in all of the various ways it works into the production process for corn etc. but if accounted, it would reduce these percentages by about one third.

So let’s play around a bit with this variation stuff and see how the future cost of production might look for hogs if we forecast it by first forecasting corn and soybean meal prices and then putting those forecasts into a cost of production model to generate a forecast for future carcass prices.

This hog cost forecast was generated assuming that corn would average about $3.50/bushel and that soybean meal would be about $250/ton on average.  Under those circumstances and some stuff I will share in a minute, the average hog cost of production for a 270lb animal would be about $62.50/cwt on a carcass basis.  However, by using the variances and the correlation between the input prices in the forecast model, we can create a forecast not only of the average price but the range over which it is likely to wander and the probability it will reach any one price in the range.

You can get an idea about some of the principles of variation by taking a look at everyone's favorite topic, corn prices. If you examine the average national corn price for the last ten years you will find that it was $2.28/bu with a standard deviation of about $0.43. Just by looking at those two numbers you can get an idea that there is some considerable variation going on in the historical pattern of corn prices.

Calculating the coefficient of variation (CV) yields 0.189, which you will recall is the standard deviation divided by the mean. Now if I were to ask you if the volatility in the corn market had increased since October 2006 what would your gut reaction be? I suspect you would be suckered in to saying "yes".