Corn Prices

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".

     There arises an issue though when comparing two distributions which requires some additional insight.  For instance, if you examine the average corn price and its associated standard deviation over two different time periods, you may want to judge which period had the greatest variability.  Simply comparing the standard deviations would be the first thought, however, that would describe the absolute difference in variation. When comparing two different distributions we are usually interested in knowing their relative variability.

     One way is to compare the ratio of the standard deviations to the means.  This is a form of indexing and can reveal which variability is more significant (when compared to the average value).   Why is this important?  When I was a lot younger, I was a carpenter's assistant which meant that I would often have the job of cutting 2x4's to stated lengths called out by my boss.  At first, I was not very good at this and would often be off a small amount.  One day the boss was angry at me over this and told me the board I just cut was 1/2 inch off.  At first blush that sounded trivial to me so I told him 1/2 inch was not very much, and asked why was he so mad?  His reply was "if your nose was 1/2 inch longer you would think it was a big deal."

If you want to know the impact of increased corn prices on your cost of production, chose a forecasted corn price (take your pick of forecaster between $3.40 and $3.85 with some as high as $5.00+ if drought develops) and crank through your feed cost calculation. If you do this and it actually turns out to be your new cost of production, you will be one of the last few producers in the pork industry with absolutely no imagination whatsoever.

One thing we know for certain is that people do not face adversity sitting still. All kinds of secondary strategies, impacts, cost cutting, substitutions, new research and experiments, adjustments in weights and plain ingenuity immediately move to the forefront. In addition, poultry producers and other meat animal species that consume corn are making similar adjustments as are tortilla makers, users of high fructose corn sweeteners and even elevator/feed mills that used to get the corn. As they do, the prices of their products change relative to the price of pork and demand shifts begin to take place at the grocery store and throughout the chain.

SwineCast 0206 Show Notes:

• SwineCast at World Pork Expo
• Purdue's Brian Rickerts looks at DDGs long term effect on protein quality
• Viewing today's prices from a historical perspective with Steve Meyer