Tuesday, March 4, 2008

Corn Is King - and Therefore a Growing Problem

Corn Is King - and Therefore a Growing Problem

By Jerry Hirsch

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Increasing dependence on the grain leaves the US vulnerable to drought-induced price spikes in food and fuel.

Corn is a key element of the U.S. food supply. It is what dairy cows eat to make milk and hens consume to lay eggs. It fattens cattle, hogs and chickens before slaughter. It makes soda sweet. As the building block of ethanol, it is now also a major component of auto fuel.

And that may signal trouble ahead.

Economists are cautioning that the nation's growing dependence on corn would make for a double jolt in the event of a drought across the Midwest: soaring prices not just for food but also for gasoline.

Analysts now warn that a "corn shock" might not be far off - and it could lead to $5 gas and $3.50 eggs as the effects reverberate across the economy.

"We are replacing price volatility from the Middle East with Midwestern weather price volatility," said Michael Swanson, a Wells Fargo & Co. vice president and agricultural economist.

Such a disaster would occur against a backdrop of soaring prices for basic food items and other commodities that are already stressing the economy. Coffee is up 21% to date, platinum 42% and already high oil an additional 6%.

After a torrid 2007, corn prices have risen an additional 20% this year because of global demand for livestock feed, sweeteners and ethanol. The rush by American farmers to forgo other grains to plant cash-producing corn, along with weather problems, has squeezed wheat supplies, pushing the price of that grain up 21%. Soy has risen 25% this year.

Analysts are already simulating what would happen if a drought hit the corn belt. Bruce Babcock, an agricultural economist at Iowa State University, estimates that corn could reach $8 a bushel from $5.46 now.

It could happen as soon as this summer.

"The risk of a drought right now is higher than normal because of the La NiƱa we are seeing," Babcock said, referring to the cooling of ocean temperatures that often has a drying effect.

As any farmer can tell you, Mother Nature is fickle. The U.S. has suffered four major weather disasters since 1971 that wiped out 21% to 29% of the corn crop at a time.

Periodic bad weather, including droughts, scorching heat waves and cold, cloudy spells at just the wrong time, has reduced harvests by billions of bushels. Previously, these disasters have raised food prices. The next drought will be the first to affect gas prices.

That's because ethanol - mostly refined from corn - will make up about 6% of the nation's gasoline supply this year, and that's expected to rise to 10% over the next five years. The amount of ethanol used in California gasoline is expected to grow at a faster rate, reaching 10% by 2010.

But if there were a crop shortfall, the rising price of corn would prevent ethanol distillers from earning a profit, prompting them to slash production, Babcock said.

Oil companies would have to scramble to fill that sudden gap with conventional gasoline. Prices would soar for both fuels, said Philip K. Verleger Jr., an energy economist in Aspen, Colo.

"One way to see this is to look at what happened last year," Verleger said. Industrial accidents and other refining disruptions - all factors outside the corn belt - cut U.S. gasoline production about 10% in February 2007, sending wholesale prices soaring, he said.

If there were a crop failure now, the U.S. would try to ease the crunch by sopping up any excess refining capacity overseas.

A slowing U.S. economy would also blunt demand. But such safety valves won't always exist. "Five years from now, this could be a big, big deal," Verleger said.

Farmers are also worried about what could happen in the short term. "A drought would be bad for everyone. The high prices would hurt my customers, and I would have no crop to sell," said Ron Heck, a fourth-generation soy and corn farmer from Perry, Iowa.

Blame oil companies for part of the problem, said Matt Hartwig, spokesman for the Renewable Fuels Assn. in Washington.

"The oil industry has just not made the investment in refineries to keep up with the demand for gasoline," Hartwig said.

As demand for gasoline outstrips refinery expansions, fuel prices will be linked more tightly with the size of the corn crop. "You might see a point where even the threat of a drought could cause gas prices to rise," Wells Fargo's Swanson said.

Lester R. Brown, an author and president of the Earth Policy Institute, sees a different scenario, one with global implications.

He estimates that as long as oil prices continue to hover around $100 a barrel, ethanol distillers could pay up to $7 a bushel for corn and still make money.

However, Brown said, "if the ethanol producers stay in the market, that will disrupt the food supply."

Because of the interrelationships among crops, a major shortfall in the U.S. harvest could tip global grain and soy markets into chaos. It would affect the prices of food made directly from these commodities, such as bread, pasta and tortillas, and food made indirectly, such as pork, poultry, beef, milk and eggs.

If it happened this summer, it would be especially bad because of the current pace of global food inflation.

"The rest of the world is less able to pay high prices for food. What's annoying for us is life-threatening elsewhere," Brown said.

The shortfall would lead to the "politics of scarcity," in which nations would stop exporting their domestic grain and soy crops to keep food prices under control for their own people.

Even without a crisis in America's corn belt, that's already happening, Brown said.

In January, China levied export tariffs of 5% for corn, rice and soybeans and 20% for wheat to keep grains from leaving the country. Russia, Argentina and other nations also are slapping tariffs on grain exports to protect their food supplies.

All of this has contributed to the growing cost of corn and wheat. With wheat prices at record levels, economists expect American farmers to shift some corn acreage back to wheat, a move that could make corn supplies and prices even more vulnerable to the climate.

Here in the U.S., a corn shortfall would also force federal regulators to make difficult choices. Among them: Should they stick to the ethanol production goals outlined in the 2007 Energy Independence and Security Act or work to free up corn stocks to replenish the domestic and international food supply?

The government could also lift tariffs on sugar-based ethanol from Brazil and start buying up available product.

Regardless, U.S. consumers would be faced with higher prices for gasoline or food, probably both, analysts believe.

"We could see a spike that would raise prices so much in so many places that it could tip the U.S. into a recession," said Darin Newsom, senior analyst for DTN, an agriculture and energy research firm in Omaha.

More research and improved production of cellulosic ethanol - made from agricultural waste, switchgrass and other nonfood plant material - would ease dependence on corn, said Hartwig of the Renewable Fuels Assn.

But substantial production of such fuel is at least a decade away, according to government projections.

For now, the U.S. will have to hope for good weather, Brown said.

"Historically, we have had a food economy and an energy economy that were for the most part separate," Brown said. "Now they are starting to fuse."

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