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08-01-2012 10:27 AM - edited 08-01-2012 10:29 AM
Had a really nice visit with Chris Hurt at Purdue this morning on the growing contention between the livestock and ethanol sectors and what those sectors can do to stay alive trying to keep corn supply chains intact with corn possibly on its way to $10. Kind of follows up to this conversation over in Farm Business Talk.
At any rate, I am writing a story based on our chat, but I thought everybody might want to read the full transcript. So, here's what Chris said. Basically, there are some potential ways around a total logjam between the livestock and ethanol sectors, but a couple of things are looming: Corn going to $10 and cattle herd liquidation so great that the country may not have enough slaughter capacity to keep up. What do you think?
"The drought is what has caused the damage. Not the government, corn farmers or the livestock industry. It's Mother Nature. The issue, then, is this is potentially disasterous for a number of different groups. If we can take a broader perspective, how does agriculture get through this with the least damage to agriculture in the long run? The bottom line is there is billions of dollars in losses that could be allocated differently depending on decisions made by EPA and Congress.
"Again, we're going to link congress into this pretty quickly for a couple reasons: Number one, federally subsidized crop insurance. Second, disaster aid for the animal industries in Congress. I don't know if they'll come up with anything. It's further complicated by the differences on the new farm bill. We're 60 days from expiration of the old farm bill. These things come into a bit of balance. The crop sector does have well-developed assistance program for drought. That's not forced down the throat of any producer. They make the decision if they do or do not want to go into that program. Those premiums are heavily subsidized, 50% or 60%. This is going to be important to the crop sector in being able to recover from what Mother Nature gave us. Call it an act of God.
"EPA is implementing the law, so they are not out there saying what's best for agriculture. They're saying "we have a law and we have to follow the law. We're not worried about fairness." There's nothing in that law saying they have to treat everybody fairly. We do have their one test of that where I think a lot of us thought that Rick Perry's petition in 2008 had merit, in the sense that there was economic harm taking place in the livestock sector,but that was not upheld. The one observation of behavior we have is EPA is looking at that and saying "the law of the country is we want biofuels."
"Now, I guess the merit I see in that interpretation is to say "well, wait a minute, did Congress adequately consider these years like 2012?" The answer could be yes -- they put an out-clause in there. So, I can't blame EPA if that's the way their attorneys interpret that, that the country wants fuel. But, Congress writes those laws and maybe Congress really didn't foresee a year like this. The U.S. wil go through these criticisms from around the world -- "you have the ability to put food in your fuel and drive your SUVs to do something trivial while we starve."
"Any legislation has some shortcomings. We write a law for the problems of today and then 5 years down the road, a new problem comes up. Then, that law has to evolve to solve that problem. The ethanol policy is one of the factors that has given us high corn, soybean and wheat prices. Those prices are part of why land prices have doubled. So, that's where the big money is at. If I was in the corn growers, I would say do not back off that ethanol standard at all. That is what has made huge wealth in the last 5-6 years. China bought a lot of soybeans -- almost as big as ethanol impact. You don't back off of that. It has been so important. And, not just important, but our crop producers, Congress asked them to do this. They asked the ethanol investors to put your money in ethanol and we'll back this. They did that, and that is really impressive.
"Then, they say "I risked so much and I took on all of this risk because I was given the idea that the U.S. Government was going to back this." That's all well and good, but we still have a disaster out here. I think there are some arguments for cutting the mandate for the corn grower; we can foresee a scenario where if this yield is really so poor, if we get down to 120 bushel yields, (none of us know what that # is going to be), it is the issue of demand destruction. Particularly if the ethanol industry was to use around 5 billion bushels of corn.
"My numbers are telling me if we go down into that national average of 120 bushels/acre, we're going to have to go to $10 for corn and $20 for beans. My numbers on hogs, that's an $80 loss per head in the 4th quarter of this year. This is massive. You're talking about massive liquidation. What does that do for the corn grower in the long run? We set ourselves up next year to perhaps plant 100 million acres of corn and looking at a usage base more like 10 1/2 billion bushels with a crop of 15 billion. How about corn at $4? Maybe that won't be the case -- maybe China will buy everything we can raise for $4.
"We're not only setting up for the highest-priced crop ever seen, but also going to $4 or lower. That would be the biggest inversion we've ever seen. Building inventories of 3-4 billion bushels. That has been disastrous in the past. Then, you're begging the government for assistance. We have a different demand base than the '80s and '90s, but again, you've got to take care of your customers. We've got to be careful thumbing your nose at your customers. It is a demand destruction issue.
We're right on the cusp of the end of the growth of the ethanol industry in terms of any more big growth in bushels, but not at the end of growth of supply. We largely had, this spring, seen that demand was simply growing faster than supply, but supply has largely caught up with demand and already, we're looking at moderating those prices of corn and soybeans, bringing them down some. This was going to be a flattening out period of prices, land values, and costs might flatten out too. All it took was shifting the other way, the world having a short crop...the drought averted that.
"Demand destruction is really serious. Livestock people would say this is how it works -- you force them out of the business and when times get better, you bring them back. Livestock people are going to bear the worst brunt of the drought. Losses will be worse than the crops sector. The crops sector really has 2 offsets, one is for the low yields in our market system -- low yields are offset by higher prices. We've got a corn crop down at least 20% to 25%, but prices are up 60%. That might give the average producer the average yield we end up with, if they can sell more corn at $8 rather than $5, more revenue. Then, billions coming from crop insurance.
"Not everybody in the crop sector's going to be okay. There will be some farm bankruptcies from this. We have farms that will have virtually no harvest. So, they don't get that compensation on what they get for price. We have farmers who have sold more bushels than they're going to raise. If they forward sold more than they could produce, high prices are negative for them.
As we think about this from the consumer side, anything that lowers corn prices, who does that help and who does that hurt? If you do something like lowering the RFS that lowers corn prices, that is going to help the end-users of corn, people like the livestock industry. That would be one that would very quickly come to mind. if you lower corn prices, that would help reduce the liquidation that's going to have to occur in the livestock sector. If you reduce that liquidation, that has impacts on reducing the amount that food prices are going to go up, so it helps the consuemrs of food. If you reduce the corn price, that reduces the cost of ethanol and lower ethanol prices lower gasoline prices. Who are the primary beneficiaries of anything lowering corn price? End-users -- livestock, the food consumer, the gasoline consumer.
"Let's take 1 bushel of corn. If it goes to an ethanol plant, then the livestock industry has the potential for 18 pounds of distillers grains. If that bushel doesn't go to the ethanol plant -- if the RFS is lowered and effectively lowers the value of corn -- the livestock industry has a bushel, 56 pounds. It is an argument, but when you take a bushel away from the current end-users, the feed you get back, you get back a different product, and you get 18 pounds back. You have a net loss of 2/3 of that bushel. Economics doesn't work that way.
"There's an additional complication for cattle, and that's forages. Not only do you have the corn and soybean meal issue, but you have that forage issue. Drought has devastated pastures. When you look at conditions, it is bleak. Eighty-three percent of Missouri's pasture is in very poor and 15% in poor. And, Missouri has the highest concentration per square mile of beef cows. What we can feed the cows now is our hay. If this doesn't turn, we're not going to have any more grass this summer and fall and we're feeding our hay and that's going to be gone in a few months. And, the disaster isn't in full proportion yet. We're going to be in drought for the next 3 months. Drought is a deficit of long period of below normal rainfall, so it doesn't just end abruptly. It takes time. That's not to say the pasture won't green up again, so there's hope.
"Think about what's going to happen 60 days from now. There may not be enough capacity to kill those cows. We're already looking at record-high consumer beef prices. That record will be broken in 2013 and 2014. We're setting up, if this doesn't turn, this same area could see small square bales of grass hay at $12 to $15 a bale versus $3 to $4. The dairies in the eastern Corn Belt have already been out to their neighbors are out buying corn and getting silage. They're not waiting for the crop farmer. They're proactive. It's helpful to try to help crop farmers understand some of those issues.
"For the cattle industry, then: 2 things have to happen: 1 is that the southern Plains drought (and elsewhere in Kansas, Oklahoma, Colorado and other areas) has to get better so there's some pasture. Secondly, you've got to get lower grain prices. That will increase the calf price. We've seen calf prices down 40 cents in the last 6 weeks. The impact of the drought in the CME corn pit started June 18. On June 15, we were still flirting with $5 corn.
"We don't really know what's going to be in that corn field, how much damage has occured. This is what we will all be anxious to see when USDA actually goes out in the ifeld. Balance is good in this. Understanding is good. To the extent we can avoid pushing things so high and causing such tragedies for end-users. We could see potentially horrible unbelievably low prices for 2013 for crop farmers. I also like the concept of this isn't the ethanol industry trying to rake somebody over the coals. This is a natural disaster. When a Katrina comes, how many of those communities in Iowa, Illinois, Minnesota, Indiana sent teams to help out when it hit? That's what we're dealing with. Many of those farm families contributed. They helped. That's the way I feel about it. Unfortunately, it is tied up with policy now.
"We could see a $621 million disaster assistance package for the livestock industry, possibly. $600 million is not much. Could make them whole. A few percent. I would guess those industries won't turn down some assistance. Basically, the idea for the livestock industry is in the short run, you're going to lose a ton of money, but if you can hang on when corn goes to $3.50, you're going to make a lot of money. But, that's after some pretty major liquidation.
"The market will very quickly tell you you're on the wrong side. It's tough. And, the market doesn't care about anybody. What they'll say is there's not enough corn. If the ethanol industry is still mandated to get 5 billion bushels even if there's only 5 billion bushels of corn, the law says that it all goes to ethanol production. Then, you just get rid of all those end-users. That's what the law says. But, there's an emergency clause. The law says "unless there's an emergency."
"Maybe something that seems logical that is one aspect of this is if the crop is down 25%, then we should set up some flexibility for a 25% adjustment. That's not to say every end-user should adjust 25%. But, we should not set it up so they don't have to adjust at all. This would require it to get down to 3.8 billion bushels of corn versus 5 billion. For the ethanol industry, with these RINs, that's equivalent to about 900 million bushels, so that's a substantial amount of that reduction. Would only take about another cut of about 250 to 300 million bushels to to get them down to a use of 3.8 billion. The RINs, that's 18%. Our guess is we wouldn't go to zero RINs. I don't think anybody in the livestock sector would have the flexibility to cut that much.
"There would be some questions about whether that would work on this magnitude. Again, why don't we use every bushel of corn we have? That pipeline needs to stay intact. There might be an inventory that the refiners and blenders would want to hang on to.
"Balance the facts. There's value in taking the extreme peaks and valleys out of society. If we don't throw all the livestock producers out of business, don't have to spike all these food prices as much, then we won't have to have as much downside. The bottom line is this is a natural disaster and we're all going to have to kind of come together and think about what's best for us in the long run."
08-01-2012 10:52 AM - edited 08-01-2012 11:05 AM
He paints a pretty grim pictture. Whether it all comes to pass is another story.
He dosn't address RIN, which account for about 900,000,000 bushels of corn - not a lot but certainly a significant number that won't go to ethanol if prices get high enough. Reducing the ethanol mandate will go on top of the RIN, further driving down corn prices..
Emotion is going to end up drivign politics. Many interest groups are going to use this disaster for their own advantage and will sway the discussion to it's extremes rather than help us find middle ground.
So, this is what vertical integration does? Back in 1950, every farm would have livestock and would have moderated the diaster to a great extent on their own. If market forces acting through verticial itnegration caused this inability to internally adjust so now we will adjust at a bigger level. No little tremors, just the big earthquake instead. My point is that sometimes fixing one problem causes another and at some point in time we might consider letting nature take it's course. It won't be this time, though.
From my personal, individual point of view - leave things along. Does that mean drop crop insurance? I can live with that.
08-01-2012 10:58 AM
Good points, Jim. One thing that didn't really occur to me before I talked to Chris about the RINs: I asked him why they wouldn't just roll them all over. But, that's where his remark about the corn pipeline for livestock came in. Basically, they want to keep a sort of RIN 'pipeline' intact so they likely wouldn't blow through them all now. Do you think that's about right? Or, if it's inevitable that these corn prices will eventually go back lower, would they use them now while they can get the most (or least, I guess) bang for the buck?
08-01-2012 11:04 AM - edited 08-01-2012 11:06 AM
Here is a U/Ill summary of RINS and implications.
Given the drought conditions experienced throughout the country and the resulting expectations for a short corn crop in 2012, meeting the non-advanced portion of the RFS2 mandates over the next few years may require use of the RIN stocks estimated to have been accumulated via the RFS2 banking provisions since 2007. Current estimates of RIN stock levels would allow for more than 900 million bushels of flexibility in the use of corn-for-ethanol over the coming marketing year. The greater likelihood of binding mandate conditions has begun to be reflected in the ethanol RIN market as prices for RINs generated in 2012 have increased at a rapid rate since mid-June. If the necessary market conditions are present (ethanol prices near or above gasoline prices), the RFS2 mandate may be met through use of available RIN stocks in the coming marketing year, and further increases in RIN values and market volatility can be expected.
This underscores the important impact that the banking provision of the RFS2 may have in meeting the non-advanced component of the mandate over the next few years, and also the importance of the need to address the seemingly opposing policies of the RFS2 mandate levels and the current blend limitations on ethanol. This is especially true when the advanced components (cellulosic and other advanced ethanol) of the mandate are considered. Unless projected gasoline consumption increases or higher blend levels are approved and effectively penetrate the market, waivers from the EPA may be required for even the non-advanced component of the RFS2 mandate."
" Ethanol RIN values generally declined through the first six months of the year, reaching a low of $0.01/gallon in mid-June. RIN prices have increased significantly throughout July, with a high price of $0.0465/gallon reported on July 19th, 2012."
08-01-2012 11:05 AM
As a founding member of the new organization Vegans For Ethanol I am opposed to any change in the ethanol mandate, in fact I think we should be ramping up production.
08-01-2012 11:08 AM
"As a founding member of the new organization Vegans For Ethanol I am opposed to any change in the ethanol mandate, in fact I think we should be ramping up production."
Which DDG level best fits your protein needs and do you prefer wet or dry?
08-01-2012 11:18 AM
Dr. Hurt has some good points.
It is understandable that if he wants to be heard by the PTB he needs to be conciliatory (ie. "nobody's fault") but the truth is that the policy was likley FUBARed from the start owing to the speed of the ramp up on the mandate and the false belief that Monsanto could deliver 170 bpa corn every year.
And most inconveniently, we do have 1 in 20 droughts every so often, in fact amazingly enough, about every 20 years!
Go figger on that one.
08-01-2012 11:50 AM
I agree nox. Let's ramp up ethanol production and let the livestock liquidate. Al Gore was all in favor of importing our food supply anyway. Diversification has always been the key. Those of us that are still diversified are the ones who will likely weather the storm better than those who are not. I liked reading the dialogue as it basically says what I've been saying all along. We're doing irrepairable demand destruction right now. The swine and poultry industries where they're vertically integrated will be the first to come back when corn drops into the threes. However, the beef industry will more than likely never come back.
By the time someone in gov't gets around to doing anything, it will be too late. This is why analysts recommend selling one to two years ahead in drought years like this. While 5.25 corn in 2014 might not look very good today, it could look mighty attractive come October 2014. What would tickle my fancy more than anything would be to see nothing done. Then, I'd like to see crude fall into the 60's as Europe implodes. It would be karma for bad policy.