FIRST TO FUEL AND THEN TO FEED - THE RISE OF CORN-BASED ETHANOL / THE FINANCIAL TIMES ( VERY HIGHLY RECOMMENDED READING )

Note from the editor

First to fuel and then to feed - the rise of corn-based ethanol


When I visited Iowa last year I was welcomed to Des Moines’ airport by a large advertisement placed by the state’s college promoting a degree in agronomy. Nothing surprising so far as Iowa is at the centre of the US corn belt. But what surprised me was the advertisement’s fine print: “I’m an agronomist. Applying science to fuel and feed our global society”. I thought it was a curios order: first to fuel, later to feed.


The latest report from the US Department of Agriculture proves that corn-based ethanol is indeed taking the foremost role, at the expense of food supplies. It does not sound right to me. But the market has no opinion about which component of demand should take priority – and now corn prices will rally significantly to resolve the problem.


The USDA estimates that during the 2010-11 season the US-based ethanol industry will consume 4.95bn bushel of corn, equal to a staggering 39.8 per cent of the country’s corn production. The share of ethanol demand in US corn supplies is moving upwards season after season, but the last two years had been explosive. In 2008-09 ethanol consumed 3.71bn bushels, or 30.6 per cent of the country’s crop.


The result is that US – and global – corn supplies are under massive strain. True, the problem has been exacerbated by lower-than-expected crops in the US, Argentina and Ukraine. But without runaway ethanol demand corn will not be trading above $7 a bushel, nearing the all-time high set during the 2007-08 food crisis of $7.65 a bushel.


Worse, the ethanol industry, supported by generous subsidies, appears insensitive so far to higher prices. The USDA hiked its forecast for ethanol consumption on Wednesday in spite of prices in December and January in excess of $6 a bushel.


A combination of government mandates, forward buying earlier in the season at lower prices and high oil and sugar prices means that ethanol remains, in spite of near record prices for corn, a profitable business in the US. “Rising corn prices have reduced spot margins relative to variable costs to breakeven levels in recent weeks; however, ethanol blender incentives remain in place,” the USDA said.


The runaway demand has cut US 'ending stocks' to a precarious 675m bushels, equal to 5 per cent of demand. The stock-to-demand ratio match modern history's record low of 1995-96 and it is only a notch above the absolute record set in 1937.

The ending stocks figure is so low that corn prices will need to surge significantly higher now to curtail demand. If ethanol consumption remains at pace, other – read here food – will need to drop. At 675m bushel, the US risk breaking the minimum level of stocks needed to maintain the supply pipeline. By the end of the season, the US will have stocks to survive for 18 days. So think about what will happen with supplies – and prices – if bad weather delays the harvest by, say, two weeks.