GLG News by Philip Corzine

Implications: An over-emphasis on ethanol has combined with a poor production year and a major speculative push on commodity prices to push livestock net returns into the red.  Animal feed has long been US corn and soybeans primary source of demand, but high feed costs, with no way to push up the selling price of their products, has created a situation that will soon, if not corrected, turn into a significant liquidation of the US pork industry.  To push up commodity supplies, changes need to be made now in the US CRP program rules to push up 2009 planted acres.  In addition, (possibly) temporary waivers in the ethanol subsidy and or import tariff should be considered to slow the conversion of corn into ethanol, keeping those supplies available for feed, and helping to ease the price of livestock feed. 

Analysis: Livestock producer are price takers, not makers, and right now, they are caught in a squeeze between ethanol escalated feed costs, without adequate price increases of their product to match the cost increases. 

Pork producers are facing significant losses-per-head of production, and in an excellent example of Murphy's law, the only way for them to improve their net margins, is for them to get out....leave the business, as most producer's fixed costs won't allow them to scale down.  It's pretty much all or nothing, and so most producers are faced with the situation of deciding how long they can hold out, hoping for better times.

Meat prices will go up, as soon as enough producers exit the business, and profits will return, but the US livestock industry may be permanently changed by that point, consolidated, or perhaps even relocated off-shore, where costs are lower and environmental regs are easier. 

It's also not just the pork industry, as this story points out, the poultry industry is also under feed-price pressure as well. - Butterball cites ethanol policy in local job cuts

As a farmer, $7.00 corn is a great thing to sell, but as a business owner, any change or impairment of the client that buys 1/2 of the product I produce is something I need to be seriously concerned about. 

In the short-term, temporary waivers on Renewable Fuels Standards and the ethanol production subsidies and import tariffs should be considered. 

Longer term, changes in the CRP program to increase planted area for 2009 and beyond should be considered as well.

Implications: Just like this time last year, traders in Chicago may believe that Brazilian farmers are poised to significantly expand soybean acreage, as they have moved prices above $15 per bushel.  However, just as they misjudged them last year, they may be doing it again, as fertilizer prices have doubled, and have brought potential net returns on Brazilian soy back down enough that a significant expansion is currently unlikely, unless fertilizer costs can be reduced, or prices go significantly higher, very soon.

Analysis: Thankfully, soybean prices are finally higher in Brazil.  At harvest last year, we were selling beans in Tocantins state for 28 real per sac ($5.80 per bushel).  Last week, Granol, a Brazilian biodiesel company with a buying station in our area, was paying 44 real per sac ($12.50 per bushel).  So the good times are rolling again on the soy farms in Brazil then?

Unfortunately, the profit party has been spoiled by fertilizer costs, which represented 50% of our $240 per acre crop budget last year, and have doubled in price for this next crop, pushing our expected cost-per-acre up in the $430 per acre range.  If we budget a 43 bushel per acre average yield (not overly conservative on our soils that are only in their first to fifth year of production), and if we could sell them for $13 per bushel, we MIGHT end up with about $120 per acre to cover land and management.  Not exactly windfall profits.

Accordingly, most producers we talked to, prior to this last run up in prices, were not planning to expand soy production at all.  Fertilizer costs were listed as the main reason.  The current price rally may change some minds on that, but I don't expect it to add more than 2-3%, so my current expectation is still for a 5% or less increase in soy acres in Brazil. 

Time is running short.  Decisions need to be made now, in order to allow time to get all the inputs bought, paid for and delivered.  Lime, if needed, needs to be applied yesterday, so future price increases in Chicago may not have much more effect on farmer's plans in Brazil.

The government of Brazil's saber rattling over fertilizer costs is more than likely simply trying to force this industry to transfer some of their very generous margins to their farmer/customers.  This story: Brazil Vale Speeds up Projects Linked to Fertilizers
is proof that the government's tough talk is having some affect.  Bunge's very profitable fertilizer business in Brazil may be affected by these actions, but they will be affected by lower-than-expected soy plantings to an even larger degree, if indeed, that is what transpires.

Implications: Expiring contracts may add two million acres a year to planted area in the US, but don't look for many contracts to be "broken" unless they were recently signed, as the penalty's are too severe, even with high commodity prices. It seems likely that given the current situation with a poor crop in the fields (flooding and late planting) and high prices, changes in the program are somewhat likely, and if they occur, they will have some market impact.

Analysis: Expiring contracts could add 2M acres per year to US crop acreage, but exceeding that number will likely require some change in policy from USDA on the program. 

Current penalties for leaving early require all payments to be repaid plus interest, plus a 25% additional penalty on one-year's payment.  Even with the current high commodity prices, anyone that has been in the program for any length of time, will find that too steep of a price to pay.

Another complication is the fact that a recent (2007) re-enrollment program (known internally as REX) re-upped 23M of the 28M acres that were due to expire in the 2007-2010 time period.  More highly erodible farms were put into new 10 to 15 year contracts, so those farms might be more likely to leave their contracts, since the penalties would be relatively low.  Less erodible farms were simply extended for periods of 5 years or less, so they would face penalties based on their original contracts, which would be significant, and would make breaking their contracts mostly non-feasible.  So the poorest land that needs protection the most has the biggest incentive to flee and farm....unless a change is made in the rules.

According to this article from IA State, it is feasible that 2M acres per year, for 10 years, could be brought back into production, which at its conclusion, would amount to an increase in planted area of 6% over today's production area.

It seems likely that given the current situation with a poor crop in the fields (flooding and late planting) and high prices, changes in the program are somewhat likely, and if they occur, they will have some market impact.

Implications: The USDA's most recent projections on planted area for corn, soy and wheat in the US for 2008 appear to be optimistic at best.

Analysis: Darrell Good of the Univ. of IL does a nice job of taking a critical look at the most recent report from the USDA on their expectations for planted area for corn, wheat and soybeans in the US in 2008. 

USDA has indicated they expect US farmers to increase planted area for these crops by 7.4 million acres, with the growth coming from,according the Dr. Good,
> Reduced cotton plantings (1.1M acres)
> Increased double cropping of soybeans after wheat (2M acres)
> Land coming out of the Conservation Reserve Program (2.5M acres).

Here are three issues to consider. 

First, double cropped soybeans are not nearly the same as first crop soybeans.  The success of planting soybeans following the wheat harvest in June or July is driven by location (in IL, south of I70, it's a good risk, but north of I72 and your odds are better in Vegas) and weather (is it going to rain a lot in July?).  It would seem to be wise that if USDA is pumping up their total soy area with 2M double crop acres, some reduction in average yield would be wise.

Secondly, the 2.5M acres coming out of the CRP program has a similar problem.  Farmers typically don't idle their top-producing land in the CRP program and a great deal of the acres in this program are in fact, much better off never being farmed.  So even the "best land" coming out of CRP will likely be at the bottom on typical yields, regardless of what crop is being produced.  Interestingly though, the USDA is projecting corn yields next year up 3.8 bushels per acre from 2007, which would be a four-year high. 

Last problem is a bit more glaring.  There are another 1.8M of "new" acres that can't be explained.  Is there some cerrado somewhere in the US that farmers are busy clearing for planting in a few months?  Is  pasture being plowed up in preparation for corn or bean planting? 

Or are the USDA's planting expectations a bit on the optimistic side?

Implications: The ag commodity markets are trading on emotion, and to some extent, fear, without and regard for supply and demand, and the continued economic viability of that demand.  The old market saying is that high prices are the best cure for high prices, but the "cure" may be a bitter pill to swallow.

Analysis: This article brings light to the increasing concern that the ag commodities markets are not only highly over-priced, but also that these current prices are being driven by non-traditional participants, and if and when the market turns, the reversal is likely to be fast, and the drop significant. 

Expanded limits on wheat prices now allow daily price changes of over one dollar per bushel, so when funds decide to exit the market, watch out below.

I know some new players to this sector believe we have entered a new period of ag prices, and I would concur.  Where I differ is on what this new level is.  Is $5.00 corn the new standard? 

Even ethanol can't keep corn at these prices forever, with margins now of less than $0.30 per gallon in some cases, and that's with crude oil at record levels.

Livestock feeders certainly wont be able to withstand these feed prices forever, at least until they reduce numbers, forcing meat prices, and profitability back up. 

The ag commodity markets are trading on emotion, and to some extent, fear, without and regard for supply and demand, and the continued economic viability of that demand.  The old market saying is that high prices are the best cure for high prices, but the "cure" may be a bitter pill to swallow.

Implications: DuPont's new "in-the-bag" refuge system will probably steal some market share from Monsanto trait seed, until Monsanto introduces the same, but likely gains will be small due to the ability of producers to satisfy the refuge requirements with simple in-the-row methods.

Analysis: In order to protect against the development of insects resistant to the protection trait inserted, genetically, into the seed (ie: biotech seed, stacked traits, triple-stack, etc), farmers are required to leave "refuge areas", or in other words, parts of a field are to be planted with non-trait seed, to be sure that some of the target insects are allowed to live, reducing the odds that the whole-fields of insect-trait protected seed would "select" for resistant insects, which would then breed until they are large in population and potentially uncontrollable.

So the question is , with DuPont introducing this new product that removes the need to have refuge areas, will farmers flock to this product at the expense of Monsanto seed, requiring refuge areas?

From our experience here in IL, I can tell you that the farmers that I hire to custom plant my farms use a 24 row (60 foot wide) planter, and they simply dedicate a few of the rows on the planter to non-trait seed, creating in-the-field refuge areas, and not requiring much real effort on their part.  This refuge system is simply, cheap, and effective, and DuPonts new seed would not be an added value under this situation.

However, producers using other planting systems that have a generic seed hopper (ie: one large seed bin for the planter rather than several, ie: 24 in this case, individual rows), might find more value in this new trait.

In general, I think there will be some opportunity to gain market share here until Monsanto introduces similar technology, but I also believe the potential gain in market share will be minimal.

Implications: The US ag sector is showing strong signs of being overheated, and is likely to see a correction soon.  The question is, how far and fast will it fall.

Analysis: This commentary and interview with a Deere & Co. (John Deere) sales representative further raises concerns that the US ag sector is overheated, and will eventually suffer a correction. 

The concern is that since a great deal of the source of the push up in prices for all the ag commodities is speculative in nature, and funded by market participants not historically common to trading ag commodities, how fast and far will the markets drop, if and when they do drop.

Farmers ordering farm equipment for 2009 before they even know the price of the machine they are ordering, in my mind, isn't a sign of a healthy sector, but rather one that is over-heated and due for a correction.

Implications: Demand from the biofuels industry, not feed-based demand, is driving the rally in the commodities markets.  Soybean prices have been high before, but high prices will eventually "fix" the supply shortage concerns.  The weak US Dollar vs. the Brazilian Real is also one reason behind the high commodity prices, but with current prices, and assuming the Brazilian Real holds near its current level, Brazil may start to "fill the gap" on world soy production in the next 12 months.  What happens in the biofuels industry here in the US is probably "the" key factor in predicting where commodity prices will be headed over the next 12-24 months.

Analysis: While I agree with the author that prices of agricultural fertilizers, and the profits of the companies that manufacture them, will remain in a demand-driven up-trend, I believe he is mistaken in believing that this new demand is being driven by the food side of the demand equation.
He is correct in his remarks that the world needs a continually growing supply of protein, but the world's production of protein and feed grains has in the past, been able to keep pace with these increases in demand.

In 1990, the soybean market was in the midst of a price rally, and most  agricultural marketing guru's proclaimed that China's growing appetite for meat, and the subsequent need for soy to fill the protein component of the feed to grow out those hogs, as the reason that prices for soy would never fall below $7.00 per bushel again.

Enter Brazil with a massive expansion in production area for soy, good crops in the US, and some changes in the direction from China on import policies, and prices once again collapsed to the level of government loan prices here in the US.

These markets--corn, soy, wheat, are all being driven by bio-fuels, primarily from corn based ethanol.  The situation has also been significantly affected by the weak US Dollar vs. a strong Brazilian Real, keeping Brazilian soy farmers from mounting a rapid expansion in acres.

Why is the distinction important? 

Food based demand is growing, but at a predictable, and sustainable pace.  It's the demand from the rapidly growing biofuels segment that has the markets out-of-balance, so anyone that cares where prices for commodities are headed, needs to keep a very close eye on what the biofuels industry does over the next two years. 

Also, if soybean prices remain at these levels into mid-summer and if the Brazilian Real holds close to where it is against the US dollar, look for a significant expansion of soybean area in Brazil for the crop to be planted in the last quarter of 2008.

Implications: The expansion in planted area in Brazil over the past ten years is impressive, but the potential exists to add 300-400 million more "new" acres in that country.  The expansion has been held back by low domestic prices for soy, but that may be coming to an end.  Prices for soy in Tocantins are only five Reals per sac below what we sold for in 2003, and there is now, the opportunity to turn a profit again in this sector.  If conditions, ie: the exchange rate and soy prices on the CBOT, hold, we should expect a significant expansion in soy area in Brazil for the crop to be planted in the third quarter of 2008.

Analysis: An expansion of over 83% is alone, quite impressive.  However, this doesn't even take into account the fact that planted area actually fell during the 2006-2007 crop.  During the boom years of the early 2000's, expansions in acreage of 12-15% per year were not uncommon.

A climbing Brazilian Real vs. a weakening US Dollar, in combination with a fall in the world price for soybeans, the dominant crop in Brazil, for the most part, shut down the land development operations over most of Brazil. 

By August of 2006, prices for soybeans in Brazil had fallen to less than one-half of what they were selling for in 2003, and profits were hard to find, especially on "new farms", where costs are higher and production is lower during the first five years.  In fact, for farms across all of Brazil, production costs, especially for fertilizer and for fuel, all climbed higher.

Operating losses caused debt to mount on many farms, and that problem continues to affect the sector today, as it remains difficult for some producers to get financing, which has also held back increases in production.

Times are changing, however, as the skyrocketing prices for soy on the CBOT have pushed prices for soy in Brazil back up to respectable levels, even with a continuing strong Real relative to the Dollar.  Current prices in our region of Tocantins are approaching 40 Reals per sac, only five Reals below what we were able to sell soy for in 2003. 

If these prices, and the exchange rate holds near present levels, we will see more growth in Brazilian planted area next crop.

USDA and Brazil's Embrapa believe there may be an additional 300-400 million acres of farmland that could be "created" from cerrado (basically range or brush-lands) and pasture in Brazil alone, and if the financial incentive is there, you will get farm development operations turned back on in Brazil. 

We have only seen the beginning of the expansion in agricultural lands for row-crop production in Brazil.

Implications: A couple of dollars per acre might not seem like a lot of money, but on US operations that can cover several thousand acres, it can add up to several thousand dollars per year, and all for buying a product that they have already found to be a good investment for their operations.  So although it seems small, it points out a company that is continuing to do all the right things, to command significant market share in the race to supply seed genetics to agricultural producers.

Analysis: To someone outside the industry, the issue of saving a couple of dollars per acre on crop insurance if a farmer plants Monsanto genetics, might seem insignificant, but US farmers are very good at controlling costs, and the opportunity to save a few thousand dollars per year will be just one more reason for farmers to keep buying more Monsanto seeds.

Of course, performance still is the determining factor in purchase decisions for seed, but Monsanto has been getting good reviews from producers in that area as well.  US farmers are coming off of, what for many was, all-time personal records for both productivity, and for profit, and many will tell you that they believe that the genetics in the seed, very often which came from Monsanto, is one of the prime reasons they were able to achieve record yields.

So, a few dollars an acre may likely be "icing on the cake" for some producers that were already sold on using more genetics from Monsanto.

Implications: Lack of infrastructure is creating price-gluts, and low or negative margins for ethanol producers.  This situation could continue for another two years, as improvements in infrastructure struggle to keep up with expansions in production of ethanol.  Corn acreage is already at its highest level since 1944, and with the current price relationships, will have a hard time gaining more acres in the US.  Regardless, expansion of ethanol capacity continues in the US, as there are more plants online, under construction, and in planning stages, than there was just 3 months ago.  Iowa continues on the part to become a "corn deficit state", and basis levels have been turned on their ear all over that state.

Analysis:

Infrastructure for moving ethanol to the south, and to the east and west coasts has not been able to expand enough, fast enough, to handle the increases in production of ethanol, which has caused wholesale prices of ethanol to trade at a large discount to gasoline.

It looks like it could be another 2 years before infrastructure catches up with ethanol production capacity to improve this situation

An expansion of allowed ethanol blends to 12-15% could expand ethanol demand in the US Midwest by 20-50%, which could significantly reduce the transportation-driven low ethanol prices there.

US corn acreage is the highest it has been since 1944, and in the previous crop, stole acres from cotton (-29%), soybeans (-16%) and wheat (-8%). Given the currently significantly higher prices for soybeans and wheat, it will be difficult for corn to steal additional acres from those crops, and it may in fact lose ground to them in the coming crop. The situation for the cotton market in terms of area, is less clear.

The current price situation for ethanol has plants operating at a deficit, but projected numbers reported here indicate that between July and November, the number of plants operating in the US increased by 5 to 139, the number under construction increased by 2 to 91, and the number in some stage of planning increased by 14 to 242.

Also according to this report, if all the ethanol plants currently planned to be built in the state of Iowa are built, ethanol alone, not counting the demand for feed and exports, would consume 159% of Iowa's 2006 corn crop. A quick look at the ethanol draw-map included in this report reveals a storm of competition brewing in this state, and the results of that can already be seen in basis levels in that state. Northwest Iowa farmers have typically been the recipient of some the widest basis levels in the US. However this past summer, prices in that northwest region were actually positive.

I concur with this analysis by Prof. Wisner, and feel that the US ethanol industry continues on an over-building frenzy, even after the popular press had hailed the end of the boom in plant building.

Again according to this report, 60-66% of GLOBAL corn exports will be needed just to satisfy the new demand created when the ethanol plants under construction come online. That's not even taking into account keeping the plants already online supplied, nor does it consider the 343 plants that are in planning stages.

Ethanol producers appear to be facing multiple years of low prices, and will be challenged to find profitable margins, especially given the high prices for the primary feedstock of corn, which will keep corn farmers, land owners, and producers of all manners of agricultural inputs and machinery smiling for some time as well.

Implications: US farm programs have lost their focus, and are providing subsidies to farmers during a year of record incomes.  In addition, a continued focus by the US government on expanding biofuels will do more to stimulate agricultural production in other countries, than it will here in the US.

Analysis: US farm programs have lost their focus--lost their reason for existing, so it's not surprising to see yet another article, like this one, talking about millionaires getting farm subsidy checks.  Why do millionaires get farm subsidies?  Because although the US government talks a lot about farm programs being there to help small farmers, in reality, the bulk of the program focuses on stabilizing and subsidizing commercial agriculture, so how much money you have, or you make, really isn't an issue.

Case in point....just last month I received my final "counter-cyclical" payment for corn and soybean production, amounting to a little over $23 per acre.  The odd thing is that the crop that I just harvested (approximately 210 bu. of corn per acre sold for around $3.50 per bushel, raised at a total cost of about $250 per acre...you do the math) generated lifetime high net returns-per-acre.  So I'm not sure what "cycle" these payments are supposed to be "counter" to, but clearly, it can't be net incomes.

Furthermore, this talk of expanding renewable fuels goals is mind boggling.  Look at commodity prices, and you can see the challenges commodities are having trying to keep up with the current goals.  Unless we release acres from the conservation reserve program, there are no more acres in this country to farm, they are pretty much all being used, so trying to do more biofuels from corn and soy, really means you are sending signals to other countries. 

With our farms in Brazil ramping up to raise more soy, that's fine with me, but it doesn't make much sense to me as a US farmer and taxpayer.

Implications: The biofuels boom is driving up prices for farmland across the US.  Typical prices for top farmland selling with no development potential, are now around $6,000 per acre or more in Central IL.  The higher prices are good for current owners, but bad for anyone renting land, which covers the vast majority of agricultural producers, at least in IL, where over 70% of land is owned by someone other than the operator.  Cash rents for farmland have nearly doubled during this escalation in prices, cutting out a large chunk of the expanded profits, and passing it into the hands of the farmland owners.  These higher prices and rents are creating a great deal of additional risk, as high commodity prices and average and above yields are being factored into budgets to allow them to cover the cost of higher rents.

Analysis:

Prices for farmland in the US Midwest are skyrocketing, largely due to the higher returns per acre, which is driven by higher commodity prices, which are a factor of the biofuels driven boom. 

Higher prices for farmland are great if you already own it, and are even better if you happen to be getting ready to sell it.  Anyone cashing in an estate, or just seeking to cash in, is smiling from ear to ear.

Prices for top-quality farmland in my part of the state of IL is running near $6,000 per acre, which is probably 30-40% higher than it was just two years ago, in the time before ethanol turned the agricultural world on its ear. 

Eighty acres, 1/2 mile from my farm near Assumption IL, sold a couple of weeks ago at auction for $5,400 per acre.  The farm has a ditch that cuts it into two pieces, and eighteen months ago, you would have been hard pressed to find a buyer willing to offer much over $4,000 per acre.

Obviously higher prices make it more difficult for anyone seeking to purchase farmland....and more risky as well.  Assuming that this current spike is driven in large part by biofuels, what happens to the market if that demand falls off?  Unlikely scenario?  Perhaps...but ethanol profitability has already fallen dramatically, so it seems likely that expected future expansion in demand may not reach expectations.  In addition...what happens to commodity prices if and when cellulosic ethanol becomes a reality?

Rents for farmland are also being affected by higher prices for farmland, as anyone renting farmland for cash will likely be getting their rent bumped up to keep up with the higher value of the asset that  they are renting.  Top cash rents for farmland in Central IL ran in the $180-220 per acre range two years ago.  Last year, I heard of land renting for as much as $325 per acre, and for the next crop, I have heard rents mentioned at over $400 per acre.  You can pencil out a profit with rents that high IF corn prices stay in the mid-three dollar range, and IF you don't have a crop failure.  Federal Crop Insurance can soften some of that risk...but it cant remove it entirely.

Higher farmland prices are great, if you own it, and if aren't trying to rent land to farm, but nearly every farm operation has a significant amount of rented acreage (over 70% of the farmland in IL is owned by someone other than the operator.)  So for farm operators, higher farmland prices have a dark side as well.

Implications: The adoption of new crops for biofeedstocks will be driven by how efficient the crops are (gallons per acre), and in how they fare economically (net returns per acre).  Crops like camelina may be able to gain a foothold in regions where corn and soy are less viable, like the US west and northwest.  Crops like Jatropha may gain a foothold in some regions of the world, likely in lower cost labor regions (at least initially), due to the high labor requirements.  Jatropha, however, needs to develop better genetics, and a mechanized planting and harvest systems for it to be a significant source of biofuel.  The perfection of cellulosic biofuels, however, will likely make all of these crops unneeded for fuel production, due to its higher efficiency, so all these crops probably have a limited window of opportunity to feed biofuels production.

Analysis: Producers of corn and soybeans in the US have spent a great deal of time and money over the past decade trying to develop new markets for their commodities, and with biofuels, they have finally achieved some very significant successes, and as a result, prices for corn and soy are at all time highs.  However an old axiom in the commodity markets is that the best cure for high prices, are high prices (also works well on the flip side--low prices curing low prices), and we can see that axiom being played out now in the search for other "bio-feed-stocks" to replace these now-to-expensive commodities

This article talks about a couple of these potential replacements for corn and soy, the primary one mentioned being camelina....which is a relative to rapeseed, which is already used for biofuel production.  The choice of crops to use for biofuels really comes down to two things: efficiency and economics.

Although corn and soy are currently the best the US has to offer in the area of efficiency, in the long-run, the US doesn't have sufficient arable acreage to use these crops to supply the volumes of fuel needed to replace petroleum based fuels and still supply the current customers...the livestock producers of the world....hence the current high prices for these commodities. 

What a crop like camelina does is to create a viable option to produce a biofuel feedstock in growing regions not well suited to corn or soy.  While the crop could also be grown in areas well suited to corn and soy, ie: the US Midwest, it then comes down to the economics of production to determine what gets grown where.  The economics are tied to how much each crop yields, costs to grow, and can be sold for.  In addition, the mechanization required for production plays into the equation..ie: what new equipment is required, if any, to produce a new crop.

Plants like Jatropha, also mentioned in this article, hold out a lot of potential as a biodiesel feedstock, but the challenge for this plant lie in the fact that it basically is undomesticated, meaning the genetics have not been refined enough yet to allow for consistent production.  This explains, in part, the dramatic variability in yield estimates that are being reported for this plant around the world.  The other Achilles heal for Jatropha is in the fact that it currently requires a great deal of manual labor to produce, although there is reported to be some work underway in parts of Brazil on a mechanized harvester.

In the longrun, new feedstocks for biodiesel and ethanol will undoubtedly emerge to compete with corn, soy and sugarcane, and the winners will be the most efficient crops that provide the best returns-per-acre to the producers.  The magic bullet however, is cellulosic, and corn, soy, camelina, and even jatropha, would all likely be eclipsed by the economics and efficiency of cellulosic biofuels production, if and when that becomes a reality.

Implications: The secondary effects of the world-wide ethanol boom are starting to show up in increases in prices, and in earnings, of which Deere is an excellent example.  Expansion of sugarcane in Brazil is driving sales of Deere machines there, but the effects of the big US corn crop and record high commodity prices are yet to be fully appreciated in the US ag sector.  If combine sales are an indication, next quarter should be another very good one for Deere.

Analysis: Deere is an excellent example of one company that is benefiting, in a very big way, from the dramatic expansion in ethanol production, worldwide. 

The article notes the expansion of sugarcane production in Brazil as one demand driver for investments in new machinery for that industry.  It also mentions, in passing, the soy industry in Brazil, but profitability has just returned to that sector, and I have doubts that sales for the soy sector there account for much of their growth in sales.

Even more interesting for Deere is how much of a boost they will get from the record income year that many US producers have experienced from the crop just harvested.   With many producers showing net income-over-variable-costs-of-production from corn of over $500, that income is now in the process of being pumped into the ag economy, and farm machinery will likely receive a significant share of that spending.

Last week I visited with the owner of our local Deere dealer, considered to be one of the larger dealerships in the US, and he mentioned that as of last week, Deere was sold out of combine harvesters (for corn-soy-wheat) for the 2008 harvest, and was no longer accepting orders for the upcoming harvest, still 10 months away. 

Undoubtedly, a large number of those machines have been ordered by farmers with an eye not only towards their burgeoning bank accounts, but also their potential tax liability resulting from that record income, and are choosing to invest some of it in new green paint for their operations, in lieu of the IRS. 

The party is probably far from over for Deere.

Implications: The biofuels sector continues to be the focus of negative stories in the US and Global press, highlighting many of the downsides of the push towards ethanol and biodiesel.  These stories, by themselves, might not create significant problems for the industry, but in combination with the twin economic challenges of high costs and low returns currently facing the new bio-projects, the added weight of increasingly concerned consumers could drag down the already slowing sector, even more.  

Analysis: This story, brief though it is, brings to light the growing problem of falling public support for biofuels. 

Early on, it was a full page coloring book page in Time magazine pointing at biofuels as the culprit behind future price increases in a range of consumer goods, and now it continues on a regular basis with stories pointing out how biofuels are pushing up food prices around the world.
Fuel, Grain Prices Spur Food Price Hikes

Recently we have seen stories on issues such as slave labor and deforestation in the Amazon---more negative consequences of the global biofuels push on the global environment.
Harsh Working Conditions Mark Production of Brazilian Ethanol

Last week, UN expert, Jean Ziegler called for a "moratorium on biofuel production to halt a growing catastrophe for the poor".
U.N. Expert Seeks to Halt Biofuels Output, Calling Them "Crime Against Humanity"

Falling support with consumers could eventually turn them against subsidies, both for biofuels, and for the agricultural feedstocks of corn and soybeans...which could be bad timing, with the renewal of the Federal Farm Programs currently being debated in Congress.

Of even more concern is the falling profitability in the ethanol industry due to high feedstock costs and falling prices for ethanol.
For ethanol, demand rise is matter of time

The ethanol industry should survive, and likely will prosper, after passing through this period of consolidation and maturation, but there is likely some economic pain ahead for both the biofuels sector, and for the growers of the agricultural feedstocks of corn and soybeans as well, as the sector tries to find equilibrium.

Implications: Ethanol and corn has been booming not because the US government called for it, but rather because there were opportunities for profits, largely due to oil prices. Subsidies for biofuels in the US should have a hard end-date. Dollars spent on food aid should increase, rather than expecting world commodity prices to decrease.

Analysis:

Reduced food aid is a problem and it’s one place, outside of livestock farmers, that you can see the direct impact of higher grain prices, on consumers.  We don’t have any worries about our morning bowl of corn flakes being priced out of our range, due to higher corn prices, but reduced quantities of international food aid is a real concern, and a concern that needs to be addressed.  .

The US Government isn’t diverting food grains into fuel, at the expense of consumers The US Government didn’t “mandate” that US farmers plant corn, or that US investors build more ethanol plants.  While the President’s speech of last year did “light a fire” under this industry, ethanol production has been expanding due to opportunities for profit… created in large part by high oil prices.

I do believe the US government is making a mistake with biofuels subsidies.  Subsidies should have a goal, and once they achieve that goal, they should go away.  At some point, even if they don’t achieve that goal, they should go away. 

A logical approach would be to offer subsidies to the biofuels industry for a sufficient period of time to stimulate the industry to grow and be healthy, then step away and let the market work.  The US needs a biofuels industry that can compete with anyone in the world without any subsidy.

More importantly, why aren’t we talking about spending more on food aid? 

Implications: GMO products will likely ride the biofuel train into other formerly closed markets, as global supplies of corn and beans shrink due to biofuel consumption, and non-GMO alternatives disappear.

Analysis:

When GMO's first hit the farm here in the US, I sat in many meetings on our State Soybean Promotions Board trying to figure out what it would take to make the GMO issue go away...so It's interesting to see that we may have finally found the magic bullet..short supplies.

Although I have always been a supporter of the technology and feel that it is safe to both use and consume (and I have done plenty of both), I also understood the concerns of those who didn't want to be forced to eat them. 

Pretend this happened in the world of pharmaceutical, and some drug company would have told you that they were replacing the drug you have used for years, with another drug, that looked, worked and cost exactly the same as your old drug.  The new technology made production of the drugs easier, and cheaper...for the drug company.  Only problem, they hadn't tested this new technology for very long.  So from the consumer's eyes, no benefit, but additional risk..and we wondered why some people said no to GMO.

The picture has changed though, as now, the question to our hypothetical consumer is more like ..do you want the new pill...or no pill at all?  And here we thought that it would take new GMO traits with consumer benefits to convince some of these markets to let in the technology.

Implications: Ethanol is headed for a slowdown and consolidations, but will emerge stronger and more efficient. Cash corn near $3.05 and ethanol near $1.58 per gallon leaves a profit margin of only a few cents per bushel. Corn prices will fall as ethanol plants slow consumption, but weather and currency issues for farmers in other countries has complicated the price picture.

Analysis:

The authors of this article, I believe, are pretty much on track.  Bottom-line, the ethanol industry is headed for a slowdown and a likely round of consolidations, but should emerge from this period much stronger, healthier, and right-sized. 

Ethanol, like the corn that we use to produce it here in the US, is a commodity, and in the commodity business, minimizing cost of production is the key to long-term survival.  Ethanol plants, like farmers, are price takers, not price makers, and thus are at the mercy of supply and demand, and with more than enough new plants coming online to supply current demand, they now have to ride out a “rough patch of ground.”

Plant owners would liked to have seen the cost of their feedstock fall, which would have helped them in this downturn, but that’s not happened..yet anyway.  It will happen eventually, but a drought for wheat farmers in Australia and a strong currency for soybean farmers in Brazil have propped up the prices for those competitive crops here in the US, which has caused corn prices to remain high.

With cash corn prices currently near  3.05 per bu. in Central IL and ethanol trading on the CBOT for around $1.58 per gallon, a typical ethanol plant with fixed and non-feedstock variable costs of $2.00 per bushel, has only around a $0.25 per bushel profit margin before its numbers turn red.  Prior to the drop on the CBOT yesterday (with corn again following wheat), this theoretical plant would have been very near to that BE point. 

Assuming ethanol prices remain low, this situation will begin to correct itself, as corn prices will fall to a level where marginal profits are again assured.  However, if the low ethanol prices hold in place long enough, look for plant utilization rates to fall, and also expect to see consolidations of the players.  This would be good for the industry, adding efficiency, reducing the number of players, and allowing them to have sufficient scale to operate at lower margins of profit, profitably—something that a producer of commodities has to be able to survive.

Implications: With current prices for soybeans, biodiesel's primary feedstock, its economic viability is questionable. With soybean oil selling for near $0.40 per pound, costs to produce soy-based biodiesel are running $3.20-$3.30 per gallon, at or slightly above current prices for diesel of $3.00-$3.10. The Federal Subsidy for biodiesel blenders of up to $1.00 per gallon appears to be the only thing keeping soy-biodiesel viable, at diesel prices that are almost 50% above those of one year ago.

Analysis:

Biodiesel, as a product, is great.  As the article state, it’s more efficient than ethanol, cleaner…greener.  The big problem for this product is that when you start trying to scale it up in volume, as the US and other countries are doing right now, you run into problems with profitability.   Specifically, the problem is with soybeans, being the primary (currently) feedstock for biodiesel, and with the demand for, and prices of, these same soybeans, being at long-term highs.  The economics just don’t add up right now.

A bushel of soybeans is 60 pounds, and after processing, is converted into approximately 11 lb. of oil, and 48 pound of meal (this varies by region, variety, year..etc, but these are industry standard estimates).  It takes about 7.3 pounds of oil to produce one gallon of Biodiesel, so the oil from one bushel of soybeans can be converted into approximately 1.4-1.5 gallons of biodiesel. 

Soybean oil is trading for around $0.40 on the CBOT, so feedstock costs alone will run biodiesel up to near $3.00 per gallon.  Other variable costs of processing may run another $0.30 per gallon, so you need to be able to sell your biodiesel for near $3.30 per gallon, to be able to show a profit and start paying down your fixed costs.  This doesn’t take into account the blender subsidy, which is what is keeping biodiesel costs close to BE.

The Federal Subsidy, which can equal $1.00 per gallon for a 20% blend, does put some daylight between the cost of production on biodiesel and retail diesel fuel prices, which are currently running in the neighborhood of $3.00 - $3.10 per gallon.  However, diesel prices are almost 50% higher than they were last year at this time.

If diesel prices fall, biodiesel would have to hope that soy oil prices would fall right along with it…but that doesn’t look likely to occur, as there is no correlation in their price movements. 

Furthermore, soybeans are kind of between a rock and a hard place right now, fighting for acres in the US with corn, and not getting enough new acres in Brazil, yet anyway, due to the strong real/lower exchange rate.  A price war is being played out on the CBOT, with each crop “bidding for acres” with higher prices. 

Ethanol, with a much better cost-of-production picture due to higher crop yields, can better afford to play this game than soy.  Brazil’s strong currency has kept prices lower in Brazil, which has kept Brazilian producers, so far, from mounting much of an expansion in soy acres.  That’s not to mention wheat, and you can expect to see more new fields being planted to that crop in the US than we have seen in quite some time as well. 

Push the real down and the real-dollar exchange rate back into the mid-to-upper two range, and soybeans will start showing up in a lot more Brazilian fields, prices would slide, and biodiesel would find some cost relief and more profit opportunities, but will that happen before diesel prices slide enough that biodiesel producers face non-viable costs of production?