Corn belt drought—waiting for the shoes to drop

How the corn belt drought plays out is open to some pretty creative speculation.  There are a lot of things that might happen.

First up, we hear from one of the petty speculators.  This is one of the wild cards.  There have been commodity traders and speculators for quite awhile but historically, most of the "players" actually had a reason to be in that market.  An outfit like Cargill has the capability of taking delivery of the commodities they are trading—most of the new speculators do not.  Yet the useless speculators are taking a very bad situation and making it worse.  (For example, I have seen guesses that as much as $.60 per gallon of the total gasoline price is just speculative overhead.)  Anyway, someone will try very hard to profit from this disaster.  Several someones will succeed.  This is a peek at how they think.

KOTOK: The Corn Price Shock Will Have Serious Implications Around The World For Years

David Kotok, Cumberland Advisors | Aug. 11, 2012

Two expert agricultural economists joined this year's gathering in Maine. Their expertise is worldwide. Each of them has years of experience forecasting various ag scenarios and resulting global impacts. One is chief economist of a major, worldwide trading company; the other is affiliated with a bank that is involved in agricultural lending.

We discussed corn, soybeans, and drought effects on world prices. We examined emerging economies, where food is a large component of the price index. We talked about how food spending drives the political constituencies in those countries. Bottom line: the geopolitical risk premium rises as food prices consume increasing amounts of household budgets.

The biggest take-away for me was the explanation that this decline in food production is likely to be a multi-year cycle. And this is not just one in one drought-stricken region of the world. The impact of food price increases is now global. Moreover, we have run down the inventory cushions.

Weather-induced price hikes are an exogenous shock, meaning that they are caused by factors from outside the system. Central bank monetary policy can do nothing about an outside shock. Central banks cannot grow corn. At a zero-bound policy interest rate, all the central bank can do is watch the price index climb above its targets. Any action it takes is likely to be counterproductive.

Governments often use fiscal policy to deal with food issues. Politicians act because they feel the heat from hungry constituents. In some cases, they implement food price controls that end up exacerbating shortages. In other cases there is turmoil in the streets, and it may lead to regime change, or at least the threat of regime change. But fiscal policy is constrained by large deficits in most OECD mature economies. Agree or not, we already see it being used as a subsidy in developing countries. The outcomes of fiscal response are questionable since they amount to a forced transfers payment.

The bottom line for me is to take this food price shock seriously. It flows beyond grain itself and into animal and energy feed stocks. It affects the rearing of the four-legged critters and the ubiquitous poultry found around the world. more

With skyrocketing corn prices due to shortages, there are calls to shut down the ethanol business.  Those who wish for this outcome might be pleased to know that simple economics will probably do the job.  Here in Minnesota, the shutdowns have begun.

High Corn Prices Squeezing Minnesota Ethanol Plants

August 14, 2012
Reporting Bill Hudson

LITTLE FALLS, Minn. (WCCO) – As the devastating drought continues to force corn prices higher, it’s also pushing one Minnesota ethanol plant to suspend production.

Central Minnesota Ethanol Co-op in Little Falls is shutting down for the time being while it’s unable to make a profit. The suspension of ethanol production will put about 30 plant workers out of work.

It’s one of those good news, bad news stories. Farmers or growers are relishing the high corn prices, but on the flip side, $7 to $8 bushel corn is squeezing the profits off the ethanol plants.

Lon Johnson runs Centra Sota Feeds, the local feed mill.

“The ones selling are pretty happy. The ones buying, they maybe don’t like it as well, but as long as everything else evens out – the products that they’re selling – as long as that all evens out, yeah, there’s profits in it,” Johnson said.

But Minnesota’s 20 ethanol plants are being squeezed by high prices.

The Little Falls plant will shut down and do maintenance. Today’s corn prices it’s no longer profitable.

Tim Rudnicki heads the Minnesota Biofuels Association.

“I think it’s no surprise. Certainly the price of corn is having an impact on the production cost for Minnesota ethanol producers,” said Rudnicki. more