Rationing the 2012 corn crop - Are we there yet?
click image to zoom We provide estimates in Table 1 of how the corn crop would be allocated to various uses and the implications for price under several alternative yield scenarios. We consider scenarios where U.S. average yields range from 140 bushels to 125 bushels, in 5 bushel increments. Please note that the yield scenarios reflect what we believe is a plausible range of yield outcomes for this “what if” analysis, but we do not take a position on the likelihood of any particular scenario at the present time.
The projections of total production, total consumption, and consumption by category for each scenario are based on several key assumptions:
1) Acreage planted but not harvested for grain totals 9 million acres rather than 7.55 million estimated in the USDA’s June Acreage report. This is similar to the acreage not harvested in previous drought years like 1988 and 2002.
2) Minimum year-ending stocks are equal to 5 percent of consumption. While there is not a clear consensus on the minimum level of “pipeline” stocks needed to bridge the period between the end of a marketing year and the next harvest, we believe the experience of recent years indicates this is a reasonable estimate.
3) Export demand is likely stronger than that implied by USDA’s July balance sheet due to production problems in other parts of the world, notably Argentina. This is reflected in an initial projection of 1.7 billion bushels rather than the 1.6 billion used by the USDA.
4) Export demand is relatively price inelastic, so that exports decline modestly with smaller supplies and higher prices.
5) Domestic processing demand is also relatively price inelastic, so that non-ethanol processing uses decline modestly with smaller supplies and higher prices.
6) Feed demand is relatively more price elastic than export or domestic processing demand so that feed and residual consumption declines with smaller supplies and higher prices. We impose the assumption of a 3 percent decline in feed and residual use for each incremental decline in yield. However, we also assume that for each bushel decline in corn consumed for ethanol, there is a one-third bushel increase in corn feeding to offset the reduction of distiller’s grain production. This is a simplifying assumption since some distiller’s grain is exported and the reduction in output would not impact domestic supplies one-for-one. Some of the decline in distiller’s production might instead boost corn exports.
The projections based on the previous assumptions are found in Columns 2 through 5 of Table 1. Note the very modest declines in feed and residual use of corn with lower yields and higher prices, which seems to be a contradiction of assumption (6). However, total corn-based feed consumption would decline much more rapidly than implied by the corn feed and residual projection. This is due to the decline in feeding of distiller’s grain, which is driven by the more rapid pace of decline in ethanol use (and production). Progressively more liquidation of livestock numbers would be required with each 5 bushel decline in the average corn yield through this implied distiller’s grain pathway.
The projections also imply that ethanol production would eventually drop below the mandated level of blending. We calculate the mandated level for the 2012-13 corn marketing year at 13.6 billion gallons, which would require processing of about 4.9 billion bushels of corn. However, as noted in the discussion of assumption (7) part of that the mandate can be satisfied by accumulated RINS from production that exceeded the mandate the past two years. We estimate that maximizing the use of those RINS suggests that a minimum of about 3.92 billion bushels of corn would be required to meet the mandate. Under the demand assumptions in this analysis, an average yield much below 130 bushels would not provide adequate corn supplies to meet the mandate even making full use of the available stock of RINS credits. Such a situation would require more severe reductions in consumption in other categories (likely in feed use) or some partial waiver of the mandate. Nonetheless, it is still noteworthy how low the U.S. average corn yield can sink before the RFS mandate becomes binding and much more drastic adjustments are forced on other categories of use. This highlights the key role that the RINS credits are likely to play in the upcoming marketing year.
Implications for Price
What about the question posed at the beginning of this post? Is the current level of prices high enough to ration usage in light of substantially diminished expectations about supply? In central Illinois, the current forward bid for harvest delivery of corn is about $7.20. This is consistent with the scenarios where yield is between 135 and 140 bushels. If yield turns out to be above 140 then current prices would appear to be sufficient, and perhaps more than sufficient, to ration usage. An average yield of 135 bushels or less would require substantial further rationing, resulting in record high average prices. Under such a scenario, history suggests that prices may go well above the expected average price in order to initiate the additional rationing process. Prices have probably not yet gone high enough to accomplish the necessary rationing if the average yield is below 135 bushels.
In closing, it is important to emphasize that our analysis should be viewed for what it is—a simple, first take on what might happen under alternative corn yield scenarios. How actual market dynamics will be worked out is fraught with complexities. In particular, we are in uncharted territory regarding the interaction of the corn, ethanol, and gasoline markets in a major drought. This adds even more uncertainty to what is already an extremely volatile market situation.