Forget Oil, the New Bubble Burst is Agriculture

Today, July 29, agriculture futures traded mostly lower as a warm, dry weather pattern settled into the Midwest, boosting crops heading into the important fall harvest. But as shown on the table below, corn futures rose 12.25 cents to settle at $6.135 a bushel on the CBOT.


A rush to cash in on ethanol has slowed as soaring corn prices squeeze profit margins for producers of the alternative fuel. At a recent high of $7 per bushel, the corn used to make ethanol has tripled in price since many plants were built two years ago, and some facilities have been shut down or put on hold.

Chris Hurt, a professor of agricultural economics in the heart of the Corn Belt at Indiana's Purdue University, on July 15, said, “Corn is now more expensive than it was when many of the ethanol plants were built. Two years ago, when many of the plants were being built, corn was $2 per bushel, making ethanol production so profitable, that in some cases a plant could be paid off in just 6 months”.

Since mid-2007, U.S. corn prices have increased as domestic feedgrain supply prospects have caught up with demand. As a result, ethanol production gross profit margins were reduced in the later part of 2007 to the degree that almost no new ethanol plants were announced or planned in the U.S. Actually, ethanol plants on the drawing boards were cancelled before construction could begin, and work was halted on a few plants that were already under construction.

Now, operating ethanol plants are feeling the pain of declining profitability if not outright losses. The charts below shows corn ethanol profit margin.

Source: Daniel O’Brien and Mike Woolverton, Extension Agricultural Economist, K-State Research and Extension

The Washington Times reported on July 17, that high corn prices are threatening the U.S. ethanol industry’s ability to reduce the country’s foreign oil independence. Analysts are predicting that corn prices will stay high through next year even though the number of crops planted has drastically increased.

Beside due to Midwest flood, raising corn prices is also driven by higher fertilizer prices. According to State Agriculture Secretary Roger L on http://www.cattlenetwork.com, he said the cost of growing an acre of corn had increased by about 30 percent this year, due primarily to higher diesel fuel, land rental and fertilizer prices. A ton of potash fertilizer that cost about $600 last year rose to about $1,000 this year.

When all costs are included, it cost about $500 to plant an acre of corn this year, up from about $280 last year. Things don't always turn out the way farmers expect, state farmers changing their minds since March and planting less corn. Their decision can be influenced by weather. In March, Maryland farmers announced plans to plant 490,000 acres of corn this year. That would have been a decline of 9.26 percent from the 2007 planting, the largest in 15 years.

Even Brazilian sugarcane based ethanol is not excluded from squeezing profit margin. According to Forbes on July 7, Brazilian sugar and ethanol producers' profitability has been hit not only by a surge in production costs such as the price of fertilizer which has doubled in the past year but also a strong appreciation of the local currency against the dollar.


Costs to produce anhydrous ethanol, which in Brazil is made from sugar cane, rose 20 percent in reais from February 2007 through April 2008, according to Datagro analysts, who forecasts a new increase until July. "The real problem is not the price, but costs and the currency exchange," said Luiz Guilherme Zancaner, president of Unialco sugar and ethanol group. He said fertilizer prices rose 64 percent from a year ago. Rising fertilizer and diesel prices, and growing labor costs hit mills' results hard in the past year or so, Antonio de Padua Rodrigues, technical director at the Sugar Cane Industry Association, said.

According to BusinessWire on June 2006, A Comprehensive research report on the American corn ethanol industry written by Russell Hasan on 2006, entitled “A Research Report on Ethanol Investment: Golden Opportunity or Fool's Gold?”, cautions investors about the danger of the ethanol bubble bursting in the short term, but reaches the conclusion that there are long-term opportunities for intelligent ethanol investors.

The report reaches the following conclusions:

1. The ethanol boom has been engineered by mandatory usage requirements, high tax incentives and prohibitive import tariffs. The domestic corn ethanol industry will have trouble in a free market economy.
2. Domestic corn ethanol production capacity will surpass mandated consumption levels soon, bringing about pressure on price.
3. Like the first ethanol boom and bust of the Carter era, this boom is also vulnerable to fickle political will. This is dangerous because profit margins will shrink if government incentives are removed.
4. Ethanol is more expensive and gets less mileage than gasoline. Consumer acceptance of E85 is suspect.
5. Brazilian sugarcane ethanol is considerably cheaper and more efficient than corn ethanol. Reprocessed Brazilian sugarcane ethanol can enter America from Caribbean and CAFTA countries without paying the tariff.
6. There is simply not enough corn to make large-scale corn ethanol viable, a claim that former Fed Chairman Alan Greenspan agreed with recently. Tight corn supply will put pressure on producers.
7. Corn ethanol is likely to be replaced by cellulosic ethanol, which will be cheaper and cleaner than corn ethanol.
8. Ethanol stocks follow oil prices. At the first sign of the softening of crude oil prices, institutional investors will bail out, leaving individual investors to take losses.
9. Ethanol has reached tabloid stardom because of celebrity endorsements from Bill Gates, Ted Turner and Richard Branson. Celebrities have been offered advantageous investment terms that the average investor will not receive.
10. The ethanol craze contains a lot of fool's gold, but there are still golden opportunities for investors who understand the industry.

An excerpt from the report follows:

"It is our firmly held belief that the next great fortunes are going to be made in the alternative energy industry. Unfortunately, corn ethanol is not a simple opportunity of this kind, for the reasons described above. Although this industry may be profitable for the next five years, it is highly probable that the American corn ethanol industry, except possibly for small co-ops, will face strong pressure from corn supply concerns, sugarcane ethanol imports from Brazil, and new cellulosic ethanol technology in five to ten years. Competition from gasoline will be brutal if oil prices fall, and profit margins will suffer fatal blows if government incentives like the tariff are removed. Companies overwhelmed by these factors will probably cause the ethanol bubble to burst by the end of the decade. Hopefully, the major American ethanol producers will find ways to weather this storm, particularly by exploiting new cellulosic technologies or securing cheap corn supplies, in order to achieve long-term profitability."

Related Posts :

1. Dennis Gartman Predicts Corn Ethanol Producers Bankruptcy
2. Agrium(AGU) is Temporary Oversold
3. World Food Shortage and the Ethanol Bubble

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