How Low Could Corn Prices Go?

Oil price drives gasoline, gasoline drives ethanol, ethanol drives corn price.

Published on: Nov 11, 2008

June's sharp corn price runup left livestock producers shell shocked. Corn's subsequent dramatic collapse shifted the shock and awe to corn growers.

Predicting corn prices is challenging. However, Bruce Babcock, director of the Center for Agricultural and Rural Development at Iowa State University, identified relationships you can watch for sizeable clues. One is the price of ethanol. The other is the price of oil.

Babcock calculates that with ethanol at $1 per gallon an efficient ethanol producer can pay $1.73 for corn. Ethanol at $1.50 would boost the amount the ethanol plant could pay for corn to $3.66. At $2 ethanol, the plant could pay $5.59. Each 50-cent change in the ethanol price changes the ethanol plant's ability to pay for corn $1.93 per bushel.

Marginal user sets corn price. Different corn users can pay different amounts of corn. The user who can pay the lowest maximum price sets the corn market. Why? At that price the buyer with the lowest maximum price stops buying. This last user is called the marginal user of corn.

Since fall 2007 ethanol has been the marginal user. So with corn prices linked to ethanol prices, ethanol prices joined at the hip to gasoline prices and gasoline prices a function of oil prices, oil is the key corn price driver when ethanol is the marginal buyer.

Ethanol valued for energy not additive. Since April of 2008, ethanol prices have been much lower than gasoline prices. One explanation for this change is that the rapid expansion in ethanol production has forced ethanol to compete directly with gasoline as a substitute fuel, and the price of ethanol has been forced down to create an incentive for blenders in the Southeast to expand their blending infrastructure.

An equation Babcock uses to predict prices sets the price of ethanol at 68% of the price of gasoline (to account for ethanol's lower energy value) plus the blenders tax credit (to account for the per gallon benefit of the ethanol subsidy). "But this equation has over-predicted the price of ethanol by about 8% since June of 2008," he says.

Suppose ethanol continues to be priced 8% below its energy value. "Then if we know the wholesale price of gasoline, we can predict the price of corn," says Babcock.

Babcock's model calculates where corn prices should stabilize with various crude oil prices. For example:

• With crude oil at $50 a barrel, corn could sag to $2.18.
• With crude oil at $70 a barrel, corn could stabilize at $3.24.
• With oil at $90 a barrel, corn could stabilize at $4.30.
• Crude oil at $110 a barrel could boost corn to $5.35.
Lower corn prices ease the cost/price squeeze on livestock producers, but financially stress crop farmers.

Don't wait for $2.18 to buy corn. Babcock believes corn prices would not drop to $2.18, even if crude oil skids to $50 per barrel.

"The reason is that at such a low corn price, speculators would likely move into the market to buy corn for delivery in the 2009-10 marketing year," he explains. "Furthermore, at $2.18 corn farmers would not plant enough corn in 2009 to meet the almost 13-billion-bushel demand."