Prior to late 2006, crude oil prices had little, if any, influence on the price of corn. Then, when the U.S. government mandated increased use of ethanol, corn price climbed during harvest against seasonal trends—and things changed. Crude oil began influencing the price of corn (see chart).
One can argue the timing of a lag effect in the price correlation, but it appears crude is the leader in price appreciation. In the past few months, corn has not kept up with crude's rise to more than $80. In fact, it declined, relatively speaking, after USDA's Jan. 12 reports found more stocks. This begs the question of whether corn has disconnected, found resistance at $4.25 or is merely lagging again.
Perhaps when corn is ample, it reacts to a more normal supply-and-demand scenario. If, however, the futures market is indeed looking into the future, figuring that demand for energy will increase with the expected global economic recovery or expansion of the 10% ethanol blend, it will put upside price pressure on corn again if crude oil rises.
Should the Environmental Protection Agency raise the ethanol mandate even to 12%, it would suggest a 20% increase in corn for ethanol, or an additional 800 million bushels. If so, traders may base their price projections on recent history, suggesting that $80 crude points to $5 corn—if not now, eventually! Any supply reduction and demand increase for corn, including livestock and export expansion, that points toward tight stocks will get the attention of investors.
History Lesson. History should have taught the ethanol and livestock industries a lesson. Lag or no lag, corn price can quickly respond to a potential tightening in stocks. Ethanol's more than 4-billion-bushel usage foundation isn't going away, barring a second and more severe economic malaise.
Managing price risk as an end user is just as important as it is for the producer. With planted acres once again at the center of attention and the ultimate
growing season coinciding with the emphasis of an economic rebound, the stage is set for corn prices to react, via ethanol usage, should crude stay near $80 or higher. If the demand for ethanol is there, either economically or mandated, it will take no prisoners; the livestock sector will have to compete. Neither sector can afford a repeat of 2008! Should crude retreat to $65, corn may still be too expensive.
End User Strategy. I will view a close into new highs for 2010 prior to July 1 or a close more than the previous month's high as an important indicator that end users need upside protection. Should neither happen, a monthly close more than June's highs will serve as a similar indicator. Prior to those time frames, as a producer, I want only 40% in cash contracts with 60% in futures/options that allow me the flexibility to change focus with changing times and prices.
It is when the unexpected happens that a sense of urgency is created. Corn has not responded in step with the rise of crude to $80 or more as projections for a near 2-billion-bushel carryover abound. Perhaps we are once again lagging a year behind.
Jerry Gulke farms in northern Illinois and North Dakota and has a consulting office at the Chicago Board of Trade. Contact him at firstname.lastname@example.org or (312) 896-2090.
Top Producer, Spring 2010
Is Corn Disconnecting From Crude?
By Jerry Gulke