Shock in Supply Chain

August 26, 2011 08:22 PM
Shock in Supply Chain

Corn’s explosive takeover, mighty Chinese soybean demand and a weak dollar cause crisis for other crops

From the Deep South to near the Canadian border, farmers have heard the piercing call of corn and responded by abandoning centuries-old acreage practices. Farmers, economists and industry officials alike predict that things might never go back to the way they were. The result: shock in the supply chain for the crops that corn has replaced.

The shock reverberates from the long-tested laws of supply, demand and price. In the case of corn, it’s fast-paced demand from ethanol that’s now soaking up 40% of the crop. And it’s not only a corn story. The burgeoning Chinese demand for soybeans also plays a role.

Yet even more is involved than just demand, because an increasingly weak U.S. dollar has also been a major player in making U.S. crops more competitive than those raised in other countries.
The days of predictable crop rotations have given way to acreage battles that respond to market opportunities. Larkin Martin, who farms in Courtland, Ala., knows this firsthand.

"From 2001 to 2006, 60% to 70% of our cropland was in cotton consistently, 20% to 30% corn and the remainder in soybeans and wheat. But in 2009, we grew no cotton: We were 50% corn, 18% to 20% wheat, soybeans and some sesame. This year, we’re 35% to 40% cotton and corn, along with smaller amounts of wheat, canola, sesame and soybeans," Martin says.

The reason for her dramatic year-to-year shifts in acreage? Price, pure and simple. Corn prices skyrocketed while cotton prices, until this past year, had tumbled, due largely to the global
recession that choked off demand. Since then, the industry—needing acres—bid up the price of cotton from 60¢ per pound to the highest levels since the Civil War. By late July, cotton prices had given back half of that and gyrated back down to $1 per pound, still strong by historical standards.

Move far north to near the 49th parallel and you’ll find Darwyn Mayer, who has doubled his corn acres since 2003. Why? First, prices have made corn more attractive. Demand for corn in his area is strong with an ethanol plant just 25 miles away from his Mott, N.D., farm. Second, seed companies are creating hybrids well suited for short-seasoned environments.

shock system chart

So much for the past. What’s ahead? Farmers should expect a continuation of highly volatile crop prices for the next several years, but relatively strong prices due in large part to strong export demand and, of course, ethanol use. That’s why Farm Journal and our sister brands Top Producer, AgWeb and "AgDay" TV have launched a new series, "Ready for the Ride," to help producers make the most of the ups and downs in the markets—and protect themselves from a crash and many Maalox moments.

What’s behind the ride. The factors driving prices are different in 2011 than those in 2008, which was another boom year for strong prices, according to a new report by the Farm Foundation. "What’s Driving Food Prices in 2011," researched by Purdue University economists, identifies five issues that are important to the agricultural commodity prices as well as market volatility this year:

  • The existence of two big, persistent demand shocks. Chinese soybean imports have increased in recent years and remain at high levels. Meanwhile, biofuels took 27% of the 2011 corn crop to meet the demand to produce ethanol, compared to a far more modest 10% of the 2005–2006 corn crop.
  • Greater market inelasticity. More inelastic agricultural markets—or markets insensitive to price—mean prices are both higher in response to demand shocks and are now more volatile.
  • Weather and stocks. A significant factor influencing price surges has been low stock-to-use ratios. Corn has the tightest stocks, followed by cotton and then soybeans.
  • Chinese policy. Chinese trade and stocks policies, which vary across commodities, mean the impact of income growth and dietary transition are conditioned on world market outcomes. Being nearly self-sufficient in grains, the Chinese are largely disconnected from the world markets. That is not the case in soybeans, since China imports most of its requirements.
  • Macroeconomic factors. While changes have not been as dramatic in 2011, the dollar exchange rate remains weak and volatile. The exchange rate is also correlated with other macroeconomic factors, including worldwide economic growth.

The three Purdue economists who conducted the study say that much is riding on 2011–12 corn and soybean production. A return to normal yields barely allows the world to continue to meet trend consumption.

In the absence of yields well above trend, it appears the tight world stocks for corn and beans cannot be overcome in one crop year. For farmers, that means corn prices are likely to remain at current levels for the next two years. After that, expect a range between $2 and $7 per bushel, says Wallace Tyner, the Purdue economist who is the chief author of the report.

The drivers of present high prices of corn and soybeans have been the ratcheting up of ethanol and China’s soybean stock building. The increase in demand for both is over, even though actual demand will continue at high levels, Tyner adds.

"The surge is over," he says, adding that high global grain and oilseed prices will trigger a global supply response because of the additional land being brought into production. The response will largely come from sub-Saharan Africa, Brazil, Argentina, India and China. In the U.S., additional supplies will primarily come from increased yields.

The real pain. What has hurt agriculture the most—price or volatility? Take cotton as an example.

"It’s more a problem of volatility," says John Robinson, Texas A&M University economist. The $1 to $2.50 per bale swing in prices has put some cotton merchants out of business, he says, and that ultimately hurts producers because there are fewer buyers for raw cotton. Merchants were hurt badly by volatile prices that drove margin calls to unprecedented levels for cotton futures. Although some went out of business in 2008, in 2010 merchants weathered the storm. "It just cost them a lot of liquidity and sleepless nights," Robinson says.


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Spell Check

9/1/2011 08:29 AM

  Whats the reference for the paper mentioned in the article?? Thaks

9/1/2011 08:29 AM

  Whats the reference for the paper mentioned in the article?? Thaks


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