What’s different this time?
Ph.D., Wells Fargo Chief Agricultural Economist
July 23, 2019
The 2019 corn and soybean crop has seen a terrible start with most acres delayed beyond their best planting dates, and millions of acres looking like they won’t get planted. Weather will always be the number one risk factor for crop production, and this year reminds the markets that nothing can be taken for granted until the crop is in the bin.
Represented in the below chart, the price for corn has surged both in the futures and the cash market. Last fall, the cash market in Iowa bottomed out at $3.07 per bushel for the statewide average. The week of 7/20/2019 saw the same statewide average at $4.24 per bushel, and December 2019 corn futures around $4.30 per bushel. The most recent WASDE report from the USDA reduced the forecasted 2019 production by 1.3 billion bushels, a 9% decline, from the baseline of 15 billion bushels. They expect 3% fewer corn acres, and a 6% drop in yield.
For corn farmers and corn buyers, the key question revolves around how high the corn price could get if the weather continues to reduce yield potential? In August of 2012, the Iowa state average exceeded $8 per bushel due to the drought-induced supply shock. So, with the poor start to the 2019 crop year, why haven’t corn prices risen even more? Several key factors have changed. The rest of the world can produce more corn, the U.S. dollar has strengthened, and ethanol demand growth has slowed. With larger 2019 starting stocks, the market has seen this as a one-year weather event and one-off supply shock, and it has not priced it into 2020, evidenced by the fact that December 2020 corn futures are currently priced at $4.20 per bushel.1
Not much changes in the course of a year when it comes to the global markets and their fundamentals. However, over the course of a decade, old models and thinking can become extremely obsolete and dangerous. The U.S. retains the title of market maker for the global corn market, having the largest supply and exportable surplus, but that dominance has decreased as more corn was consumed domestically for ethanol. This led many other countries to increase acreage and chase better yield through better inputs. The following charts show this changing relationship which has effectively capped some of the price potential for corn prices, even with the U.S. supply shock.
Tariffs and trade disputes have also added to the complexity of trading and price potential, but the strength of the U.S. dollar has proceeded them, and had an even bigger impact. The U.S. trade-weighted dollar stood at an annual index of 99.7 in 2012. The same dollar index reached 128.7 in May of 20192. This nearly 30% increase in the dollar strength has made other exporters more attractive, crimping the U.S. farmers’ opportunities for exporting surplus grain and oilseed production. This growth in alternative production carrying cheaper, dollar-dominated pricing will force a cap on the U.S. prices as exports disappear faster than before.
Lastly, the ethanol market has matured with limited growth potential. Policy maneuverings around allowed blend rates and refinery exemptions still get the energy lobbyists into a lather. However, the overall demand growth for gasoline remains very tepid. Year to date in 2019, U.S. gasoline demand has declined by 0.3% from last year’s very anemic demand3. This continues to defy the normal expectations for a strong labor market and overall economic expansion. If gasoline demand can’t grow with these strongly favorable conditions, what will happen in a weaker economy? Ethanol prices have risen to offset the higher corn prices, but how high can ethanol prices go in this energy environment? If crude oil prices stay in the $50 per barrel range, what type of ethanol-to-gasoline pricing would the market support for higher corn prices?
All these factors together should temper corn producers thinking about marketing. They should not use the 2012 supply shock and pricing as a model for this year. Unless the U.S. suffers back-to-back supply reductions, it appears that foreign supply growth and domestic demand constraints will cap the price at a lower level. No one knows the peak of the market, but farmers and buyers can run the numbers for profitability and margins. Those predetermined targets for returns on assets and margins should dictate the target prices, and the coffee shop talk should be taken with a grain of salt.
1. USDA Agricultural Marketing Service Database
2. Federal Reserve Economic Database
3. Energy Information Agency weekly report