Robert Pore's Ag Blog

According to an article by Cole Gustafson, NDSU Agriculture Economist, and Dwight Aakre, NDSU Farm Management Specialist, it's important to review the broad range of federal policy changes that could be undertaken to increase the quantity of foods produced and moderate the rapid inflation of food prices.

A frequent question following recent speeches on the future of biofuels concerns the impact of increasing ethanol production on food prices.We always have replied that the rising value of raw commodities is small, compared with both the total food costs and price increases for other costs food processors face.

For example, even at these prices, the value of the corn in a box of Corn Flakes, by weight, is less than 30 cents. Several studies by the Federal Reserve Bank of Kansas City and Texas A and M University confirm that the increasing costs for transportation, labor and energy overshadow higher agricultural commodity prices.

Nevertheless, rising food prices are a public concern at present in the U.S. and abroad. Therefore, it is important to review the broad range of federal policy changes that could be undertaken to increase the quantity of foods produced and moderate the rapid inflation of food prices. In other words, what can the U.S. do to increase food production in the near-term?

Several options and their merits include:

• Change farm programs – In the past, provisions of the farm program, such as direct payments and loan programs, could be adjusted up or down to manage U.S. food production goals. However, when prices for most commodities are far above support levels, such as now, these provisions matter less to producers. Therefore, even substantial changes in farm program provisions would do little to increase overall food production. Direct payments do not have an impact on what or how much is produced. Provisions, such as loan rates, loan deficiency payments, farmer-owned reserve, set-aside, target prices, counter-cyclical payments, deficiency payments, acreage allotments and subsidized crop insurance, could have an impact on the levels and mix of crops produced. Of this set of farm program tools, only crop insurance is having any significant impact today.
• Open Conservation Reserve Program (CRP) acreage – Almost 35 million agricultural acres are being idled under CRP. The USDA’s most recent survey of land use found that 442 million acres were devoted to crop production in 2006. A significant amount of acres went into CRP as whole-farm units during the financial crisis of the late ‘80s and early ‘90s. Much of this acreage is very productive, even though it is highly erodible. Returning these lands to production would increase total food supplies. However, most of this land initially was enrolled because it was uneconomical to farm. However, CRP land may be economical to farm now, but concerns about the impact of farming these highly erodible lands probably would raise the ire of enviromentalists who are important constituents of farm bill legislation. Other USDA restrictions on the drainage of nuisance wetlands, commonly referred to as the Swampbuster Program, are keeping many potentially highly productive crop acres from being adequately drained. If changed, it could result in a significant increase in production on those acres.
• Remove the ethanol blender’s tax credit – Removing the 51-cent-per-gallon blender’s tax credit for ethanol production would lessen the overall demand for corn. However, with less ethanol production, fewer distillers grains would be available. At present, distillers grains, a byproduct of the ethanol production process, is widely available as a livestock feed. For each bushel (56 pounds) of corn ground for ethanol, 18 pounds of distillers grains are left over for animal feed. Since demand for a livestock protein would remain, corn that is not directly used for ethanol likely still would be demanded for animal feed. Removing the tax credit would result in either more corn for food, more meat produced, more of other crops produced for food or a combination of all three. The bottom line is that saving a bushel of corn from ethanol production only provides two-thirds of a bushel for another use that wouldn’t otherwise be available. It is not a one-for-one savings. In addition, ethanol provides 5 percent of the total U.S. gasoline supply. Producing less ethanol would raise gasoline prices further, which would exacerbate another price problem the federal government is trying to solve. The 2007 Energy Indepedence Act codifies increased ethanol production from 7.5 billion gallons per year to 15 billion gallons per year, regardless of the profitability of ethanol production or secondary impacts.
• Remove the tariff on foreign ethanol – Removing the 54-cent-per-gallon tariff on foreign ethanol would allow more ethanol to enter the U.S. Unlike the removal of the blender’s tax credit, this policy change would dampen demand for corn acreage, but it also would result in lower, not higher, fuel prices. Again, the eventual impact would be small because ethanol constitutes only 5 percent of U.S. gasoline consumption at present. Moreover, climate change implications of this policy are mixed because imported ethanol primarily is derived from sugar cane. While the carbon footprint of sugar to ethanol is more favorable than corn ethanol, concerns have been raised about the deforestation of additional acres to meet U.S. demand.
• Remove the tariff on urea from former Soviet Union (FSU) countries – The U.S. imposes a tariff on imports of urea fertilizer from FSU countries that effectively keeps imports from these countries out. The FSU countries are the world’s leading exporters of urea fertilizer. U.S. farmers are not able to utilize this lower-priced source of nitrogen, which is a key yield-enhancing input for many crops, particularly corn and wheat. Allowing it in would lead to higher overall farm production.
• Raise interest and exchange rates – The most direct policy for increasing food supplies is monetary policy set by the Federal Reserve Board and its chairman, Ben Bernanke. The Federal Reserve has lowered interest rates in an effort to avoid a U.S. recession, restore confidence in distressed financial markets and aid a struggling housing sector. However, lower interest rates have had the unintended consequence of lowering the exchange rate for U.S. currency. Since 2000, the exchange value of the dollar has fallen by almost 40 percent. As the value of the U.S. dollar falls, U.S. food becomes cheaper overseas. U.S. agricultural exports have risen nearly 40 percent ($62 billion in 2004-05 to $82 billion in 2007), which is about as much as the fall in the value of the dollar. Likewise, a falling dollar has made it much more difficult to purchase the 60 percent of U.S. oil that is imported. Raising interest rates and the exchange value of the U.S. dollar would result in less export demand for U.S. agricultural commodities, but lower the cost of foreign oil purchases.

In summary, future food prices may be more dependent on the decisions of the Federal Reserve Board, Department of Energy and Environmental Protection Agency than the Department of Agriculture.

Brazilian based JBS-Swift & Co. CEO Wesley Batista argued Wednesday at a Senate Judiciary subcommittee hearing that his company's pending acquisitions of National Beef Packing Co. and Smithfield Beef Group would not reduce market competition, according to an article by Tom Johnson at Meatingplace.com.

Some cattle producers generally have raised the concern that the merger would effectively reduce the number of cattle buyers to three from five, subjecting cattle producers to depressed prices and costing consumers more at retail. Sen. Herbert Kohl (D-Wis.) shares those concerns, which is why he called for a hearing of the Antitrust, Competition Policy and Consumer Rights subcommittee.

Batista told the panel JBS-Swift plans to continue its strategy of maximizing production, improving plant operations and increasing sales domestically and abroad, which requires the purchase of more cattle. As it relates to the "beef belt" — northern Texas, Oklahoma, Iowa, Kansas, Nebraska and eastern Colorado — JBS, Cargill, Tyson and regional and local plants "will continue to compete intensely for the purchase of cattle," he said.

Steve Hunt, CEO of U.S. Premium Beef, the majority owner of National Beef, added that "the livelihood of all cattle producers depends on the health and the growth of the beef industry, which is why we agree with JBS's vision."

But opponents to packer consolidation, including R-CALF CEO Bill Bullard, aren't buying, saying the buying power JBS would have would put many independent producers out of business, especially the fewer than 80,000 beef cattle operations that have herd sizes of more than 100 head.

"This group … would be at greatest risk of being forced to exit the industry due to the price effects of monopsony power because it is presumed that this group is comprised of more full-time cattle producers wholly dependent on competitive cattle prices for their livelihoods," he testified.

National Farmers Union President Tom Buis is strongly urging the Commodity Futures Trading Commission (CFTC) to conduct a thorough and comprehensive investigation of recent volatility within the commodities futures market.

"With inputs continuing to soar, producers need to market their commodities, yet have been pushed out of the traditional market intended to serve as a risk management tool," Buis said. "I urge the CFTC to take swift action to inject transparency into the marketplace.

Buis urged the commission to place a moratorium on any new commodity training index until the investigation is completed. He said the CFTC needs to look at the role and impact of over the counter (OTC) trading and swaps are having on markets.

"Without a full understanding of these trades or their impact, it is impossible to say that manipulation of the commodity markets is not occurring," Buis said.

Buis said NFU opposes any increases in the speculative positions limit, which was proposed by CFTC in 2007. He added that the CFTC needs to recognize that speculators have different interests than farmers and other traditional, commercial users of the exchanges.

The CFTC held a roundtable meeting on April 22 to gather information on whether the futures markets are adequately and appropriately performing their risk management and price discovery roles. At the time, Buis said rural America is headed for a train wreck if these challenges are not appropriately addressed.

According to Daniel Gross of Slate.com, continuing crisis over high food prices has inspired a round of global finger-pointing. Politicians blame speculators, and speculators blame the Federal Reserve. Free-traders blame countries with agricultural subsidies, and countries with agricultural subsidies blame free-traders. And everyone blames the ethanol industry: The current mania to turn food crops, especially corn, into gasoline is pushing up the global price for maize, crowding out the production of other crops and generally creating an unfair competition between gas tanks in Missouri and poor consumers in Mumbai.

But judging by recent financial results, the big villains in this story—the American companies that are responding to government mandates by buying about 20 percent of the U.S. corn harvest and processing it into fuel—aren't exactly thriving. In fact, their bottom lines and stock prices are suffering pretty badly.

VeraSun (which owns Nebraska ethanol plants in Central City, Ord and Albion) is one of the largest U.S. producers of ethanol. Last month it completed its merger with U.S. BioEnergy, giving it an annual capacity of nearly 1 billion gallons. (For 2007, total U.S. production was about 6.5 billion gallons.) In the 2007 fourth quarter, VeraSun ran all out, making 142.1 million gallons, double its output in the 2006 fourth quarter. But prices fell (down 14 percent), and gross profit (broadly speaking, the difference between sales and what it costs to make it) slumped by one-quarter. For all of 2007, VeraSun's gross profit fell to 11.3 percent of revenues from 34.5 percent of revenues in 2006. The stock has lost nearly 60 percent of its value in the past six months.

The chart tells a similar tale at Pacific Ethanol, whose stock has fallen from about $15 to about $3. Pacific Ethanol's gross margin dropped from 11 percent in 2006 to 7.1 percent in 2007 partly because of higher corn costs. Aventine Renewable's one-year chart shows a precipitous fall in stock price from $20 to $4. And a Wall Street analyst recently noted that it faced a potential cash shortfall. When it reported quarterly earnings last week, Aventine said that its average sales price per gallon rose from the first quarter of 2007 enough but not enough to outweigh the rise in corn. And thanks to the high price of energy (it takes energy to produce energy), the cost of converting corn into ethanol rose more than 10 percent per gallon during the same time period. So, between the first quarter of 2007 and the first quarter of 2008, Aventine's operating margins shrunk from about 6.5 percent of sales to 4.7 percent of sales. And MGP Ingredients said profit margins in its distillery products unit fell to 2 percent in the fourth quarter of 2007, down from 22 percent in the final quarter of 2006.

What gives? In theory, business should be gangbusters in the ethanol patch. Government policy has mandated consumption of the fuel, thus stimulating investment. The Energy Policy Act of 2005 called for 5.4 billion gallons of renewable fuels to be sold in 2008 and 7.5 billion gallons by 2012. Last year, the Energy Independence and Security Act of 2007 dramatically jacked up the short-term targets (9 billion gallons by 2008) and the long-term targets (36 billion gallons by 2022), with corn-based ethanol expected to meet most of this demand.

But just because the government forces people to buy your product doesn't mean it's a surefire win. The combination of high oil prices, tariffs that protect domestically produced ethanol from imports, and tax credits for companies that blend ethanol into gasoline has stimulated something of an ethanol bubble. And as always happens during a bubble, excess capacity—and the vicious competition it creates—winds up eroding margins. The Renewable Fuels Association has excellent data on ethanol production that show a massive spike in capacity. The U.S. industry has grown from 3.4 billion gallons of capacity in 2004 to 6.5 billion in 2007. Today, some 134 plants with a capacity of 7.23 billion gallons are in operation, and another 77 with 6.2 billion gallons of capacity are under construction. Capacity has more than doubled since 2004, and, once all the plants in the works are completed, it will nearly double again. But with demand for gasoline declining nationwide, and with ethanol an imperfect substitute for gasoline (not all vehicles can use it; the distribution network isn't fully built out), producers aren't always able to dictate prices to the marketplace.

As for the bottom line, processors and distributors of agricultural commodities—from Kraft to Morton's Steakhouse—are being pinched by rising costs of grains and energy, tough competition, and softened demand stemming from the weakening economy. These factors are shrinking margins at every rung of the food-processing business. Ethanol producers are no different than cookie-makers and restaurants in this regard. After all, their biggest inputs include an agricultural commodity (corn) and energy.

While environmentalists have warned that the rapid growth of ethanol posed a danger to sustainability, the alarm may be somewhat misplaced. Oil has topped $122 a barrel and could be heading to $150. But the ethanol bubble has already popped. The recent poor results from ethanol producers is far more likely to hinder further development than any change in government policy.

South Dakota is poised to lead the nation in raising public awareness for higher blends of ethanol with a new blender pump initiative earlier this month.

Through a partnership between the Ethanol Promotion and Information Council (EPIC) and the South Dakota Corn Utilization Council (SDCUC), the initiative will help gas station retailers obtain funding and the equipment needed to sell blends of ethanol ranging from 20 to 40 percent to be used in flex-fuel vehicles.

According to EPIC Director of Operations Robert White, South Dakota is the perfect place to launch this new program.

“South Dakota is where the blender pump movement started and we are happy to partner with the corn producers there to get this initiative off the ground,” said White.

White explains that the blender pumps actually blend unleaded gasoline and ethanol in various levels. “It really is a multi-product dispenser,” he said. “It’s just like punching the octane button on a multi-product dispenser now, but instead of octane levels, you’re choosing the level of ethanol in that blend.”

There are currently about 20 blender pumps in the state and the goal is to install a minimum of 100 new blender pumps over the next year.

SDCUC Executive Director Lisa Richardson says South Dakota’s ethanol industry is uniquely positioned to increase the use of higher ethanol blends to meet the Renewable Fuels Standard.

“The two largest ethanol companies are here, people in South Dakota are highly educated about ethanol and our goal is simply that we need to figure out we can use more product and we need to give consumers the choice and the blender pump does just that,” Richardson said.

Richardson says they are directly providing the funding to help retailers obtain and install the blender pumps.

“We are actually going to give gas stations $2500 from us with a match of $2500 from the ethanol industry to install one of these,” she said. “And because it is an E85 pump they can also get up to a $30,000 tax credit from the federal government.”

All blender pumps will be branded with the stylized “e” logo and the program includes a marketing and PR campaign to increase public awareness.

“We’re going to have a website and we’re going to work with our auto dealers to tell people where they are,” said Richardson. “We’re going to launch a whole campaign, everything from radio to billboards and let people know where they can go and fill up with higher blends of ethanol.”

White says that consumer choice is the goal. “There has been a lot of outcry for choices and in this situation drivers of flex fuel vehicles will have the opportunity to make that selection of an ethanol blend above ten percent,” White said.