The world is running short of corn. That is the message being delivered by the market, where on Thursday prices pushed above $8 a bushel for the first time. The biggest potential for a reduction in corn demand comes from the ethanol industry, which is using roughly 5bn bushels of corn, or nearly 40 per cent of the US corn crop, each year to make fuel for cars and animal feed.
With no obvious abundance of international suppliers to make up for the drought-ravaged US corn crop and stocks close to record lows, traders and analysts believe demand must be pegged back.
A reduction in demand “will be necessary to prevent cupboards going bare”, says Hussein Allidina, head of commodities research at Morgan Stanley.
“Demand rationing”, as analysts call it, is already beginning to happen. The US Department of Agriculture last week lowered its estimate of how much corn will be used to feed livestock by 650m bushels, or 12 per cent. It also reduced its forecast for US exports by 300m bushels.
But the biggest potential for a reduction in corn demand comes from the ethanol industry, which is using roughly 5bn bushels of corn, or nearly 40 per cent of the US corn crop, each year to make fuel for cars and animal feed.
Already ethanol production, once seen as impervious to high prices, is waning as skyrocketing corn prices, weak gasoline demand and the expiry of subsidies hurt margins. US ethanol plants pumped out 33.7m gallons a day last week, the lowest volume since October 2009.
In late June, Valero Energy temporarily closed two ethanol refineries in Indiana and Nebraska as local corn prices had shot too high to turn a profit. Each had the capacity to produce 120m gallons a year.
“We let the local markets know when we shut the plants down that we weren’t going to be buying corn,” said a spokesman for Valero. Eight other Valero plants remain open. The company said it hoped to reopen the plants once the new corn crop was harvested in the fertile Midwest states.
However, some demand is essentially guaranteed by the Renewable Fuel Standard, the congressional mandate that will require more than 13bn gallons of corn-based ethanol to be used in transport this year, regardless of the corn price.
“One of the peculiarities of the ethanol mandate is that regardless of how dire the corn crop may be, ethanol always eats first,” says Scott Faber of the Environmental Working Group, which opposes ethanol subsidies.
Some traders and analysts believe a decision by the US Environmental Protection Agency to waive the mandate could prevent a price spike as the US corn crop withers.
“Politicians are all in denial,” says an executive at a commodity trading house. “They have to address the US ethanol programme – that’s the only way to tackle it. To take out big chunks of demand you need to take out the US ethanol programme.”
That appears unlikely in an election year. Ethanol is a political hot potato in the US, with grain-producing states and some environmentalists lobbying for mandates.
The Renewable Fuels Association, an industry group, points out that petitioners seeking a waiver must show unequivocally that the ethanol mandate would “severely harm the economy or environment of a state, a region, or the US”.
“The mandates are strong,” says one senior trader. “Just if they announce that there may be a change of legislation – I think that will put the market limit down.”
The EPA said: “We can’t speculate on waiver requests that we haven’t received.”
There are also technical issues that could prevent a large-scale reduction in ethanol use. Metropolitan areas with dirty air such as New York, Chicago and Los Angeles have to blend “oxygenates” into gasoline to improve car emissions. Since an earlier oxygenate called MTBE disappeared, the industry has been using ethanol, says Tom Kloza of the Oil Price Information Service.
However, ethanol production may be pared back without waiving mandates.