FUTURE CORN FUEL
by George Kleinman
Editor, Commodities Trends
July 23, 2007

Corn prices have just hit eight-month lows. On June 18, December 2007 corn reached a contract high of $4.31 per bushel; last Friday it was trading at $3.31--down a dollar in just one month. This is surprising because in this same period oil prices rose from $68 a barrel to 25-year highs at $75 last week.

The connection is ethanol--more than 20 percent of the corn crop is now being consumed for a demand source most people hadn�t even heard of just a few years ago.

With the price of ethanol high right now, and with today�s relatively low corn prices, every ethanol plant in the nation is likely making big money. I�ve heard of margins in the neighborhood of $2 profit for every bushel of corn that moves through these plants.

A typical 50 million gallon ethanol plant will process 18 million bushels of corn annually. That�s 1.5 million bushels in a month; multiply that by $2 a bushel and you can do the math: $3,000,000 per month profit per plant.

And there are hundreds of these plants now in operation, with some of the bigger plants producing more than double that number. Bottom line: There�s absolutely no incentive for the ethanol producer not to produce to capacity, and no incentive for new ethanol plants not to be built.

You might have heard this story before, and so has the American farmer. As a result, farmers went a bit overboard planting corn this year. Before the crop year began, the US Dept of Agriculture estimated 86 million acres of corn would be planted in America in 2007, up 10 percent from last year. This estimate was eventually raised to 90 million, and in the latest and final estimate up to a whopping 93 million--the primary reason for the recent corn price collapse. Timely rains recently fell across corn country, and the resulting price collapse can be seen in the chart below.

December 2007 Corn



Source: Commodity.com

This is all leading to what I believe is developing into a longer-term profit opportunity in corn futures.

Ethanol prices are dependent on gasoline prices. Will gasoline prices move lower over time? I don�t think so. There will, over course, be fluctuations, but the longer-term trend in gasoline consumption is relentlessly higher due to oil depletion and the double-digit growth of the world economy fueled by China, India and normal trendline population growth throughout the world.

If we accept the premise gasoline prices will remain high, ethanol prices will remain high; therefore, there�s no incentive for ethanol plants not to continue to use corn. Estimates are, at current ethanol prices, corn prices will have to rise to $5 a bushel to curb consumption for this use. This brings up the question whether farmers will continue to plant corn at the expense of other crops. I don�t think so.

This year, because so much acreage was devoted to corn, acreage was robbed from other crops such as cotton, wheat and soybeans. As a result, cotton, soybean and wheat prices have surged, and those commodities are now profitable alternatives to corn. Although demand should continue to rise, the corn supply next year could easily fall due to lower planted acreage.

Next year�s acreage is obviously an unknown at this time, but my best estimate is it will fall under 90 million, thus opening the door to a tighter corn supply and higher prices next year. If there are any weather problems next year (also an unknown right now) prices could really surge.

Because we�re trading futures, we can actually buy next year�s crop, which is only a figment of imagination, today. Here�s what the December 2008 corn chart looks like right now:

December 2008 Corn



Source: Commodity.com

Note that next year�s December futures hit about the same high price as this year�s last month. But although the market has come down sharply for this contract, the low at 382 is quite a bit above this year�s low. Next year�s corn futures appear to be well supported. In other words, there�s quiet and persistent buying interest in the future crop while most traders are focused on the present crop.

The big question is when to be a buyer of December 2008 corn. Right now the trend in corn is down, so I believe there�s no rush. One method would be to use the 50-day exponential moving average (the green line on the above chart). When the market closes two consecutive days above the 50-day, be a buyer. You�ll never catch the lows with this method, but many times it�s better than trying to catch a falling knife. Once you�re in, risk to a two-day close under the 50-day.

© 2007 George Kleinman
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