‘New Era’ in Grain Prices to Be Sustained

By Jane Fyksen Crops Editor
Wednesday, October 1, 2008 9:14 PM CDT

The prices producers are receiving for their grain and paying for inputs have changed so much in the last couple years that it’s shaken the confidence many have in the decisions they’re making. Two University of Illinois ag economists offer some assurance that the ethanol-fueled hike in grain prices is very apt to hold. Darrel Good and Scott Irwin surmise producers are seeing the first sustained increase for corn, wheat and soybean prices in more than three decades.

Irwin says this new price era could easily last two or three decades, sustained by corn prices that are now tethered to sharply higher gasoline prices and the fuel industry, because of the crop’s ties to ethanol.

Prices of corn, soybeans and wheat started moving higher in the fall of 2006 and have remained generally high and well above average prices in the previous 30 years. These higher prices, and the volatility associated with them, have resulted in producer uncertainty. Are higher prices here to stay? If so, what is the expected level and variability of prices during this new era?

From a producer's standpoint, the question really is: “What is a good price for corn, soybeans and wheat?”

Good and Irwin are helping producers answer that question.

Corn could average $4.60 a bushel, nearly double the (Illinois) average of $2.42 a bushel from 1973 to 2006, report Good and Irwin, adding that price swings stemming from weather or other market variables could send corn as high as $6.70 a bushel - or down to $3. However, Good notes, “The extreme low prices in terms of the ‘new era’ would have been considered awfully good prices in the old era.”

Soybean prices could average $11.50 a bushel, up sharply from an average of $6.15 from 1973 to 2006, with swings from $8.20 to $19 a bushel. Wheat could increase to an average $5.80 a bushel, up from $3.24, dipping as low as $3.30 a bushel or as high as $10.15.

They base their opinion on newly released research and a review of market data dating back to the mid-1900s. Although their forecasts are based on Illinois grain prices, they assure increases will likely be similar on a percentage basis in other grain-producing states such as Wisconsin.

Irwin reveals their new study stemmed, as noted, from concerns from producers trying to get a handle on rising prices in markets turned volatile in the wake of the ethanol boom. "There was frustration that they no longer had a frame of reference," he explains. "This is our first effort to try to provide some perspective on what might be ‘high’ and what might be ‘low’ - with all of the caveats about how difficult that is to do."

“These questions cannot be answered with certainty, but unfolding evidence suggests that prices are indeed likely establishing a higher average than that experienced in recent history. The factors supporting this conclusion include generally tight world inventories, growing world demand for food and biofuels, and escalating costs of production,” these analysts maintain.

Their research reveals just two earlier lasting increases in grain prices. The first was after World War II, when price controls were lifted and post-war rebuilding began. The second lasting increase began in 1973, sparked by shifts in exchange-rate policies, massive grain purchases by the former Soviet Union and a period of escalating energy prices and more rapid inflation.

Good says the dawn of this new era mirrors those earlier ones, but this one is driven by growth in ethanol, higher inflation and steeply rising production costs. Good and Irwin forecast average prices for this new era based on increases between the World War II and post-1973 eras, which ranged from 79 percent for wheat to 134 percent for soybeans. They also accounted for fluctuations as the new higher prices take hold, setting a range of possible highs and lows based on data from the first five years of the earlier eras.

Are the price level expectations for the current era consistent with known fundamentals? “The question really centers on corn prices,” they state. Their average price level projected for corn ($4.60) is consistent with other price projections that using models.

“Compared to the futures market, which is currently projecting prices close to $6 through 2011, our projection of the average corn price is relatively conservative,” they say.

Current market fundamentals center on large amounts of corn used for ethanol, suggesting that corn prices will continue to be closely tied to energy prices in the immediate future and that the price of the other two crops will have to be competitive with the price of corn.

As noted, these ag economists feel the present grain-price boom will stick around 20 or so years, thanks to ethanol. "The key is what happens in our crude oil and energy markets," Irwin remarks. "The risk on the downside is technological breakthroughs that would dramatically reduce oil consumption, lowering the whole price structure. If anything, though, the risk is on the other side. We likely are going to continually be bumping into demand for crude-oil production that we can't easily get above."

Good has more good news for cash-croppers. He says the new-era prices grain producers have been seeing of late won’t be affected by a shift from ethanol to another fuel additive made from crops, such as switchgrass. Finite land available for production will continue to drive up prices, just as corn has raised prices for soybeans and wheat.

"We would have to steal land away from corn to grow a different energy-related crop - so now you have that competition again," Good notes.

Agriculture has taken it on the chin for diverting corn to ethanol and driving up the cost of food. Irwin has good news for consumers, too. He says food costs have likely seen the worst of the shift to higher-priced grain after posting 5 to 6 percent increases this year. But he warns that commodities account for just 20 percent of food costs, so prices could still go up to cover labor, transportation or other rising supply-chain expenses.

Good and Irwin say farmers posted record earnings in last year, and likely will again this year. But profits will ultimately dip back to historical levels of roughly $50 to $60 an acre as land and production costs rise to keep pace with new era prices.

"The real winners in this are landowners," Irwin reveals. "If history is any guide, we will see every ounce of the operating margin bid into land and cash rents."

There are several important “take-home” points for producer's struggling with the question: “What is a good price for corn, soybeans and wheat?”

First, they say, it’s likely that a permanent shift has occurred in the level of corn, soybean, and wheat prices.

Second, peak prices since December 2006 for all three commodities were well above average prices projected for the new era. This doesn’t mean even higher prices cannot occur in the near future, but it does provide useful perspective on just how high prices did move.

Third, prices can still move to “low” levels in this new era, particularly in relation to production costs, and they can stay there for considerable periods of time. For example, corn prices could easily return to the low $3 range for a period time, soybean prices to the low $8 range, and wheat prices to the mid $3 range.

Good and Irwin share some detailed tables and figures from their analysis at http://www.farmdoc.uiuc.edu/marketing/mobr/mobr_08-04/mobr_08-04.html.

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