December corn has been on both sides of the $8 mark during the month of August, trading in a rather narrow range despite some significant dynamics that would ordinarily push it one way or the other. So is $8 the magic level at which corn is rationed? Will the expected long tail of the short crop soon head downward from here, or are we just pausing for a breath before making another leap upward.

About every market commentary for the past two months has used the term “rationing.” Are we there yet? If the price goes higher, does that mean we are still rationing more of the crop? At what price will it take to ration the entire current corn crop? Answers to those questions will not come easy, but the theory behind rationing indicates higher prices are needed, if there is any further shortfall in supply, lower than what is currently being traded.

Regardless how much corn is produced by the drought-impacted crop, there will have to be financial limits put on its use. Since the supply will be limited, uses such as ethanol, exports, and livestock will be unable to have more than it can pay for. In all likelihood, one of those consumption areas will be able to pay more than another, and one may see corn use decline much faster than another. That is the contention of University of Illinois ag economists Darrel Good and Scott Irwin, who suggest that potential scenarios for rationing the 2012 corn crop could take prices well into the $9 per bushel range. Their rationing projection suggests that supplies of corn could decline from the current USDA forecast of 123.4 bushels per acre.

Good and Irwin offer the current price and USDA’s estimated harvested acreage of 87 million acres as a starting point. That level of production puts export use at 1.4 billion bushels, ethanol use at 4.7 billion bushels, feed and residual use at 4.16 billion bushels, and 1.375 billion bushels used for industrial use beyond the use for ethanol.

The ag economists offer an alternative rationing allocation if the national average yield fades to 120 bushels per acre. That would suggest a 1.3 bil. use for export sales, another 1.3 billion would be used by industrial food processing, other than ethanol. Ethanol would remain at 4.7 billion bushels, and feed use would decline to 3.687 bil. And with only a 10.4 billion bushel crop, they push the average price upward to $9 per bushel.

Finally, they offer a projection of 115 bushels per acre which would produce a 10 billion bushel crop. Exports would decline further to 1.225 billion, non-ethanol industrial use to 1.25 billion bushels, livestock feeding to 3.5 billion bushels, and ethanol use would drop to 4.6 billion bushels. Such a rationing of a 10 billion bushel crop would require a price of $9.60.

While exports, feed, and non-ethanol industrial use of corn see sharp declines, due to rationing, ethanol use declines very little. Good and Irwin say, “Ethanol demand will be motivated by the need for octane rather than the RFS mandate, but will be limited by the blend wall plus net exports. Here we calculate that the blend wall for the 2012-13 marketing year is 13.3 billion gallons of ethanol and assume that net trade of ethanol is zero. Assuming a yield of 2.8 gallons of ethanol per bushel of corn, 4.75 billion bushels would be required to produce 13.3 billion gallons of ethanol.”

Good and Irwin arrive at their price projection by calculating that each 1% drop in supply will push the price 3% higher. And they add, “The balance sheet alternatives presented here suggest that corn prices are now likely high enough to ration the 2012 corn crop if production is near or above the USDA’s current projection. Higher prices, and in some scenarios much higher prices, would be expected if production is less than the current projection in order to initiate more aggressive rationing in the livestock sector.”

The Illinois economists do recognize that if the EPA changes the ethanol mandate, there will not be as much ration required for the livestock industry.

Summary: When the USDA lowered its production estimate for the corn crop, prices have changed very little, indicating the market had built an 11 billion bushel crop into the current price. But if production continues to decline, will it require higher prices to further ration the primary uses of corn? While the 11 billion bushel crop might be rationed with an $8 price, a 10 billion bushel crop would take a $9.60 price.

Source: FarmGate blog