Calming ethanol-crazed corn prices

With alternative fuel in the limelight, the cost of corn has skyrocketed, but experts say the free market should keep food prices in check.

By Steve Hargreaves, CNNMoney.com staff writer

NEW YORK (CNNMoney.com) -- Ever since President Bush proposed a four-fold increase in "alternative fuels" during this year's State of the Union address, the media has been abuzz with doomsday reports on what this will do to the price of corn.

But how much higher corn prices will go, and how much more of an effect they will have on food costs, is a matter of debate.

Corn demand and prices began surging over a year ago when Bush first touted ethanol in his 2006 State of the Union speech.

Corn is the main ingredient in ethanol, the primary alternative fuel in the United States and rising demand has sent supplies to their lowest levels in 34 years according to Phil Flynn, a senior market analyst at Alaron Trading in Chicago, a commodities trading firm.

"Ethanol is just lighting the [corn] market on fire," Flynn said.

The front-month contract for a bushel of corn (56 pounds) on the Chicago Board of Trade has jumped from $1.86 at the end of 2005 to over $4 today, said Flynn.

The rising price of corn is partly why shares of several ethanol companies, including Pacific Ethanol (Charts), Verasun Energy (Charts) and Archer-Daniels-Midland (Charts), have suffered from lackluster performance over the last year. It's been a boon for the giant seed maker Monsanto (Charts).

Pain at the supermarket

Consumers will feel the impact of higher corn prices, not just in the produce isle but in a range of products. Beef and poultry prices are likely to rise as animal farmers rely on corn for feed. Soft drink prices may also jump since drink makers widely use corn syrup as a sweetener.

"Four dollars a bushel causes a lot of pain," said Richard Lobb, a spokesman for the National Chicken Council, who estimated that the price rise has already bumped up wholesale chicken prices 6 cents per pound. "It ripples right across the economy."

Not everyone sees those ripples becoming a tsunami though.

"I see some cooling in the corn market over the next 12 to 18 months," said Cristoph Berg, a managing director at the German-based commodities research firm F.O. Licht.

"It would be truly historic to have grain prices stay so high for so many years," said Ryan Davies, a trader at Titan Commodities in San Diego. "I think they will maintain a high level, but there is a cap as to how high they can go."

Chicken Little scenario?

Simple economics is the main reason cited for debunking the "corn-out-of-control" scenario.

As the price of corn rises, farmers have greater incentive to plant more of it and increase supply.

Terry Roggensack, a grain specialist at the Hightower Report, a commodities newsletter, is seeing farmers planting between 6 to 10 million more acres of corn this year on top of last year's 78.3 million acres.

He says farmers need to plant near the top end of that range to meet projected demand. If they underproduce, corn prices could be set to rise even more.

With corn at around $4 a bushel, ethanol producers could be forced out of business - if corn prices keep climbing, while ethanol prices hover at around $2 a gallon.

"If corn prices are beyond a certain threshold, many [ethanol] plants will just stop producing," said Berg. That will cause a drop in demand for corn which would send prices down.

The Bush administration isn't too concerned about corn prices jumping.

A White House spokesman told CNNMoney.com that if the proposals outlined in the State of the Union make it into law they will be sure to include a safety valve, which would suspend the mandatory ethanol requirement if corn prices rose too high.

Corn: Not the only ethanol solution

No one spoken to, including representatives at the White House, believes that the president's call for mandatory alternative fuel use to grow - from 7.5 billion gallons currently to 35 billion gallons by 2017 - will be achieved through corn ethanol alone. The United States currently uses about 140 billion gallons a year of gasoline.

Experts say corn ethanol could account for maybe half of that without sending the price of corn even higher.

The remaining amount of alternative fuels could come from other sources and technologies, like turning coal to liquid fuel (a process derided by environmentalists) and cellulosic ethanol, a nascent but promising technology that produces ethanol from any plant matter, not just food crops.

Still, these assurances do little to calm farmers currently struggling to feed their livestock due to the high price of corn.

"That's the optimistic view, that [the spike in corn prices] is going to stop right there," said the National Chicken Council's Lobb. "It's already doubled the cost at seven and a half billion gallons [of ethanol production], it's inconceivable to think that adding more wouldn't raise the price."

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Market indexes are shown in real time, except for the DJIA, which is delayed by two minutes. All times are ET. Disclaimer LIBOR Warning: Neither BBA Enterprises Limited, nor the BBA LIBOR Contributor Banks, nor Reuters, can be held liable for any irregularity or inaccuracy of BBA LIBOR. Disclaimer. Morningstar: © 2014 Morningstar, Inc. All Rights Reserved. Disclaimer The Dow Jones IndexesSM are proprietary to and distributed by Dow Jones & Company, Inc. and have been licensed for use. All content of the Dow Jones IndexesSM © 2014 is proprietary to Dow Jones & Company, Inc. Chicago Mercantile Association. The market data is the property of Chicago Mercantile Exchange Inc. and its licensors. All rights reserved. FactSet Research Systems Inc. 2014. All rights reserved. Most stock quote data provided by BATS.