Ethanol Production Fueling ‘Food Inflation’

Courtesy of NEWSMAX:

While rising food prices have been a factor in recent riots in Egypt, Tunisia and elsewhere, the United States is continuing to increase its use of corn to make ethanol, pushing up grain and meat prices worldwide.

“The global economy is getting back on its feet, but so too is an old enemy: food inflation,” The Wall Street Journal states in an editorial, noting that the United Nations benchmark index for food reached a record high in December, “raising fears of shortages and higher prices.”

In 2001, only 7 percent of America’s corn crop, about 707 million bushels, was used to make ethanol fuel for vehicles. By 2010, nearly 40 percent of American corn went for ethanol — almost 5 billion bushels out of total U.S. production of 12.4 billion bushels.

American farmers account for about 39 percent of global corn production, and about 16 percent of the crop is exported, so America’s ethanol production can influence world prices.

March futures for corn recently hit a 30-month high of $6.67 a bushel, up from $4 a bushel a year ago.

Also, since 40 percent of U.S. corn production is used as animal feed, rising corn prices push up the cost of beef, poultry and other items as well.

“This trend is the deliberate result of policies designed to subsidize ethanol,” and it “coincides with a growing consensus that ethanol achieves none of its alleged policy goals,” The Journal observes.

Ethanol supporters claim it reduces American dependence on foreign oil, but a Cornell University scientist calculated that even if the entire American crop was used for ethanol, it would satisfy just 4 percent of our oil consumption.

And the Environmental Protection Agency has downplayed assertions that ethanol provides a cleaner source of energy than gasoline, saying it “has a minimal to negative impact on the environment,” according to The Journal.

The American Thinker on Monday observed: “Today there is a global food shortage and sky-rocketing prices. This has become the underlying factor in the riots in Tunisia, Algeria and Egypt, where up to 56 percent of a person’s income is dedicated to the acquisition of food. These riots are now leading to the upheaval of governments and the very real possibility of the ascendancy of the radical elements into control.”

A significant factor “in the overall global food situation is the American decision to, in essence, burn food in its cars, a policy championed by the environmentalists since the 1990s,” American Thinker also noted.

“There is no quicker way to foment riots and revolution than to deprive the populace of food, particularly when so much daily income goes into feeding oneself and one’s family. The pictures we have seen in North Africa may well be repeated elsewhere throughout the world.”

Noting that Congress recently voted to extend the $5 billion tax credit for blending ethanol into gasoline, The Journal concludes: “At a time when the world will need more corn and grains, it makes no sense to devote scarce farmland to make a fuel that exists only because of taxpayer subsidies and mandates.

“If food supplies tighten and prices keep rising, such a policy will soon become immoral.”

Investment Suggestion – Agriculture

The Best Investment Opportunity of 2009
By Chris Mayer, editor of Mayer’s Special Situations

“Investing in agriculture today will be like investing in the oil sector in 2001-2002,” writes Mark McLornan in the May issue of Marc Faber’s Gloom Boom & Doom Report. McLornan runs a fund that invests in farmland. Some of his on-the-ground observations confirm many of the things I’ve been telling my readers for the past several years.

As for likening agriculture today to oil in 2001-2002, an investor’s pulse quickens. We all know the great run oil stocks had as the price of oil sprinted from under $30 to a peak of $143 per barrel. Investors made hundreds-of-percent gains – even thousands-of-percent gains. What most investors forget is that oil prices halved from 2000 to the bottom in 2001, just before the great run-up. The same sort of setup seems to be happening today in the agriculture sector. Most ag commodities fell more than 50% after hitting their June 2008 highs.

This is the pause that refreshes.

The biggest reason to get excited about agriculture is the fact that supplies are at multi-decade lows. In fact, as McLornan points out, “agriculture is one of the very few sectors globally that currently face supply shortages.”

The “stocks-to-use ratio” provides a helpful context. This ratio measures how much supply is on hand versus how much we use. High ratios imply a fully supplied market. Low ratios hint at possible shortages. You have to go back to the 1970s to find ratios in wheat and corn as low as they are today.

The kicker to all this is that last year, the world’s farmers produced a record wheat crop and the stocks-to-use ratio barely budged. There is no way we are going to top that harvest this year with all the drought hitting different parts of the world.

The International Grains Council (IGC) predicts a fall in total wheat output in 2009-10. The IGC predicts global wheat output of 650 million tons, down by 5% from the previous year. The largest declines are seen in the European Union, the U.S., China, Russia, and Ukraine. “Although conditions in the Northern Hemisphere are generally favorable,” the IGC says, “production is likely to fall sharply.”

McLornan says that global yields for wheat hit a plateau in the 1980s and “gene modification technology has been unable to improve what natural selection has achieved over the past centuries.” So we already have tight supplies. And they look to get tighter.

The financial crisis also threatens to reduce supplies. Farmers who cannot gain access to credit cannot put seeds in the ground. Thus, the twin forces of drought and financial crisis seem likely to exert a growing influence over the grain markets – depressing supplies and therefore, boosting prices.

We’ve seen this movie before…

In 1933, in the pit of the Great Depression, writer Sherwood Anderson took to America’s back roads to see how the country was making out. He wandered into coal towns and mill towns, farms and factories.

His account, published in 1935 as Puzzled America, gives us a peek at Depression-era days. As the title lets on, most Americans seemed not to know quite what to make of the Great Depression. “Puzzled” seems just the right word.

It was puzzling because a man was prosperous and then suddenly was not any longer. A common story in farm country during the Great Depression began something like this: There was a prosperous farmer with lots of land who grew wheat. He then went into debt to buy more land and plant more wheat. The price of wheat suddenly fell like a shot quail. And the farm went under. Just like that, our man was broke.

If the financial crisis didn’t take the farm, Mother Nature did. “It was a farm until he plowed it,” Anderson quotes one man as saying of his uncle’s place. Then the drought came. The dry soil swirled around like snow in a blizzard. The farm simply “blew away.”

The hot winds tore the bark right off the trees and burned crops to ash. Fences lay buried under dust drifts. Dust storms blackened the sky. Topsoil of thousands of acres blew away. Anderson describes a little church in North Dakota:

The boards of the church cracking and curling under the dry heat, the paint on the boards frying in the hot winds… and the dust of the fields sifting in through the cracks. Dust in the mouths of the people as they prayed for rain.

Commodity prices took a big tumble after the crash of 1929. That’s what bankrupted the once-prosperous farmers. Then you had fewer farmers farming. Then you also had drought. Supply fell and prices soon rallied hard off their bottoms. By 1937, most food commodities – corn, wheat, sugar – were as high, or higher, than their ’29 highs.

Today, we also have the dual threat of drought and financial crisis. Farmers across the southern plains report poor crop conditions, thanks to dry weather. We also have drought in many places in the world that usually grow a lot of food.

One example: China’s Ministry of Agriculture said that a third of its crop faces drought issues. The country’s stocks-to-use ratio will fall below 30% for the first time since 1971. As AgCapita, an investment fund specializing in farmland, notes in a recent letter, China will be a net importer of 12 million metric tons of wheat. By way of comparison, Canada’s entire annual wheat exports average around 15 million metric tons.

We also have cutbacks in supply, as farmers have a harder time getting financing to buy seed, fertilizer and machinery. As The Wall Street Journal reported recently:

Across the nation, farmers are making plans to cut their production of corn, wheat, rice, peanuts, beef, pork, poultry and milk… Also, some farmers plan to grow just one crop on land that normally produces two each year, and to let some land lie fallow throughout the year.

Production of meat in every category will fall for the first time since 1973. Meanwhile, consumption of grains keeps rising. Globally, wheat demand should rise 6% this year. No surprise that retail food prices rose nearly 6% last year. I think they could rise as much this year.

Ultimately, we’ll have to grow more food…somehow. So a forward- looking investor will want to invest in the ideas that help that process along. Fertilizers are one such idea. Like a prizefighter with a tough chin, fertilizer demand doesn’t stay down for long. The reasons are simple. Lower fertilizer use means lower crop yields. Lower crop yields tend to raise prices for food. These higher prices then provide an incentive to plant more, so fertilizer demand comes back.

I’m a fan of PotashCorp (POT:nyse), which benefits from these trends. It also owns more potash, a key fertilizer, than anybody else. As Barron’s recently noted: “Longer-term investors can take comfort in the knowledge that many crop-planting, potash-guzzling countries – like China, India, Brazil – all have growing economies.” And they have growing populations as well.

There are other ways to invest too. You can buy other ag-related businesses. You can also invest in the actual food commodities. I expect good moves on this stuff in the back half of the year after the fall harvest disappoints.

What about demand?

I think we’re getting close to the moment when the world’s meager supplies of grains become front-page news. We have another few months before the reality of a lousy fall harvest sets in. Agriculture investments should do very well from that point – for everything from fertilizer stocks to agricultural equipment makers to the grains themselves.

As always, I recommend buying assets like these before the crowd sees it on the 6:00 news.