In an extremely challenging market environment for the ethanol industry — when driving demand has fallen 80% in certain regions of the United States and some ethanol customers have declared force majeure to back out of contracts — it’s perhaps not surprising that ethanol producers would, in turn, kick against the prices of their raw materials, especially corn. This was suggested by Green Plains CEO Todd Becker, speaking on Bloomberg TV on April 6, when he declared, “Corn prices are too high” in relationship to crude oil.
After analyzing the relative values of the energy content within a bushel of corn today or a barrel of oil today, I can agree that the price ratio of these two commodities is far out of whack. It’s also clearly unfavorable for ethanol producers, but that doesn’t automatically mean, in my opinion, that corn prices are “too high.” Rather, I think it’s fairly obvious that the proper way to express this mispricing is to point out that crude oil prices are just drastically low amid simultaneous demand and supply shocks.
First, consider that all these commodities contain energy. Usually when thinking about agricultural commodities used in animal feed or human consumption, we think about a calorie (a unit of energy required to raise one gram of water one degree Celsius). Corn has calories (about 100 per ounce), wheat flour has calories and hay has calories. However, the energy industry measures the heat-producing capacity of its commodities differently, in Btus (British thermal units). One Btu is the energy needed to heat one pound of water one degree Fahrenheit. If we express corn’s energy content in Btus instead of calories, we see that No. 2 yellow field corn at 14% moisture contains about 401,000 Btus per bushel. Therefore, a bushel of corn today, at $3.35, is pricing its inherent energy content at $0.008 per Btu. Meanwhile crude oil at $26 per barrel, with 5,705,000 Btus in each barrel, is currently worth only $0.0005 per Btu.
As a ratio, the energy in corn is currently priced at 1.8 times the price of the energy in crude oil. And yes, this price ratio is wildly off from its historically normal value. Looking at the corn-to-crude oil (in cents per Btu) ratio over the past 10 years, we see that corn’s Btus are typically a little cheaper than crude oil’s Btus. The ratio’s 10-year average has been 0.94-to-1. It has never before been this far weighted against corn, reaching a peak of 2.37-to-1 (corn Btus-to-crude oil Btus) last month when the crude oil chart bottomed out at $19.27 per barrel.
If we were trying to arbitrage just these two markets against each other based on just this one factor — the relative values of their energy content for use in refining fuel — we would expect the ratio to eventually snap back to “normal.” That would imply that when crude oil is $26 per barrel, as it is today, corn ought to be $1.72 per bushel or when corn is $3.35 per bushel, crude oil ought to be $50 per barrel.
The most realistic outcome is probably that crude oil and corn ought to persist in an unusual price relationship, for the time being. Crude oil really only has one use — to be used as fuel. Yes, there are byproducts from crude oil refining just as there are byproducts from ethanol production, but the energy in crude oil can really only be used in engines. When those engines suddenly go idle during the COVID-19 pandemic, and at the same time global crude oil supplying countries willfully overproduce the commodity, then the market price of that commodity obviously experiences a profound drop.
Corn, on the other hand, will always have some inherent value even if there was never another gallon of ethanol ever produced in the world. The energy in each kernel can be converted in the stomachs of cattle, hogs and poultry instead of in the engines of commuter cars, and that energy will always have some value unrelated to the price of crude oil. The two main global corn markets (the energy market and the feed market) are intertwined by DDG substitutes and the competition between each sector’s basis bids, but the feed market can and will continue to exist no matter what happens to ethanol.
Furthermore, corn isn’t a perishable commodity, such as milk or vegetables, which are currently experiencing such heartbreaking supply chain problems while the routes to willing consumers are shifted during the pandemic. Dry, stored grain like corn can maintain its value for another six months, or eighteen months, or however long it takes for demand patterns to return to normal. There are limits to how much can be stored and for how long before farmers need to convert the commodity into cash or before the next crop (however large it may be) requires the storage space. But for now, the corn market may find it possible to maintain some independence from the energy markets’ poor prospects.
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