Last year, with corn bouncing around $3.70/bu, I wrote an essay called The Mythical Ethanol Threat. I noted the number of new ethanol refineries under construction, and predicted that overbuilding would lead to additional ethanol mandates (which it did). I wrote – Note to self: Corn futures to double again by 2009.
Today corn for September delivery traded at $7.50/bu. Corn for later delivery flirted with $8/bu. Why has this happened? Lots of reasons: Increased demand due to the ethanol mandate, increased costs due to sharply higher fuel, fertilizer, and pesticide prices (all due to higher oil prices), and now decreased supply is the icing on the cake. As I warned in Unintended Consequences, all it would take was a natural disaster in the Corn Belt to push corn prices up very sharply. Surprise! We have our natural disaster in the form of Midwestern flooding.
Our esteemed political leaders have set up a situation with corn analogous to the situation with oil. As spare capacity dried up, the oil markets became volatile. Prices have climbed as spare capacity eroded. (See Peak Lite Revisited for a graphical explanation). If for some reason a million barrels of oil went off the market, you could easily see prices race past $200/bbl because there are no producers who can step in and fill the shortfall. This is now the situation with corn, where the biofuel mandates have assured that continued record harvests are the only hope against sky-rocketing prices. We now see what happens when the record harvest fails to materialize – there are no producers who can step in and fill the supply gap. That is a recipe for volatility, and rapid price increases at the first sign of trouble. Get used to it – as well as more rationalization from the ethanol lobby that the mandates aren’t impacting food prices.