The Corn Conundrum

Mexicans are protesting in the streets. The price of tortillas has risen from 7 pesos (roughly $0.70) per kilogram to more than 10 pesos per kilogram. In some parts of the country, the price has doubled to 14 pesos. Nearly half of the Mexican population lives in poverty, and for the poor, the higher prices mean they may be spending as much as 33% of their income on tortillas.

Furthermore, they blame the price increase on the U.S., claiming it's due to a large increase in the price of corn. Corn prices have gone up because the U.S. is trying to cure its "addiction to oil" by ramping up ethanol production. Massive increases in ethanol production have sent demand for corn skyrocketing, causing the price of corn to nearly double over the past year.

Not just tortillas
The problem extends far beyond tortillas. Corn is used for all sorts of food products, from the feed for chickens and cows to sweeteners in soft drinks. Sure enough, pork producers like Smithfield Foods (NYSE: SFD  ) have warned that if high corn prices persist, they'll have to be passed on to consumers in the form of price increases. On Motley Fool CAPS, deej8888 says that chicken producer Sanderson Farms (Nasdaq: SAFM  ) is "going to get crushed by high corn prices." Corn Products International (NYSE: CPO  ) is one of the largest makers of corn sweeteners. It has already raised prices by 19% and is negotiating further increases due to the price of corn. This will likely cause higher costs and prices for companies further down the value chain, such as Coca-Cola (NYSE: KO  ) and PepsiCo (NYSE: PEP  ) .

In other words, there could be higher prices for just about the entire food supply because of rising ethanol production.

What can a Fool do?
Assuming the ethanol frenzy continues, we can already see who some of the winners and losers will be. First, I wouldn't bet on the ethanol producers, because ethanol margins are also being hurt by rising corn prices. Furthermore, some of the companies may look pretty but have ugly financials. Second, if you own any of the food-processing companies whose production costs are being affected by high corn prices, keep an eye on the quarterly reports to make sure the higher prices are being passed on to consumers.

On the positive side, one company already experiencing the benefits is Deere (NYSE: DE  ) . This will likely continue, because if we're going to increase our ethanol production nearly tenfold, there is going to be an enormous investment in farm machinery. Even if the best scenario doesn't pan out, Deere has been a stellar performer for the past 50 years.

Final thoughts
The scenario I've outlined is known as the food vs. fuel debate. With President Bush recently setting the goal of requiring 35 billion gallons of alternative fuel in 2017, you can bet this debate is going to heat up. When it becomes mainstream, we'll find out if consumers would rather pay higher gasoline prices or higher prices for everything in the supermarket.

Sanderson Farms is a former Stock Advisor selection and Coca-Cola is an active Inside Value pick. The Fool has a newsletter for almost every type of investor.

Fool contributor Robert Aronen does not own shares of any company mentioned in this article. He buys his tortillas by the 10-pack, not the kilogram. Feel free to share your comments with him.


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