The Coming Corn Crisis

The spread of communication channels makes it easy for things to get out of hand. The benefit is that it also makes it easy for important things to be heard. Right now, the 2012 grain harvest is teetering in the middle of those extremes, and the world is watching to see what happens next. The UN is cautioning against using the term "crisis," while major exporters are assuring the rest of the world that if a crisis does hit, they won't do anything to make it worse. Regardless of the outcome, the situation has already had massive implications for investors and consumers, and there's still a whole harvest season on the line.

The landscape
According to the UN's Food and Agriculture Organization, the cost of food has risen to near record levels, with the forecast for grain looking especially grim. The shortfall has been driven by bad weather in a number of the world's biggest growing regions, including the worst drought the U.S. has seen in decades. That's leading some countries to start talking about export bans, which could mean bad news for an already troubled global economy.

One of the biggest long-term concerns for consumers is government sponsored demand for ethanol, and in the U.S., anywhere from 16% to 40% of all corn grown goes to create ethanol. That's due, in part, to government mandates which set out renewable energy standards for producers, and which give consistent demand to corn farmers. Both presidential candidates have expressed support for ethanol production, so the demand is unlikely to change for some time.

That will be good news for corn producers, and the companies that support them. ConAgra (NYSE: CAG  ) and Monsanto (NYSE: MON  ) both stand to benefit from regulations, both as sellers of corn seed, and potentially as refiners of ethanol. But now there is pressure from within the government to make a change. Corn prices have risen, along with other grains, and that has hurt both consumers and producers. As corn prices continue to rise, meat farmers are killing off animals at a record pace, in order to cut down on their feed costs.

Robbing Peter to pay Paul
President Obama vowed $170 million to buy meat from ailing farmers, which will support meat prices but could do so at the expense of corn. That's because keeping the government set demand for ethanol means keeping demand for corn high. That pushes up corn prices, making meat more expensive to raise. The government could have eased the demand for corn by enacting a waiver for the ethanol mandate, as many governors have requested.

But the situation might actually have a release valve already built in. Like seemingly every piece of legislation, the mandate for renewable fuel use isn't as simple as telling refiners they need to produce it, and then checking to see if they did. Why would it ever be so simple? Instead, for each unit of renewable fuel produces, refiners like ExxonMobil (NYSE: XOM  ) and BP (NYSE: BP  ) get a certificate. Then, they turn those certificates in to show that they produced the right amount.

I mean, sometimes
Unless, of course, they don't. Companies are legally allowed to sell off the certificates, and they can hold on to almost 20% of the excess created in any one year to put toward the next year. That means that oil companies could have a relief valve in their back pocket, waiting to see how the U.S. crop turns out before they cash them in. If that's the case, then corn prices could correct at the end of the year, helping to avert that non-crisis that we're starting to hear about.

But if the worst does come true, and grain prices continue to rise, what would it mean for the economy and investors? In the U.S., there would be a small increase in food costs, which grocery chains and restaurants would likely be hesitant to pass on, due to the bad press and cost of a price increase. Gas prices could edge up, as the ethanol mixed into the gas becomes more expensive, but the price fluctuation would probably be small compared to the overall cost of a gallon.

Outside the U.S., and especially in developing African and Middle East countries, the consumer impact would be much larger. Because of those countries' reliance on imports, consumers could start to see shortages. That's could be the beginning of a humanitarian crisis, which would also hurt investors in those developing countries, which need stability in order to grow.

All those unknowns make me hesitant to jump in with any ethanol focused company. I also have some qualms about profiting from fuel that could be used for food instead. That's one of the reasons so many people are excited about the natural gas boom -- though not in the literal sense of explosion. The Fool has a new report on the one energy stock you must own before 2014. This natural gas producer has all the right components to succeed, and you can get all the details for free in this limited time report.

Fool contributor Andrew Marder does not own any of the stocks mentioned in this article. The Motley Fool owns shares of ExxonMobil. Motley Fool newsletter services have recommended creating a modified stock repair against synthetic long position in Monsanto. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.


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  • Report this Comment On September 08, 2012, at 4:07 PM, funfundvierzig wrote:

    Monsanto, potentially "a refiner of ethanol."?

    To date we have seen no indication that Monsanto, unlike its nearest rival DuPont, is going into the business of actually manufacturing fuel from food.

    DuPont's "leaders" have long embraced a business paradigm of FOOD-to-FUEL & FABRICS. This flawed business model is about to bring them tonnes of bad publicity and likely little or no profit. For example, DuPont along with its partner oil giant BP is cranking up a huge factory in Hull England which will gobble up over 1 million tonnes of wheat yearly to manufacture into costly butanol. In the midst of a global food crisis, how is this going to go over with consumers and starving millions and their political leaders? Not well. Nor will manufacturing carpets and clothes and auto parts out of costly corn look like a brilliant idea.

    Destroying perfectly good food to use as a raw material in industrial manufacturing is a misguided and misfiring "Sustainability" stunt in the 21st century. DuPont executives should know better. Feeding food to factories, not to malnourished women and men and children...really now.

    ...funfun..

  • Report this Comment On September 09, 2012, at 8:04 AM, skypilot2005 wrote:

    Andrew

    Thanks, for the article.

    I don’t have an opinion on the “ethical” implications of “food to fuel”. It seems to me that if we don’t do it, other countries will. It’s called “Supply and Demand”.

    I am interested in if there is a correlation between grain prices and precious metal prices?

    Has anyone looked at this?

    Also, is there a simple way for individual investors to buy / sell corn & grain futures?

    Fool On,

    Sky

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