As with any new business, there were many unforeseen consequences and the ethanol industry was no different.  The first came in the fall of 2006 when the demand for corn to supply the ethanol plants forced prices sharply higher.  This was a boon to the grain farmers… not so much for livestock farmers who saw a substantial rise in their feed costs.  A couple of years later, with the demand for corn growing even stronger, the first “food-vs-fuel” debate surfaced as many believed that ethanol production was driving food prices higher.  More issues surfaced – the water and energy required to produce ethanol was higher than expected; and the amount of money the government was spending to subsidize and protect the industry was excessive, especially in times of huge budget deficits.  Slowly but surely, the attractiveness of this wonder fuel was beginning to fade.

Earlier this year, Congress voted to end the direct subsidies to ethanol producers as they deemed them too expensive.  Just recently, the livestock and food stuff industries took their swing at the piñata.  As reported in the Des Moines Register (Lawmakers Seek to Cut Ethanol Mandates), a bill has been proposed in Washington that would lower the mandated amount of ethanol to be used in gasoline during periods of high corn prices.

Theoretically, this sounds like a good idea – put a mechanism in place that will protect the livestock and food producers during short crop years.  But I’m skeptical -  corn production is almost totally dependent on the weather and I can’t see the “trigger” working fast enough, or accurately enough, to truly smooth out prices.  The result… corn prices will become even more volatile to benefit of no one.  While I personally believe that ethanol has a place at the energy table in the U.S., I don’t think that it will be of the size and scope that the enthusiasts hoped for just 5 years ago.

Even though corn prices have dropped back into the $3 range, the discussion of the merits of corn-based ethanol continues.  Only now, the question is whether corn should be viewed in the context of agricultural policy or energy policy (or both!).  The University of Illinois recently published an article (Will Corn Prices Follow Energy Policies Or Commodity Policies) that addresses this issue.  In a nutshell, farmers and traders will need to determine if corn prices are more likely to follow the direction of the oil market, or the oil seeds (commodity) market.  The ability to understand the affect that both markets will have on corn demand, may be the difference in locking in a profit or a loss in the future.

Let’s be honest – in less than 4 years, corn-based ethanol has created both incredible prosperity (for grain farmers) and unmitigated disaster (for livestock farmers and ethanol producers) at the same time.  It has driven farmland prices and cash rents to record levels that may or may not be sustainable in the future. I believe that corn-based ethanol will continue to be a key component of our country’s energy policy well into the future.  How it is ultimately viewed (and manipulated?) by policy makers, is yet to be determined.

The author looks at 2 possible factors – Multiple consecutive years of low farm income and increasing interest rates.  If a situation were to occur, whether it be a natural disaster, a decrease in demand for corn based products (e.g. Ethanol or high-fructose corn syrup), or simply the fear of the unknown, where commodity prices languished at low levels for many years, this would eventually negatively affect land prices.  At lower commodities prices, farmers will not be able to continue to pay at the same levels of rent payments.  With lower rent payments, the landlord’s return on his/her property is going to be lower, which will finally affect the farm ’s value.

The situation that the author lays out with regards to interest rates is that if interest rates increase, credit may become harder for some farmer-landowners to acquire all the necessary credit to continue their operation.

While neither of these situations appears very likely today, it is always wise to seek out possible weak points in the market so that we as investors can be prepared as best as we can.

What are your thoughts on where the farmland market currently is and where it may be headed?

The U.S. Energy Information Administration recently speculated that as the economy continues to recover in 2010 the demand for all fuel, including ethanol, will climb.  Also, new state and federal regulations are taking place this year which will require more biofuel production…and even more strict guidelines could be on the horizon.

Being involved in the ethanol industry the last few years has not always been a smooth ride…for everyone from the farmer to the production companies.  Let’s hope that the analysts are correct and that 2010 will show a correction in direction for this industry.

Read the entire Des Moines Register article here.

What are your thoughts on the state of ethanol?  Are you optimistic for a turn around for 2010?  Let us know at eric@loranda.com.

Source: DTN

What do you think – is spending more of your tax dollars in additional support of the auto industry a better use of funds than ethanol?  Should money be spent on either sector?  Let me know by e-mailing me at doug@loranda.com.