May 25 2007 10:42AM | Permalink | Email this | Comments (2) |
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It is time to worry about how the corn ethanol bubble will end now that we have a reasonable good fix on the resolution of the housing bubble. Near term, there is a risk of sharp price increases for fuels, food and hence general inflation and credit costs and farmland which is where most building lots come from. Longer term, the ethanol bubble, like the housing bubble, could burst or leak rapidly. This could restrain inflation but at the cost of a crash in income and space demand in the corn-belt from Ohio to Colorado.

Corn prices have nearly doubled since last summer when they were near the 10-year average of just over $2.00 for a bushel. The increase is almost entirely due to rising demand for corn from ethanol distillers. Less than 10% of the corn crop was used for ethanol in 2005. The share is now approaching 20% of an expanded crop.

The Agricultural Department projects that ethanol production will take more than 30% of the corn crop in 2009. Curiously, they do not expect this to raise the price of corn. Instead, corn acreage will expand at the expense of soybean plantings so the price rises will be in that food chain. Unless, of course, the process to produce bio-diesel from soybeans is improved and farmers switch back to soybeans from corn. The USDA projection assumes that the soybean producers will not able to get subsidies from taxpayers similar to the corn producers. This is fantasy. But the bureaucrats have to stay out of politics.

One way or another, food inflation is headed higher. So are land prices which have already risen substantially in the corn-belt. USDA projects that ethanol demand for corn will by itself raise national farmland prices 30% within two years.

How did this happen? Congress imposed a $0.54/ gal. tariff on imported ethanol a few years ago. This was about a 50% tax at the time. Congress also gave gasoline blenders a $0.51 / gal. direct payment for each gallon of ethanol blended into gasoline. Perhaps Congress did this because they were so pleased with the results of their micromanagement of the peanut, rice, sugar and milk markets which raised consumer prices and boosted producer incomes. Ethanol could not sustain competition with gasoline from $60.00 crude oil without these subsidies and the mandate to raise ethanol use in gasoline more than 50% to 7.5 billion gallons in 2012. Demands to raise ethanol use to 35.0 billion gallons by 2017 are now being considered in Washington. This would consume more than 125% of the current corn crop.