ANALYSIS-Ethanol no longer seen as big driver of food price

CHICAGO Thu Oct 23, 2008 7:03pm BST

CHICAGO Oct 23 (Reuters) - Heavy demand for corn from ethanol makers was seen as a key driver of corn futures to record highs in June, but since then the sharp decline of corn along with other commodities shows that belief was mistaken.

Corn is down about 50 percent from its record high in June, even as the amount of the grain used to produce the renewable fuel in the United States remained the same.

"The record high prices were a speculative bubble," said Stewart Ramsey, senior economist for Global Insight, Philadelphia (www.globalinsight.com/)

"We had a lot of reasons for prices to go up and to go up a lot and ethanol use was one of those," he added.

U.S. food prices, which normally rise by about 2.5 percent a year, surged by 4 percent in 2007, the biggest increase in 17 years. World food prices jumped a stunning 40 percent, causing food riots, hoarding and bread lines in some countries.

The government has forecast that U.S. food prices will rise 5.5 percent this year and 4.5 percent in 2009.

Chicago Board of Trade corn futures set a record high $7.65 per bushel for a spot contract at the end of June. By the spot contract's price had been halved to $3.85 per bushel.

The use of corn to produce ethanol in the United States does add to the price of the grain. Analysts, including some in the ethanol sector, say ethanol demand adds about 75 cents to $1.00 per bushel to the price of corn, as a rule of thumb. Other analysts say it adds around 20 percent, or just under 80 cents per bushel at current prices.

Those estimates hint that $4 per bushel corn might be priced at only $3 without demand for ethanol fuel.

Federal law calls for production of 9 billion gallons of biofuels this year and 10.5 billion next year. The requirement increases to 36 billion gallons by 2022, with ethanol supply from corn capped at 15 billion gallons.

It takes roughly one bushel of corn to produce 2.8 gallons of ethanol.

The Department of Agriculture has earmarked 4.0 billion bushels of corn or roughly a third of this year's U.S. corn crop for ethanol use next year, up from 3.0 billion bushels or about 23 percent of last year's record 13.1 billion crop.

MONEY SHIFT TO COMMODITIES KEY REASON FOR PRICE GAINS

Analysts said soaring corn prices were a symptom of big shifts of investment money into corn and other commodities. As big money began shifting out of stocks a few years ago, commodity markets like corn futures began climbing.

"There was a speculative bubble in the market and that's one of the bigget things that came out of the market is just that equity markets weren't good and for a while the money came into commodities," Ramsay said.

By mid-February non-commercial investors, including speculators, index and hedge funds and managed pools of money, held nearly 484,000 long positions in CBOT corn futures or 2.42 billion bushels of corn.

That would be enough to produce more than 6.7 billion gallons of ethanol and more than 20 million tonnes of livestock feed, according to the Renewable Fuels Association, Washington D.C.

By October those investors held about 240,000 long positions in the corn market, less than half the levels seen in the spring and early summer, the RFA said.

"We had adequate corn stocks, there was no shortage of corn, that wasn't the issue," said Don Roose, analyst and president of U.S. Commodities, West Des Moines, Iowa.

"What we got into is the dollar went so low, crude oil went up and that inflated a lot of things...it was that factor of the least resistance moving up...it was an all-in attitude in the commodity markets in general no matter what it was."

U.S. capacity to make ethanol has risen about 60 percent since last year to about 11.2 billion gallons per year and if all the new plants and expansions come on line total U.S. capacity would be about 13.8 billion gpy. (Reporting by Sam Nelson; Editing by David Gregorio)