September 11, 2013 / 12:03 PM / in 4 years

COLUMN-Corn bears to prevail as focus shifts to demand: Maguire

(The author is a Reuters market analyst. The opinions expressed are his own. To get his real-time views on the markets, please enter the Global Ags Forum.)

By Gavin Maguire

CHICAGO Sept 11 - Assessment of crop-tour yields, readouts from combine harvester monitors and grain-elevator sales reports have been the talk of the U.S. corn market lately as participants attempt to assess the size of this year's uneven domestic crop.

Demand, however, will soon become the chief determinant of price, as the harvest already under way across the South begins in earnest across the heart of the Corn Belt next month. With ethanol demand topping out, exports threatened by competition, and feed demand constrained by poor margins, corn bears look set to dominate the market.

BRACE FOR IMPACT

U.S. ethanol production should play a more subdued role in corn-demand growth after driving it for the past 5-7 years as refiners approach the government's mandated alternative fuel production targets and the 10 percent "blend wall" caps the amount of ethanol that can legally be blended into the U.S. fuel stream.

Indeed, the U.S. Department of Agriculture is already projecting corn demand from the ethanol industry to come in below the 5 billion bushel mark for the second year running. It peaked at 5.02 billion bushels in 2010-11 and then eased to 5.01 billion the year after before dipping to 4.65 billion last year as high corn prices forced a number of refiners to halt production for several weeks.

This leveling off means the ethanol industry is clearly no longer growing at the rates that redefined usage in the 2005-09 era, when corn used in ethanol production vaulted from around 14 percent to more than 35 percent of total corn demand.

What's more, the general contraction in U.S. fuel demand in recent years due to greater vehicle-fleet efficiency and more prudent driving patterns means that demand for ethanol itself is likely to slow and lead to a further decline in corn consumption by the sector as the industry moves to a more stable phase.

FEEDER APPETITE SLOW TO RECOVER

While ethanol has had the fastest-growing share of corn use over the past decade, the feedlot sector remains the largest, and is projected to account for 4 out of every 10 bushels consumed this year, or around 5.1 billion bushels.

That total is down by about 1 billion bushels from the high levels of corn-feed use seen in 2004-05, but is still up more than 600 million bushels from last year's levels, which were also affected by the historically high corn prices that then prevailed.

Corn bulls are keen to cite the upside potential of feed demand in the low corn-price environment, and argue that the days when cattle feeders routinely chewed through more than 6 billion bushels annually could return if the price level spurs cattle production.

Such thinking overlooks the irreversible changes in the cattle industry wrought by the evolution of the ethanol industry. Not only have corn prices shifted but so has the feed-supply ingredient list by dint of dried distillers grains (DDGs), which are a byproduct of ethanol production.

Livestock feedlots domestically and abroad have worked to incorporate growing amounts of DDGs into cattle, hog and poultry rations in recent years as a protein-rich alternative to corn while corn prices rose to multi-decade highs.

Now that those prices are projected to move sideways or down, many corn traders are expecting at least some of those DDG portions to decline in favor of heavier corn servings. Nevertheless, animal herds have shown favorable growth rates while consuming DDGs, and feedlot managers have grown reliant on them to provide an element of risk diversification as a competitively priced alternative to feed grains.

Furthermore, whereas fresh corn supplies only come at harvest time, DDGs are created daily through the ethanol production process, resulting in a regular supply stream. That provides feedlot managers with the flexibility to incorporate higher amounts of DDGs into animal rations whenever other ingredients run tight.

For all these reasons, DDGs look here to stay, and are apt to act as a constraint on corn-feed use, serving to keep corn demand by the feed sector capped below previous highs.

PERMANENT SHIFTS IN EXPORTS

One of the most high-profile shifts in the international corn trade lately has been China's gradual transition from a net exporter to a net importer. Its restriction of imports from other origins due to biosanitary concerns has so far worked heavily in favor of U.S. farmers.

Some important changes on the supply side of the market may have more longer-lasting repercussions.

Argentina, Brazil and Ukraine have all aggressively increased corn production over the past decade and have emerged as large-scale exporters offering an alternative in terms of seasonal availability and point of origin.

Access to Black Sea ports by Ukraine have allowed it to penetrate European and South Asian markets lately, while Argentina and Brazil have also exploited Asia's growing interest in corn and other crops and could carve out growing shares of global grain and oilseed trade after having expanded production and logistics capabilities across the region.

Argentina has also made progress on corn-quality agreements with China that could mean larger shipments there. If Brazil follows suit, U.S. exports will slow, especially since its corn-production schedule is the same as China's, whereas South American growers can deliver in the off-season when corn is often needed most.

All told, once the corn market's focus shifts away from supply in the weeks ahead, bearish traders may gain the upper hand as corn consumption expands amid a mixture of heightened competition from alternative grain supplies and slowing overall growth. Certainly lower corn prices will ensure solid consumption rates across the board. But traders looking for higher prices may have to wait for a fresh supply-side story to emerge either during the upcoming South American growing season or next year in the United States. (Reporting by Gavin Maguire; Editing by Prudence Crowther)

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