R-Squared Energy Blog

Pure Energy

Gas at $4 and Corn at $7

For the first time ever, with oil prices pushing $140/bbl on Friday, the U.S. national average price for gasoline cracked $4/gal:

Gas price record reaches $4 a gallon

NEW YORK (CNNMoney.com) — Gasoline rose to a milestone mark Sunday as the national average compiled by motorist group AAA reached $4 a gallon for the first time.

The national average for regular unleaded rose 1.7 cents to $4.005, according the daily measure on the group’s Web site. That surpassed the previous record of $3.989 set Thursday.

People are starting to get the message, as gasoline demand is softening. This week I had to rent a car. I had requested a small, fuel efficient model. Guess what? Fresh out. How about this Nissan Titan with a powerful V8 instead? Same price as the fuel efficient model. I took it, because 1). I don’t have to drive much while I have the vehicle; 2). I didn’t have much of a choice unless I wanted to go to another rental agency. Jet lag across seven time zones argued against that.

Corn also reached an all-time high of $7.01 a bushel:

U.S. corn soars above $7 as crude rockets

CHICAGO, June 6 (Reuters) – U.S. grains and oilseed futures markets caught fire on Friday, with corn notching an all-time high above $7 a bushel, caught in a frenzied broad-based commodity rally led by soaring crude oil, traders said.

Further boosting corn and soybean prices were worries about the young U.S. crops. Torrential rains pummeled the American heartland this week, increasing prospects for a yield drag on both.

“There are Noah’s Ark-like conditions in the Midwest through next week,” said Vic Lespinasse, analyst for grainanalyst.com.

Farmers were hoping for ideal growing conditions this year given the huge world demand for grains and oilseed for food and feedstocks to produce biofuels.

Corn prices are caught up in a perfect storm. Of course high oil prices have a direct impact. The diversion of corn into biofuels has a direct impact. But I have warned and warned and warned that there was a very big potential danger from diverting food into fuel: A bad harvest would cause grain prices to spiral out of control. (See Unintended Consequences). I always used the example of a Midwest drought, but it looks like Midwest flooding is accomplishing the same objective. I also suggested that it would take something like this to cause us to reevaluate our biofuels policies.

A little over a year ago, I wrote an essay called The Mythical Ethanol Threat. At the time, corn was bouncing around $3.70/bu (Ref: Historical Commodity Futures Charts for Corn). After noting the number of new ethanol refineries under construction, and after repeatedly predicting (accurately, it turned out) that overbuilding would lead to additional ethanol mandates, I wrote – Note to self: Corn futures to double again by 2009. Another $0.20, and that milestone will be reached.

June 8, 2008 Posted by | corn prices, gas prices, mandates, oil prices | 22 Comments

A Vicious Circle

What a vicious chain of events our politicians have set into motion. It just continues to worsen.

It started out innocently enough. Oil prices were climbing. Our energy production was shifting to an ever greater extent to countries that are hostile to the U.S.

So, Step 1 is to propose a solution:

1. Subsidize ethanol production to encourage biofuels and enhance energy security.

However, subsidies didn’t do the trick. It was still too expensive to produce ethanol. People still chose gasoline derived from hostile sources over more expensive ethanol. What we really needed was Step 2.

2. Let’s mandate ethanol usage.

At the point that the subsidy turns into a mandate, things change. Now, the fuel doesn’t have to be economically priced. It is going into the fuel supply regardless of the price. And this kicks off a massive expansion of ethanol capacity.

But soon we notice that too many people are building ethanol plants. This is causing a glut of ethanol, and putting downward pressure on the price of ethanol. On the other side, it is raising the price of corn. This lowers the margins for ethanol producers, and some producers start to go bankrupt. Projects are delayed or cancelled. The solution? Proceed to Step 3 (which was entirely predictable):

3. We need to raise the mandate for ethanol usage.

Unfortunately this leads to more of the problems that arose from the original mandate. Corn prices go even higher. Land prices continue to climb. Land is shifted to corn production, forcing commodity prices up in other areas. Very few segments of the population are experiencing true benefits.

The primary beneficiaries are commercial corn (and other commodity) farmers who purchased their land several years prior to the mandate. They are truly experiencing a windfall from these policies, and thus will fight the hardest to continue down this ill-advised road.

Secondary beneficiaries are lobbyists who defend the practice, as well as those who are willing to write papers (commissioned by the National Corn Growers Association) that downplay the consequences (or even better, point the finger in another direction).

The ethanol producer is hurt each time the overbuilding cycle occurs. They are starting to realize that the energy business is often low margin (and cyclical), and not as lucrative as they once thought. Maybe the solution is to increase the mandate again? 😉

The cattle rancher (like my Dad) and pig and poultry farmers get hurt from higher feed prices that cut into already razor-thin (or negative) margins.

The person trying to buy farmland is hurt by land prices that have exploded as a result of the mandates (unless they inherit family land).

The environment suffers as the mandated corn production means more herbicide, pesticide, and fertilizer usage, some of which ends up in our waterways.

The person who eats is hurt because higher commodity prices ripple through their food budgets, already stretched because of increasing energy costs.

So what’s the solution to this mess that has been made? I think it is simple, really. We all need to become either corn lobbyists or corn farmers. That way we all get rich and can afford to pay the financial consequences of spiralling inflation resulting from these mandates. (I suppose we will need to be subsidized for our farm purchase, since farms have gotten pretty expensive).

As for the impact on the environment? We can simply commission a study to show that there is in fact no impact on the environment. Ah, the aquifers. I forgot about those. Looks like I will need to commission another study.

Problem solved.

March 10, 2008 Posted by | corn prices, environment, ethanol subsidies, food prices, mandates, subsidies | 342 Comments