Ethanol is attractive as a solution to high gasoline prices because it promises a free lunch:
- U.S. farmers would grow corn.
- U.S. ethanol companies would turn the corn into ethanol.
- U.S. consumers would go about business as usual.
- And everyone in the U.S. would be less dependent on foreign oil producers.
- But, repeat after me: There is no free lunch.
So far, this not-so-free lunch has resulted in higher food prices and rising U.S. dependence on fertilizers produced by, you guessed it, foreign oil and natural gas producers.
The costs are just starting to work their way through the U.S. and global economies. But it's none too early for investors to revise their portfolios to take account of the costs of this free lunch.
The corn-ethanol price connectionSoaring demand for corn from ethanol producers isn't the only reason for the price increase, of course. There's rising demand from export markets for corn to use as animal feed and for human consumption. And there's increasing demand for corn sweeteners from the food industry.
But there's no getting around the corn-ethanol price connection. Corn prices are up despite projections of a record 12.5 billion-bushel corn harvest in the United States this year -- because ethanol producers will eat up 27% of the U.S. corn crop this year, according to the U.S. Department of Agriculture. Corn consumption by ethanol producers is projected to climb to 3.4 billion bushels in 2007, up from 2.2 billion bushels in 2006, when ethanol producers consumed 20% of the corn crop.
Supplies would be even tighter if high corn prices hadn't deterred some buyers. Corn exports, the U.S. Department of Agriculture says, are expected to drop by 10% in 2007. And corn purchases for animal feed will drop 3%.
The soybean and grain marketsThe high price of corn has had a ripple effect on the price of other farm commodities, too. With corn so profitable to plant, farmers have shifted acreage from soybeans, for example, to corn. In 2007, the acreage planted in corn will grow by 16% from 2006, while the acreage planted in soybeans will fall by 11%. So it's not especially surprising that the price of a bushel of soybeans was up 36% as of June 4 from a year earlier. (Corn isn't just displacing food crops, either. In the southern U.S., the acreage planted in cotton is down 20% in 2007 as farmers switched to planting corn.)
And the ripples haven't stopped with the grain markets. The U.S. food industry is largely built on corn. It feeds the chickens, pigs and cows that wind up on our dinner tables. It's the source of the sweeteners in everything from soda to cookies to bread. And it's processed into starch for use in candies, soups, cake mixes, baked goods and, in the general economy, into plastic, paper, adhesives and textiles.
Food prices on the riseSo if the price of corn is up, you'd expect the price of everything to be up. And so it is. If you grilled steak on this past Memorial Day, it cost 5.5% more than a year ago, according to the U.S. Labor Department. Think you can escape by barbecuing chicken? Forget it. Whole chickens cost 7.7% more than they did in May 2006. Milk and cheese are up, too, since corn makes up the bulk of a dairy cow's diet. Milk prices are up about 3% from a year ago, or about 10 cents a gallon, according to the U.S. Department of Agriculture. But higher costs could push up the price of a gallon of milk by an additional 40 cents in the next few months to a national average of $3.78 a gallon.
And those annual rates of increase understate the spike in prices so far in 2007. In the first quarter of 2007, raw milk prices were up 23%, for example.
And so far in 2007, food inflation in the United States is running at an annual rate of 6.7%. If that rate holds for the entire year, that would be the fastest rate of increase in food prices since 1980.