Barron’s is Wrong Series Post 4: New ethanol plants and declining oil production in major countries support the prices of food and oil
Man when I started saying that the Barron’s article that the prices of commodities are going to crash was wrong several weeks ago I had no idea that we would see such an explosive rise in prices so soon. Oil and food prices have been going bananas lately (actually, I’m not sure exactly how much bananas cost right now, but I’m sure that they’re expensive). I don’t know if we are due for some sort of short-term correction in prices, but long-term I have no doubt that food and oil prices are headed higher, much higher.
I have been ranting about the government’s absurd ethanol boondoggle for some time. Today a brilliant friend of mine at STA Futures put together some information for us that illustrates just how ludicrous the current administration’s ethanol policy is (thanks Roger). The government currently supports the ethanol industry by providing ethanol producers with a subsidy of $0.50 for every gallon of ethanol that they make. In addition to this subsidy, the government has placed a $0.54 per gallon import duty on ethanol produced in Brazil so that the low cost ethanol that they produce from sugar cane there cannot compete with the corn ethanol that U.S. farmers grow. It’s pretty ironic how the tax dollars that you and I work so hard to pay the government are actually being used to make the food that we have to buy more expensive. Without this government support, ethanol producers in the U.S. would lose money.
This massive federal support has encouraged ethanol companies to build more plants in the U.S. There are currently 147 ethanol plants here with a combined capacity of 5.084 billion gallons. Another 55 plants and 6 expansions of existing plants are under construction right now. When all of this work is complete, U.S. ethanol producers will have the capacity to produce 13.6 billion gallons. With an industry average yield of 2.7 gallons per bushel of corn these 202 ethanol plants will consume just over 5 BILLION bushels of corn. Assuming an average corn yield of 155 bushels/acre, these plants will consume the production from more than 32 million acres of farm land! This is 32 million acres of prime farm land production that could be used to provide food for us and our families. When one adds the 34 million acres that the government refuses to let out of the Conservation Reserve Program to this total, the government is preventing food from being grown on 66 million of the total 300 million acres of U.S. farm land, that's 20% of the available farm land! Add this to a falling dollar and rising global demand and its no wonder corn, soy beans, and other ag commodities are trading at record high levels (see article: Food Costs Rising Fastest in 17 Years. All of this means that companies that cater to farmers will continue to do well and that consumers will continue to feel the pinch, likely having to cut back discretionary spending.
Now onto higher oil prices. Yesterday brought news that production in Russia, the world’s second largest producer of oil behind Saudi Arabia, declined for the first time in a decade: Russian oil production has dropped this year for the first time in a decade. Russian government officials have actually acknowledged that oil supply growth in their country appears to have hit a ceiling for now. A vice-president at Lukoil said "The period of intense oil production is over." Add to this the fact that oil production from another of the world’s top oil sources, Mexico, seems to have peaked as well (see chart below) and the fact that global oil demand is rising and it is impossible not to conclude that long-term the price of oil has nowhere to go but up. Again all of this is bad for consumers and discretionary spending, but great for oil companies, oil services, drillers, etc…
P.S. As I mentioned back in February, A. Gary Shilling is wrong too: I hope you’re not too hungry