The great corn gold rush
The price of America's most important crop has just doubled, and farmers have ethanol to thank for the jackpot, reports Fortune's Jon Birger. But are they now sitting on a 'dot-corn' bubble?
NEW YORK (Fortune) -- Drive down the empty back roads that lead to Gerald Tumbleson's Martin County, Minn., farmhouse, and you'd never know you were riding through one of America's newest boomtowns. It's February, and Tumbleson's cornfields lie fallow under a foot of windswept snow. Tractors sit idle as local farmers await a thaw that won't come for weeks. The clearest evidence of life is the manure stench drifting from Tumbleson's pig barn.
The one giveaway things have changed: all the new bins. Tumbleson now has nine of them - each steel silo rising 60 feet above his front yard contains some 30,000 bushels of corn. Corn growers, you see, didn't used to store so much corn. Farmers delivered most of their crop to the local grain terminal or elevator at harvest time and took whatever price they could get. But that was before the ethanol boom.
There are now four ethanol plants (and two more being built) within 60 miles of Tumbleson's farm, each with a ravenous and constant appetite for corn. In Martin County and all across the Cornbelt, ethanol plants are bidding up corn prices and persuading farmers like Tumbleson to bypass traditional grain markets and sell corn to them year-round instead.
"Farmers tend to be pessimists," says Tumbleson, a 64-year-old veteran of Minnesota farming who has seen freak hailstorms destroy entire crops but never thought he'd see a sustained run of $4-a-bushel corn. "Around here, that's starting to change."
Four-dollar corn. The price probably doesn't mean much to many Fortune readers, certainly not the city slickers who wouldn't know a combine from a planter. But in farm country, $4 corn is more than a big deal. It's a phenomenon. "It's the center of conversation in the center of the country," says Elizabeth Hund, head of agricultural lending for U.S. Bancorp. (Charts)
In the span of just eight months, the price of the U.S.'s most important crop - our biggest agricultural export as well as the staple feed for our livestock - has doubled from $2, about where it had been stuck since the late 1990s, to $4 a bushel. The cause is soaring demand from ethanol plants, which bought 2.2 billion bushels last year, 34% more than in 2005. Previous price spikes were short-lived and usually caused by drought, but the futures market thinks this rally has legs.
May 2008 corn recently traded at $4.20 a bushel, while December 2010 futures were at $3.74. This means farmers can lock in terrific prices not just for the 2007 crop but for the three after that as well.
Problem is, what's good for farmers - and even better for the companies selling them tractors, seeds, and fertilizer - has started to roil other parts of the economy. The feed costs of cattlemen and hog farmers have skyrocketed. Ethanol producers have seen their profits slashed. Food companies are being squeezed and are starting to pass along higher costs to consumers. (This isn't just a U.S. problem: Mexico is in an uproar over soaring tortilla costs.)
Corn growers themselves wonder whether they're in a bubble. Some joke about "dot-corn," even as true believers preach of a "new plateau" - a refrain reminiscent of late '90s "new paradigm" talk. But if there's one thing everyone in corn country agrees on, it's this: 2007's crop should be a moneymaker of historic proportions.
The returns on last year's crop were good but not great- much of the harvest was sold well before corn hit $4- but 2007 is shaping up to be a most extraordinary year for Midwest corn growers. According to United Agtech, a Martin County crop consultant, local growers stand to net around $270 for every acre of corn they grow this year- ten times the profit they were realizing just three years ago. (That assumes an average yield of 180 bushels an acre and price of $3.50 a bushel.)
Put a little differently, the farmer who was making $27,000 raising 1,000 acres of corn in 2004 is in a position to earn $270,000 from 2007's crop. Of course, this requires some cooperation from Mother Nature, which, as farmers are quick to point out, is never a sure thing. Nationwide, corn growers' total profits from the 2007 crop could top $13 billion, a tally already rippling through the farm economy.
Demand for farm equipment and inputs (seed, fertilizer, herbicide, insecticide) is soaring. Many Deere dealers sold out of combines in January, around the same time Monsanto (Charts) sold out of its top-of-the-line, triple-stack hybrid corn seeds (valued for their resistance to rootworm, corn borer bugs, and Roundup herbicide).
"There is unusual optimism," says Michael Pragnell, CEO of Syngenta, a Swiss ag-chemical company that produces herbicides and Garst-brand corn seeds. "No question- this is going to be a strong year in the Midwest for inputs." And while the dollars that individual farmers are spending on themselves pale in comparison to what they're plowing into their fields, there have been some celebratory splurges.
Nebraska Furniture Mart, a home furnishings and electronics superstore with locations in Iowa, Kansas, and Nebraska, reports that sales growth among customers with rural zip codes was six times higher during the 2006 Christmas shopping season than in 2005. Says Irv Blumkin, CEO of theBerkshire Hathaway (Charts) - owned retailer, "Farmers are feeling better than they've felt in a long time."
Still, talk to farmers in southern Minnesota about the wealth being created here, and you'll discover there's almost as much anxiety as euphoria. Gerald Tumbleson embodies this as well as anyone. A former National Corn Growers Association president, Tumbleson sees current corn prices as the culmination of a decades-long campaign by corn growers to promote ethanol and create a new market for their crops.
Ethanol production is expected to consume 26% of this year's corn harvest, up from 11% in 2004, and Credit Suisse (Charts) energy banker Paul Ho expects that number to hit 36% by 2008. Still, Tumbleson is wary of how fast corn prices have risen. Sitting at his kitchen table one February morning, Tumbleson lays out a scenario in which $4 corn proves to be the ruin of many growers. "A young person just coming into farming now could get hurt really bad by these prices," Tumbleson says, his wife Joanne nodding in the background while she prepares roast chicken and a delicious rhubarb cobbler for lunch.
Tumbleson's nightmare: With so many farmers trying to cash in on $4 corn, land sale prices and rents skyrocket. (Tumbleson and two sons rent about 3,000 of their 4,000 acres, a fairly typical mix.) All the while, farmers are upping how many acres of corn they're planting, often at the expense of wheat, cotton, or soybeans. This shift pushes up prices for equipment, seed, and fertilizer, as corn is a more input-intensive crop to grow.
Eventually, land and input costs rise so much that farmers are making no more off $4 corn than they were at $2. Worse, their businesses are now riskier: higher fixed costs mean farmers have less safety net should drought or storm hit. Then there's the short-term threat. The U.S. Department of Agriculture's latest planting survey estimates 90 million acres of corn will be planted this year, the most since 1944 and a 15% increase from last year's 78 million acres. You don't need a degree in economics to see the risk all that new supply poses to corn prices. Were a market crash to take corn back to $2.50 a bushel, it could bankrupt farmers who had bet the farm on $4 corn.
Experience is all that keeps Tumbleson from making such a bet. He mortgaged his farm to the hilt in the early '80s to buy more land, so convinced was he that corn prices would keep rising. (They didn't.) "Jo is married to a whole different farmer from the one she first married," Tumbleson quips. "Back then I was a plunger - nothing was going to stop me. We were leveraged so deep, it's a wonder we're still farming." Tumbleson isn't alone in his worries. "Four-dollar corn is a bad thing - write that down," says Steve Sodeman of United Agtech, who in addition to being a crop consultant also grows corn of his own. "Greenspan talked about excessive exuberance - well, sad to say, I can tell you that farmers and their landlords suffer from that too."
Land prices in Martin County have already exploded, rising from an average of $2,900 an acre in 2005 to $4,100 today. The last time prices were this high, says local farm auctioneer Allen Kahler, was 1981, when good farmland sold for $4,000 an acre. Within a few years, though, corn prices were down, and many farmers couldn't afford their mortgage payments - especially with interest rates north of 10%. Eventually, land prices fell to $1,500 an acre. "A lot of good people got forced out," remembers Kahler, his voice tinged with melancholy.
So far, land rents have yet to catch up to land prices, but that's only because of a fluke in the farming calendar. Rents are set in September, which last year came before corn prices began their surge. With landlords itching to cash in, farmers may face their steepest rent increases ever this September.
Equipment costs are also rising. Prices on used combines, tractors, and other farm equipment have risen 20% since last fall, Kahler says. As for new equipment, those prices would be up too - if dealers had any inventory. Kelly Artz, manager of Mindeer, Martin County's John Deere dealership, says he's been sold out since January of combines that can be delivered for this year's harvest. All told, his dealership sold 25 new combines for 2007, which is a lot given that new combines retail for as much as $225,000. Still, Artz thinks he could have sold another ten or 15 if Deere had had them available. Asked about tractors, Artz just sighs. "I don't even have one for my showroom," he says.
CEO Robert Lane explains that Deere used to have a bad habit of overproducing tractors and combines during good times and then getting stuck with unsold inventory whenever demand fell short. So while Deere has increased production - responding to what Lane calls "very positive macroeconomic conditions" - it's doing so cautiously. "We're trying to be very disciplined and not overbuild," he says. Deere expects sales of agricultural equipment to be up 8% in 2007.
The demand for Deere's newest equipment reveals a lot about how lucrative the business of growing corn has become. The cabs on its tractors and combines are surprisingly comfortable, equipped with air conditioning, AM/FM stereos with CD players, and seats with adjustable lumbar support. Xenon headlights - yes, the same ones available on luxury cars - are an option, as are, for combines, computerized yield-mapping systems that monitor how much corn is being harvested and which acres are producing the best yields.
Perhaps the hottest option of all is GPS. Deere's global positioning satellite systems allow tractors and combines to literally steer themselves, giving farmers time to multitask - for example, be on their phones or laptops - while out in the fields. More important, when uploaded with data from yield monitors or an agronomist's soil tests, GPS systems can automatically vary fertilizer, insecticide, and herbicide applications depending on what's needed where. And because the system knows where each seed was planted, the application of inputs is incredibly precise.
Tumbleson suspects the biggest beneficiaries of $4 corn will be companies like Deere and the other ag suppliers. "I'll probably upgrade a couple tractors myself," he says. "I'll use a little more fertilizer this year too." He doesn't have much choice when it comes to fertilizer. Like many Martin County farmers, Tumbleson plans on growing 80% corn this year instead of evenly dividing his crop between corn and soybeans, as he has done before.
When farmers plant "corn on corn" - grow corn on the same fields in consecutive years - they need to use more fertilizer. "Our profits will probably be double what they were a few years ago," says Kevin Jones, manager of local fertilizer dealer NuWay Cooperative. All this is music to the ears of ag-stock investors like Bob Turner, founder and chief investment officer of Turner Investment Partners, which has $23 billion under management. Turner considers agriculture the nation's newest growth sector and believes ag stocks are at the dawn of a "supercycle," a rally that could last into next decade.
Turner has been investing in a range of farm-related stocks such as Deere (Charts), Monsanto, and fertilizer maker Agrium (Charts). He even has one of those dot-com-era baseball metaphors to explain where we are in the ag- sector growth curve: "We're still singing the national anthem," says Turner, who grew up in rural Illinois and owns some farmland there. "The farmers who leveraged up may get their heads handed to them," he adds, "but the secular trend of more grains being grown for biofuels isn't going away."
Right now that trend has tremendous popular support, given the desire to reduce U.S. dependence on foreign oil and use cleaner-burning fuels. There are some chinks in ethanol's armor: Ethanol plants are water hogs, a rallying cry for some environmentalists and other NIMBYists. And while ethanol boasts lower greenhouse emissions than gasoline, the advantage is diminished the more producers like ADM burn coal to power their plants.
But the biggest test of all will come once the impact of $4 corn hits supermarket shelves. Campbell Soup, Hormel Foods, Smuckers, and Tyson have all warned of higher food prices, citing the high price of animal feed and food ingredients. Soft-drink prices may be headed up too, as the price of high fructose corn syrup has increased 53% in two years, according to the USDA.
"We're clearly feeling the pinch," said Coca-Cola executive Scott Young at a recent food industry conference. It's not just food execs who are grumbling. Four-dollar corn is creating a rift within the farm community, pitting farmers who raise corn against those who raise livestock and use corn for feed. Doug Bettin, 47, a Martin County hog farmer, says he would have a hard time making ends meet if he didn't grow half of his own corn. "I just didn't think it would hit this hard, this quick," he says of rising feed costs. "Hopefully, hogs are going to go up in price to compensate us." Unfortunately, lean hog prices have actually declined 20% since last August.
One cheap feed alternative is distillers grains, a high-protein byproduct of ethanol production. (Ethanol plants are essentially distilleries that turn corn's carbohydrates into grain alcohol.) Ethanol producers like ADM and VeraSun are quick to tout distillers grains whenever questions are raised about ethanol's impact on feed prices. But Bettin says the value of distillers grains has been oversold, at least for hogs. "If you use too much of it, it softens the fat so much they can't be used for sausage," he says. Cows and steer fare better on partial diets of distillers grains than hogs, but that hasn't placated ranchers and cattle feeders.
Four-dollar corn was the hot topic at February's annual meeting of the National Cattlemen's Beef Association in Nashville. "I don't think the government should be subsidizing one group of farmers to the detriment of the cattle feeders," says Leo Vermedahl, a Texas feedlot operator on the NCBA's executive committee. The NCBA passed a resolution urging Congress to phase out the 54-cent-a-gallon tariff on cheap Brazilian ethanol and the 51-cent-a-gallon refiners tax credit two subsidies crucial to the profitability of U.S. ethanol. (It's a wash for taxpayers: $4 corn has greatly reduced the cost of farm subsidies that effectively set a floor under corn prices.)
For now the NCBA is fighting an uphill battle, given the support for ethanol in Congress and among leading presidential candidates. (Credit the Iowa Caucus for the latter.) Unless beef prices rise enough to offset higher feed costs, cattlemen have some very tough choices. "We're looking at the biggest structural change this industry has faced in 50 years," says NCBA chief economist Gregg Doud.
For instance, do feedlots deal with higher corn costs by squeezing the ranchers who sell them calves and young steers? Or do they switch to a diet heavy on distillers grains, though some experts believe it reduces the marbling that gives beef flavor? "If you're used to eating USDA choice beef, you may have a harder time finding it," says beef industry consultant Len Steiner. "Generally speaking, I'd say the more of the corn crop that's consumed by ethanol, the more the American public has to think about higher food prices."
There is another industry threatened by $4 corn, only this one doesn't dare complain. It's the ethanol industry. Last summer when corn was $2 a bushel and oil was $70 a barrel, ethanol plants were minting money. They averaged $1.06 in profit for every gallon of ethanol sold, according to Credit Suisse. Today, with oil at $60 and corn at $4, ethanol producers typically net an average of only 3 cents. To be sure, ethanol plants buy corn through long-term contracts, and most aren't yet paying $4. Nevertheless, the trend is worrisome.
If corn spikes to $5 - a real possibility, says A.G. Edwards commodities analyst Dan Vaught - or oil declines to $50, ethanol's once-fantastic margins would turn negative. That possibility is creating tensions between ethanol producers and corn growers, two groups whose lobbyists are normally attached at the hip.
The Renewable Fuels Association, the ethanol trade group, is withholding support for a seemingly pro-ethanol measure that President Bush proposed in his State of the Union address: increasing mandated usage of alternative fuels from 7.5 billion gallons yearly by 2012 (a level likely to be hit this year) to 35 billion by 2017. For the record, RFA spokesman Matt Hartwig insists that its position has nothing to do with protecting ethanol profits from policies that could lead to even pricier corn: "Our board simply believes that a bigger renewable fuel standard doesn't need to happen before the current one is fully implemented."
Looming over all this is a huge catch-22: $4 corn is a result of the 31 new ethanol plants built since 2005, but investors won't keep bankrolling new plants if $4 corn keeps eating up their profits. That's why Credit Suisse's Ho thinks a corn correction is inevitable.
Back in Minnesota, Tumbleson isn't waiting around for the market to change. Using crop insurance and forward sales contracts, he and his sons have all but locked in a $144-an-acre profit on half their 2007 crop. Sure, some neighbors think $4 corn is a pit stop on the way to $5 and are holding out for an even bigger payday. But Tumbleson has seen too much go wrong during 40 years of farming to get greedy now. "We're talking 2,000 acres times $144 an acre in profit," he says. "Why in the world would you not take that?"