Saturday, March 8, 2008

Bio-diesel & Ethonol craze could harm US Food Supply

Corn is a key element of the U.S. food supply. It is what dairy cows eat to make milk and hens consume to lay eggs.

It fattens cattle, hogs and chickens before slaughter. It makes soda sweet.

As the building block of ethanol, it is now also a major component of automobile fuel. In fact, Bio-diesel is largely dependent on it.

And that just might be a signal of trouble ahead.

Economists are cautioning that the nation’s growing dependence on corn would make for a double jolt if there were to be a drought across the Midwest: soaring prices not just for food but also for gasoline.

Analysts now warn that “corn shock” might not be far off — and it could lead to $5 gas and $3.50 eggs as the effects reverberate across the economy.

“We are replacing price volatility from the Middle East with Midwestern weather price volatility,” said Michael Swanson, a Wells Fargo & Co. vice president and agricultural economist.

Such a scenario would occur against a backdrop of soaring prices for basic food items and other commodities that are already stressing the economy.

Coffee is up 21 percent to date, platinum 42 percent and already high oil an additional 6 percent.

After a torrid 2007, corn prices have risen an additional 20 percent this year because of global demand for livestock feed, sweeteners and ethanol.

The rush by American farmers to plant cash-producing corn — along with the added pressure from weather problems — has squeezed wheat supplies, pushing the price of that grain up 21 percent. The cost of soy has risen 25 percent this year.

Analysts are already simulating what would happen if a drought hit the corn belt. Bruce Babcock, an agricultural economist at Iowa State University, estimates that corn could reach $8 a bushel from $5.46 now.

It could happen as soon as this summer.

“The risk of a drought right now is higher than normal because of the La NiƱa we are seeing,” Babcock said, referring to the cooling of ocean temperatures that often has a drying effect.

As any farmer can tell you, Mother Nature is fickle.

The U.S. has suffered four major weather disasters since 1971 that wiped out 21 percent to 29 percent of the corn crop at a time.

Periodic bad weather, including droughts, scorching heat waves and cold, cloudy spells at just the wrong time, has reduced harvests by billions of bushels.

Previously, these disasters have raised food prices. The next drought will be the first to affect gas prices.

That’s because ethanol — mostly refined from corn — will make up about 6 percent of the nation’s gasoline supply this year, and that’s expected to rise to 10 percent over the next five years.

But if there were a crop shortfall, the rising price of corn would prevent ethanol distillers from earning a profit, prompting them to slash production, Babcock said.

Oil companies would have to scramble to fill that sudden gap with conventional gasoline. Prices would soar for both fuels, said Philip K. Verleger Jr., an energy economist in Aspen, Colo.

A slowing U.S. economy would blunt demand. But such safety valves won’t always exist.

“Five years from now, this could be a big, big deal,” Verleger said.

Farmers are also worried about what could happen in the short term.

“A drought would be bad for everyone. The high prices would hurt my customers, and I would have no crop to sell,” said Ron Heck, a fourth-generation soy and corn farmer from Perry, Iowa.

As demand for gasoline outstrips refinery expansions, fuel prices will be linked more tightly with the size of the corn crop.

“You might see a point where even the threat of a drought could cause gas prices to rise,” Wells Fargo’s Swanson said.

Lester R. Brown, an author and president of the Earth Policy Institute, sees a scenario with global implications.

He estimates that as long as oil prices continue to hover around $100 a barrel, ethanol distillers could pay up to $7 a bushel for corn and still make money.

However, Brown said, “if the ethanol producers stay in the market, that will disrupt the food supply.”

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