Reasons for corn price spikes and measures to reduce the price fluctuation

It is reported that the rising price of corn has reached its new record recently (Polansek 2011). As corn is one of the four major crops (wheat, rice, corn and soybeans), the trend of its price is vital for the world. This essay tries to figure out the potential reasons for such a high price, and analyses the characteristics of the corn demand and supplies. Furthermore, the author attempts to explain why the primary agriculture products prices fluctuate and proposes some recommendations to reduce the fluctuation. Why does the corn price go so high? Both fundamentals and the financial market are needed to be considered. Polansek (2011) stated that the main reason for this price surge was the inelastic demand versus lower supply (Figure 1). The demand for corn is mainly from livestock feeding and ethanol producing. The commercial meat and egg production is 2% more than early 2011. In addition, as forecasted by Global Renewable Fuels Alliance (2011) the world ethanol production would increase more than 3% in 2011 than 2010. Such growth might cause higher, or at least, stable demand in corn market. In addition, there was a buyer who bought 1.25 million tons in late March (Polansek 2011). This action may also stimulate market price as a signal of higher demand.

Figure 1: Reduced supply increases corn price

On the other hand, the supply of corn is determined by the inventory of the producers (Marsh 2005). When USDA (The Unit States Department of Agriculture) reported that the corn stock was 15% lower than expected before (Briefing.com 2011), the supply might be limited. As high demand and lower supply, it is no doubt that the corn price will rise. However, was the price soar caused by speculation? To what extent should the price soar due to higher demand and limited supply? The futures price went 16% higher when USDA released the news of low inventory. This means the financial market sentiment was influenced by the low stock. But the scope seems reasonable because the demand was inelastic and the stock was 15% lower than expected. So the financial market may play a less important role than fundamentals in this price spike. Furthermore, the world worries about that the high price will last for long. As reported by Wilson (2011), the demand looks like it is rising gradually. Firstly, the biofuel production is stimulated by the high oil price these days; secondly, the livestock market is also growing stably. So it is reasonable to predict that the demand is growing and inelastic in the future. On the other side, Wilson (2011) also noted that the weather this spring had delayed US corn planting. Farmers need warm, dry weather to plant corn before May 10. Otherwise the yield will be reduced by heat in July. In addition, it is expected that there would be a reduced yield in corn due to the La Nia this year (Wattagnet.com, 2011). As the bad weather happens all over the
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world these years, the corn supply does not seem to be great. In conclusion, the corn price may stay high for a while until some good news comes from supply. Similarly, the world primary agricultural products price fluctuates frequently these years (World Bank, 2011). The causes for the price soar can be divided into two groups, long-term reasons and short-term reasons. And short-term reasons are the main drivers of food price. Long-term reasons refer to long-term contradiction between demand and supply. Long-term demand, such as population expansion and income growth, is increasing steadily. Whereas it is a challenge to keep long-term supplies increasing. Agricultural productivity is facing increasing land and water constraints. In addition, the storage and transportation costs are increasing the agricultural inputs. It is a tough task indeed to maintain high supply growth. In the current case, the corn supply in long term is still waiting for good news. So it is reasonable to predict that the price will increase gradually. However, the large scale of price fluctuation is less relative to those longterm causes. Short-term reasons, such as weather variability, trade policies, oil prices, and financial investments, are more frequent and forceful to influence the price fluctuation (World Bank 2011). Weather shock may lead a loss of yield and also cause more investment and cost in agriculture sector (Kelly, Kolstad & Mitchell 2005). Those effects reduce supply in the market, and raise the cost of agriculture sector. So the price may go up significantly when weather shock happens. In this case, weather has less influence in current stock, but it is crucial for the stock next year. Trade policies have been blamed for contributing to price instability, because they induce, or reduce the global market function (World Bank 2011). For example, subsidy policies of OECD countries distort world agricultural markets, because their prices are lower than other countries. Furthermore, the policy responses of other countries increase trade distortions. This is a prisoners dilemma. If countries protect
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their own producers or consumers by reducing other countries benefits, the world trade market would not work efficiently. But it is really difficult to form an international cartel. Oil prices affect the need of biofuel product and agricultural sector cost. Biofuel is a good substitute of oil. When oil price goes up, the demand for biofuel will increase. Thus lead to high demand of corn, which would induce other food prices to climb. On the other hand, the high oil price also adds more cost in producing and trading agricultural products, such as fertilizer and irrigation. As the oil prices are increasing these days, they might have affected the corn price in the current spike. There is also a number of evidence proving that the prices fluctuation of primary agricultural commodities is due to financial speculation. As stated by Lines (2010), after institutional investors piled their money in corn, wheat, and rice market in 2006, their prices started to go up fast, and when the banks cut back loans, those agricultural products prices fell down about 20% in a very short period. And Morgan Stanley (cited by Lines, 2010) reported the number of maize futures contracts increased 5 times from 2003 to 2008. Kaufman (2010) asserted there was more than US$ 300 billion in commodity index funds, while the number was only US$ 13 billion in 2003. Such a significant increase, UNCTAD (2009) believes the financial speculation may have move market from its fundamentals. However, recent corn price rise may be different as discussed before. As a consequence, both fundamentals and financial policies are needed to reduce the price fluctuation of primary agricultural products. Firstly, global financial system should be reformed. Financial investment should be limited in some particular food commodities, and speculators who are only interested in making money in price changing should be restricted. Secondly, trading and storage information system should be enhanced to reduce the market information asymmetry. Thirdly, national agricultural products reserves should be established to counter the international prices variation. Fourthly, the world should work more efficiently on agreement of
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international trading policies. At last, policies should be made to enhance agricultural productivity and farmers income.

References: Briefing.com, 2011, USDA releases planting/grain stocks reports, 11 March 2011, viewed 23 April 2011, < http://www.briefing.com/GeneralContent/Investor/Active/ArticlePopup/ArticlePopup. aspx?SiteName=Investor&ArticleId=NS20110331091645HeadlineHits >. Global Renewable Fuels Alliance (GRFA), 2011, Global ethanol production to reach 88.7 billion litters in 2011, 11 Feb 2011, viewed 23 April 2011, < http://www.globalrfa.org/pr_021111.php >. Kaufman, F., 2010, The food bubble: how wall street starved millions and got away with it, Harpers Magazine, vol. 32, July 1010. Kelly, D.L., Kolstad, C.D., & Mitchell, G.T., 2005, Adjustment costs from environmental change, Journal of Environmental Economics and Management, vol. 50, no. 3, Nov 2005, pp.468-495. Lines, T., 2010, Speculation in food commodity markets, World Development Movement, vol. 1. Marsh, J.M., 2005, Demand and supply factors in the feed grain market: effects on corn producers, Agricultural Marketing Policy Center Briefings, briefing no.71, Feb 2005. Viewed 23 April 2011, < http://ageconsearch.umn.edu/bitstream/29212/1/br050071.pdf>. Polansek, T., 2011, U.S. corn prices likely to curb export demand first, The Wall Street Journal, 11 April, viewed 21 April 2011, < http://online.wsj.com/article/SB10001424052748704415104576250453152120680.ht ml?mod=googlenews_wsj>. UNCTAD (United Nations Conference on Trade and Development), 2009, Trade and Development Report. Wattagnet.com, 2011, January 2011 estimates for US corn, soy harvest revised, 28 January 2011, viewed 23 April 2011, < http://www.wattagnet.com/January_2011_estimates_for_US_corn,_soy_harvest_revis ed.html >. Wilson, J, 2011, Rising corn Acreage seem failing to meet increased US feed, ethanol use, 29 March 2011, viewed 23 April 2011, < http://www.bloomberg.com/news/201103-29/rising-corn-acreage-seen-failing-to-meet-increased-u-s-feed-ethanol-use.html >. World Bank, 2011, Responding to global food price volatility and its impact on food security, 4 April 2011, World Bank, Washington, DC.