Should You Prepare for a Dot-corn Bubble?

Physician's Money Digest, July 2007, Volume 14, Issue 7

In order to reduce US dependence on foreign oil and use cleaner-burning fuels, 31 new ethanol plants have been built since 2005. These plants' need for a constant supply of corn has pushed some farmers to bypass traditional grain markets and meet that demand year-round. Fortune reports that the price of corn has doubled from $2 a bushel in the late 90s to $4 a bushel. In May 2008, corn traded at $4.20 a bushel, while December 2010 futures were at $3.74, allowing farmers to lock in terrific prices not just for the 2007 crop but for the 3 subsequent years as well. As the need for corn appears to keep building, investors debate how high corn can grow.

There is a downside to the new direction of corn growth. With farmers dedicating crops to ethanol plants, the effect on noncorn farmers has been harsh: feed costs have skyrocketed, land prices and rents are rising, and equipment and supply prices are rising. Even ethanol producers have been hit, their profits slashed by the rise in corn costs. And some environmental experts complain that ethanol plants require large amounts of water and burn coal for power, diminishing the advantage of the low greenhouse-gas emissions of their product.

Fortune warns that the corn industry could be set up for a fall. If corn prices rise to $5 or oil declines to $50, ethanol's margins could turn negative. Although highpriced corn is a result of the perceived growing need for new ethanol plants, investors won't keep bankrolling new plants if $4 corn keeps eating up their profits. Farmers could be hurt the most if a market crash were to drop the price of corn to $2.50 a bushel, bankrupting farmers who had bet the farm on $4 corn.