For those unfamiliar with the corn market, I’d like to hit on several key areas that are affecting this market and make some suggestions as to how best to tackle this volatile market.

ETHANOL

Corn demand has surged in the past several years due to an increased use of ethanol. Since corn is the primary fuel for ethanol production in the United States, a larger percentage of the U.S. crop has gone to processing for ethanol. According to my calculations derived from USDA and The Renewable Fuels Association data, approximately 22.9% of the 2007/08 crop will go towards ethanol production. This is an increase from about 14% just two seasons earlier for the 2005/06 corn crop. The USDA projects that this expansion will continue to climb to 31% of production use in 2016/17.

Calculations are based on a 2.75 gallon of ethanol yield per bushel of corn processed. Recent USDA updates have lowered corn estimates used to make ethanol to 3 billion bushels. The 2007/08 crop produced 13.074 billion bushels, which works out to 22.9% of corn crop going to ethanol processing.

Looking forward, the USDA is estimating a 33% increase of corn use for ethanol in the 2008/09 seasons. That would mean that 3.99 billion bushels of corn would be needed to satisfy ethanol production needs. Fortunately, there is a projected decrease of total corn use to 12.760 billion bushels from 13.010 billion in the previous year (due to decreased exports, feed, and residual use). At a projected 12.125 billion, 32.9% of this year’s corn crop will be processed for ethanol – already exceeding previous USDA projections.

The Prospective Plantings report for the 2008/09 season estimates a planted area of 86 million acres and the USDA estimates a 2.8 bushel per acre year-to-year increase in yield. In my opinion – given the delayed planting pace and continued cooler than average temperatures, the ODDS of an increase in yield for this new crop as compared to last year are slim and wishful thinking. I wouldn’t be surprised to see a yield of less than 150 bushels per acre.

YIELD EXPECTATIONS

Chart provided by cmegroup.com

My doubts regarding the achievement of a 153.9 acre yield stem from the extent of planting delays in key producing states and the continued cool weather, which has slowed the emergence rate. A 2006 Iowa State University study indicated there could be a 6.5% yield drop-off (in Iowa) if corn is planted between May 5th and the 20th. It is logical to expect a similar yield reduction in neighboring states. As of the May 12th Crop Progress Report, the following key states were lagging far behind the most recent 5-year planting average:

Illinois – 60% planted vs. 88% 5-Year Average
Iowa – 46% planted vs. 82% 5-Year Average
Missouri – 34% planted vs. 83% 5-Year Average
Wisconsin – 29% planted vs. 60% 5-Year Average
Minnesota – 32% planted vs. 82% 5-Year Average

In comparison, at this time last year Illinois already had a 63% EMERGENCE rate. Iowa was at 36% emerged, Missouri at 48%, Wisconsin at 16%, and Minnesota at 45% emerged.

If we come in with last year’s yield of 151.1 bushels per acre and we use last year’s same percentage acreage harvested, final production will be about 12.006 billion bushels (119 million bushels less than current USDA estimates). If we adjust that yield down to 148 bushels per acre, we are looking at production of 11.76 billion bushels (roughly 940 million bushels less than anticipated demand).

GROWING DEGREE DAYS

In addition to the wet weather that has delayed plantings, the early lack of growing degree-days could potentially become a problem for achieving a yield over 150 bushels per acre. Corn has a base temperature requirement of roughly 50 degrees Fahrenheit and requires about 1360 growing degree-days. The Climate Prediction Center from the National Weather Service provides data tracking GDDs by region. A quick glance shows that we are behind the norm through the period from March 1st – May 10th for many regions.

There are a few exceptions such as Michigan, which is actually ahead of pace on their plantings and is 47 GDDs ahead of their norm. Tennessee, which is roughly on their 5-Year average plantings pace, is ahead 34.6 GDDs. Of those that are behind in plantings, Iowa is down 81 GDDs, Illinois is down 40.2 GDDs, Missouri is down 57.2 GDDS, and Minnesota is down 40.33 GDDs. However, it is important to note that not all regions have reported data within those states.

As we proceed into the growing season, you may want to check on the accumulation of GDDs to help you gauge the crop potential.

ACREAGE SWITCH

The big question is how many acres will be switched away from corn to other crops, such as soybeans? As some areas remain too difficult to plant, farmers will be faced with the difficult decision of whether or not to switch crops. This is an unknown factor that may further reduce the potential size of the new crop.

STOCKS-TO-USE RATIO

As a consequence of the various factors above, the USDA is estimating that the stocks-to-use ratio for corn will fall to less than 10% for the 2007/08 season, which is the lowest ratio in over a decade.

Chart provided by cme.group.com

The last time that the stocks-to-usage ratio was this low the price of corn doubled on a year-to-year basis. While it is difficult to fathom that the price of corn could double this year as compared to last year, if it happened then we’d be looking at $8 corn.

(Daily Chart of the December 2008 Corn Contract, settled at $6.20 ∏ on 5-14-08)

INVESTMENT STRATEGIES

One way to tackle this market is to take a low cost initial trade that would capitalize on a strong trend higher. There are some risks if the market explodes higher in a rapid fashion but I like 1:2 call ratio spreads such as buying a Dec $7.00 call option and selling a PAIR of $8.50 calls for 5 cents or less, net initial premium. I would also recommend allocating about $1000 for margining purposes per spread. Should corn fail to rally your loss would be limited to the initial net premium cost and transaction fees. If corn rallies the risk-reward gets very interesting, call me to discuss.

Contact me if you are interested in going over strategies to capitalize on these or other markets. I can be reached at: Francisco.ramirez@archerfinancials.com or call 877-377-7920 between 9 AM – 2 PM CST.

Futures and options trading involve significant risk of loss and may not be suitable for everyone. Therefore, carefully consider whether such trading is suitable for you in light of your financial condition. The views and opinions expressed in this letter are those of the author and do not reflect the views of ADM Investor Services, Inc. or its staff. The information provided is designed to assist in your analysis and evaluation of the futures and options markets. However, any decisions you may make to buy, sell or hold a futures or options position on such research are entirely your own and not in any way deemed to be endorsed by or attributed to ADMIS. Copyright © ADM Investor Services, Inc.