Why biofuel mandates link agriculture prices to the energy sector
If investors had the insight to see that government mandates to blend more ethanol into gasoline would drive demand and prices for corn, and in turn soybeans and other crops, fertilizer stocks would have been a good bet. Companies such as Potash Corp. (POT), Mosaic Co. (MOS), Intrepid Potash Inc. (IPI), and Sociedad Quimica y Minera de Chile ADR (SQM) have outperformed crude prices and corn prices.
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Ethanol and corn
Since 2005, we can trace a large source of fertilizer stocks’ success back to increased use of U.S. corn as an input for ethanol production, which pushed corn prices up from around ~$2.50 a bushel to above $4.00 a bushel.
As the chart above shows, the relationship between ethanol and corn prices strengthened from 2007 as the energy market became a key buyer from the agriculture market. Today, about 31% of corn is used to produce fuel ethanol, while just a few years ago, the figure was less than 15%. As crop prices and demand grew, farmers’ income rose and fertilizer producers benefited from higher shipment volumes and prices.
The relationship between gasoline, ethanol, and corn is complicated. Gasoline prices are known to set the ceiling price for ethanol—a topic we won’t go into. Ethanol prices, in turn, drive corn prices. But note that corn prices can also have a large impact on movements in ethanol prices, as they did in late 2010 and recently.
So although corn prices have risen and the United States’ fuel consumption has grown substantially over the last few years, it seems the agriculture sector has been able to adjust to higher demand—though on the back of higher prices.