Commodities: Who Profits from Corn's Pop?

The crop's prices are as high as an elephant's eye. But what savvy plays can investors harvest from the spike?

by Alex Halperin

For Ken McCauley, it's not just corn's color that's golden. With government-mandated ethanol purchases sending corn prices soaring, the White Cloud (Kan.) farmer and president of the National Corn Growers Assn. is optimistic. And that's no small thing in his famously feast-or-famine line of work.

It's not the first time McCauley has seen expensive corn; bad storms or drought can lead to meager harvests—and resultant price spikes. But there's a giddiness surrounding the recent climb in the price of the commodity. The cash price for central Illinois was $3.53 per bushel in December, up from $1.89 in 2005.

Why should anyone who doesn't drive a tractor care? The price action in corn can have widespread implications—from the gas pump to the frozen-foods aisle and, ultimately, the bottom line of big consumer-products companies. A look at the ripple effects can identify opportunities—and pitfalls—for investors.

Future's in Fuel

What's driving the boom? In a word, ethanol. The alt-fuel has become enshrined as part of U.S. energy policy, if mainly as a gasoline additive (see BusinessWeek.com, 5/19/06, "Ethanol Myths and Realities"). Corn farmers see it as a life preserver—one that will ensure a steady demand for the crop in the years to come. McCauley aims to capitalize further through his stake in a small ethanol plant now under construction. For the upcoming planting season, he's shifting more of his 4,000 acres to corn from soybeans this year.

"The increase in prices has helped us get our profit from the market now," he says, instead of government programs. It amounts to a nice payoff after several years of corn prices below what they needed to be for farmers to break even. Additionally, for McCauley, the ethanol boom reassures him that his son, a graduate of Kansas State University, can become a farmer.

Ethanol's benefit to corn farmers notwithstanding, the fuel's environmental and practical merits remain controversial. And a tariff that shelters U.S.-produced ethanol from foreign competitors—thereby propping up prices for the fuel—drives its opponents into hysterics (see BusinessWeek.com, 9/12/06, "A Slow Burn for Ethanol"). But in an age of global tensions over energy, domestic renewable fuels appeal to voters. So for the moment, corn growers are in a strong position.

Tricky Choice for Investors

But can investors benefit from corn's pop? Finding an opportunity to profit on the price rise can be tricky. First of all, the smart play isn't necessarily ethanol. Yes, the agriculture giant Archer Daniels Midland (ADM) saw ethanol production as a driver of its record profits last year. But shares in "pure-play" ethanol outfits like VeraSun Energy (VSE) and Aventine Renewable Energy (AVR) have been less successful, with their shares recently trading below their IPO prices.

Amid rising production, producers can still get squeezed between volatile ethanol prices—they tend to fluctuate parallel with oil—and expensive corn. They'll also confront more competition as production capacity expands. The 2005 Energy Policy Act requires the purchase of about 7.5 billion gallons of ethanol by 2012. However, industry observers expect the actual total to grow faster, raising the possibility that supply outpaces demand.

As farmers increase their corn production, prices could drop, but market signals point toward at least a plateau. Tim Hannagan, head grain analyst at Chicago brokerage Alaron, says corn growers, at least, think "this isn't going away." Commodities can be a puzzling play, but he says investors who agree should consider going long on corn futures.