Wednesday, January 02, 2008
If You Buy Distillers’ Grain, How Do You Know If You Are Paying A Fair Price?
The new federal Energy Bill continues to promote ethanol production, first with up to 5 billion bushels of corn, until cellulosic feedstocks can take over. But in the meantime corn demand at the growing number of ethanol plants will support higher prices of corn and likely push more livestock producers toward distillers’ grains as an abundant feed source piling up at ethanol plants. But how is the price risk in distillers’ grains managed?Certainly, the Chicago Board of Trade has not opened a distillers’ grains (DG) pit, and neither has the MERC. In fact DG varies in content, quality, and other factors from one ethanol plant to another. Recently, the USDA’s Grain Inspection staff offered to establish standards for DG, but farm groups were unsupportive of the effort. Without an industry standard and the lack of standard pricing information, how can a DG user be assured of getting the best price while managing the cost? Feedlots typically hedge calves and corn, but in the case of DG, that is not possible. But is it even possible to establish a price relationship across the network of ethanol plants that produce DG?
That is what Kansas State ag economists Tyler Van Winkle and Ted Schroeder wanted to find out in their research on price discovery, dynamics, and leadership in the DG market. They believe that within the growing DG market, more information is needed about price relationships among ethanol plants to determine if a futures market could exist. But the problem is whether there is any integration in the DG market that could help establish some commonality of price. In the past there has been extensive research to determine if a livestock feeder could hedge DG needs using corn and/or soybean meal futures. There is a limited relationship that was found, but insufficient to rely solely on that marketing tool. Additionally, they found less of a current relationship between DG prices and the futures markets than in past years.
The Kansas State economists looked at 6 years of prices in the DG market from Lawrenceburg, IN, Atlanta, GA; Buffalo, NY; Chicago, IL; Los Angeles, CA; Okeechobee, FL; Portland, OR; and Minneapolis, MN, Muscatine, IA; Atchison, KS; and Macon, MO. The price quotes were difficult to reconcile because of the sources of the information, plus the addition of freight and margin to some quotes. The researchers found that some DG markets did have limited price relationships with each other and with the corn and soybean meal futures markets, but that raised some additional questions because corn and SBM are not integrated with each other. Also, the researchers found very slow reaction from one market to another in the adjustment of prices.
The results of the research found that only one-third of the DG market seems to be connected, suggesting the limited opportunity for hedging price movement. However, there was no price correlation in the distance between markets, indicating that a buyer of DG could expect some success in shopping for price quotes. Even though there is a very loose network within the DG market, the suppliers are not independent of each other, but there is no dominant market. Cross hedging corn and soybean meal was not found to be a viable tool in managing DG price risk, but that might give rise to the trading of a DG futures contract.
Summary:
Both the supply and use of distillers’ grains will increase, providing an alternative feed source for livestock producers, but management of price risk for DG is difficult. There is minimal correlation in price movement within the DG supply network, and cross hedging DG with the corn and soybean meal market does not guarantee success. The lack of dominant markets and the need for better price information about DG may prompt the establishment of a DG futures market.
Posted by Stu Ellis on 01/02 at 01:16 AM | Permalink