The relationship between ethanol and corn is recognized by the corn crush spread, which may be used by companies producing ethanol to hedge the cost of corn with the income from sale of the distillation process — ethanol and distillers’ dried grains (DDGs) that are sold for animal feed. The corn crush margin, also suitable for speculation, is shown by the CME Group publication “Trading the Corn for Ethanol Crush,” and assumes that one bushel of corn produces 2.8 gallons of ethanol and 17 pounds of DDGs. The crush margin formula is:
(DDG price x 0.0085) + (ethanol price x 2.8) – corn price
Prices in the crush margin formula include DDGs in dollars per short ton multiplied by 0.0085, ethanol in dollars per gallon multiplied by 2.8 and the price of corn in dollars per bushel. As shown by “Ethanol, gasoline and corn,” ethanol varies in price with corn, but there are tradable variations that may be explored and analyzed. Along with futures prices for corn and ethanol, CME Group has announced new futures on DDGs. With this addition, the complex of futures needed for the corn crush should be complete.
In the final analysis, there are two leaders in the energy sector and one of them is not an energy product: Corn. Environmental and political concerns have pushed ethanol to a prominent position, but the underlying supply and price of corn determines its price movements to a large extent, at the same time that ethanol production has a reverse impact on corn.
As always, it is the interplay of prices between two or more commodities that makes profitable spread and crush trades possible.
Paul Cretien is an investment analyst and financial case writer. His e-mail is PaulDCretien@aol.com.