FM: How did you recognize that opportunity?
PN: When we looked at ethanol plants and really [reviewed] the potential green sites that were going to be brand new and how many plants were going to be built, we started [noting] the impact locally, that is, how much corn wasn’t going to go to export or wouldn’t go to an end user. We knew that there was going to be a disallocation, number one, and number two, [there would be a change in] the supply and demand curves [if] we met the RFS (renewal fuel standard). I don’t think people fully understood the implications of how much more corn was going to be used locally, domestically. A 100-million gallon plant uses almost 40 million bushels of corn; that literally is one county in Iowa production, and that county was feeding hogs, cattle and everything else. So once (I) started going through the numbers, [I thought] something is not going to add up; corn is not [going to continue to] sit at $2.50 [a bushel] anymore. That was the beginning.
FM: So the ethanol business in the United States is still growing?
PN: It’s actually developed into a crush margin, like how a refiner looks at a crack spread. In an ethanol or bio-diesel plant, with corn you’re making ethanol, DDGs (distillers dried grains), and if you have the third aspect, CO2. [Those are] the three products that come out of [the corn]. And you get corn oil off the DDGs, which they’ve now refined, and corn oil can go into bio diesel or feed or pharmaceuticals. So the basic premise of an ethanol plant from where it started to where it is vertically integrated, and at the end of the day it’s all margin related.
And now with more plants than 10 years ago, there’s more competition. And pretty much we’re at full usage from a corn basis; we’ve hit the top of what was mandated for corn for ethanol. We’re not in an upward slope anymore; we’ve peaked out at 5 billion (bu.) of corn for ethanol.
But the rapid transformation on the upside is what I think surprised everyone in the corn market because the demand was so exponential. And the mandate is nearly negligible now. When you look at ethanol [the last few years], it was as big as the feed number. And this year it is projected to be four times the export market. Projected for ethanol in 2013-2014 [is] 4.9 billion bushels of corn; exports projected for corn are 1.225 billion bushels. So ethanol is now a driver. And with all the arguments of the RFS, and all the good and bad and big oil, we now have out of the demand base of 12.6 billion bushels of corn, almost 5 billion in ethanol. So if we got rid of ethanol, agriculture would have a [crash] and the land prices and everything [would drop]. So we had to live through some of the heartache and misery, but now it’s just part of the equation.
FM: So is food for fuel a bygone argument, like peak oil?
PN: I think it is. Out of ethanol you do get distillers grain, and that is fed to cattle and dairy, and now it’s even having inclusion rates in hogs, and [we’re] getting corn oil off the back end. And depending on [type of plant] we get CO2, that goes into hydroponics and such.
And when you look at it, it was a local product; it was done by a local community with local farmers, it was financed by Midwestern banks and such so it is exactly the root of what we dealt with. [And] it has reinvigorated middle America. We’ve lived through the hysteria because we have globalized commodities, [for example] we have corn being grown in Brazil and all over the world.
FM: What about the financialization of commodity markets? Are you seeing an impact on price discovery?
PN: We are into a carrying charge market now. The backwardation or inverted market we had was just fine when the carry out usage ratio charge of corn was 5%, now all of a sudden we’re projecting 14% carry out to use. So we are building carries.
I’m not one to be a demagogue on high-frequency and algos, they have their places, and within agriculture, we don’t have the depth of the market you get in the dark pools in equities. We will get some spikes and literally the market comes back. More than not when you see that big trade blow in, as soon as they’re done, the market goes back to where it was. You don’t see that overall manipulation, [especially] with the CFTC and the oversight today.
We had more issues back in the 1980s with some grain companies and different trading houses trying to corner soybean markets, and the soybean trade. Remember the name Ferruzzi? You had more of that happening with squeezes in the market. A high-frequency trader is just that, he’s in and he’s out. He’s not a position trader for more than a nanosecond. HFT is there just to trade in and out, and in a commodity market where you have an underlying physical asset that is there, I don’t see it as a big issue. I mean, [HFT] is part of the market makeup.
FM: Beyond HFT, what about other players coming in, like investment banks?
PN: Within agriculture, I don’t think you’ve seen as large of a change by the investment banks. The investment banks are more in the energy sector, which is a much larger globalized commodity. Beside your ABCDs, which all have a place in the business, you see new companies emerge that are into that, like the Nobles, Olams, Glencore…you’ve got a lot of different trading houses and they are all part of the equation. At the end of the day, none of them predetermine what the price of corn will be three or six months from now. They are hedging, doing risk management or trading on a perception, but [bottom line], agriculture is a fundamental market and if we have another drought and less acres, or big acres and a big crop, that will [determine the price].
You can get into how the world globalized soybeans, or the inverse or backwardation of soybeans this year. That’s something that [we may be concerned with] because delivery points are within the U.S. [although there’s] as big of a supply [of grain] now in South America as [we have] in the U.S., even bigger. That’s more of a fundamental key. It’s projected now that next year Brazil will have 88 million metric tons of soybeans, which would be bigger than this year’s crop in the United States. Then you throw in Argentina at 50-60 million metric tons, yet we’re all trading Chicago, [and the] delivery points [are a problem]. So like this past year, we may not have had a lot of soybeans here, but they’re somewhere else in South America. That’s where you get the disallocation. [We don’t] have a true delivery point.