U.S. Ethanol Boom Fuels Farmland Price Spike, and Some Fear a Bubble

Farmers have found a source of steady demand for corn. But the conditions may be inflating a bubble, which if bursts could drag farm country into recession

Midwest farmers — and the land on which they rely — have prospered in recent years, even as the U.S. endured a financial crisis and economic recession.

And for better or worse, agriculture has built its good health on the fortunes of energy.

While rising global demand for food — particularly from densely populated and growing countries such as India — gets a chunk of the credit, this newfound prosperity is closely linked to the U.S. government's backing of corn-based ethanol. Farm incomes and farmland values have surged as the ethanol industry emerged and then swelled in the past decade, creating a new form of steady demand for corn and hastening the rise in value of the soil in which it grows.

Additionally, some in farm country are squeezing even more from their land by making swaths of it available for wind turbines, an emerging energy sector.

A Real Estate Boom

Farmland prices doubled nationally in the 2000s, to more than $2,300 per acre, according to the U.S. Department of Agriculture, and prices today in soil-rich areas of Iowa and Illinois are more than three times that level. Non-irrigated cropland values soared by 10 percent or more in 2010 alone in states across the Midwest, according to the Federal Reserve Bank of Kansas City.

According to Darin Newsom, senior analyst for Omaha-based Telvent DTN, the trend proved a good marriage: Farmers, historically subject to volatile prices, found a source of steady demand for a key crop while contributing to a developing way of addressing the nation's ambitions of gradually weaning itself from foreign oil.

"Farmers across the country who are raising grain have had very attractive conditions," Newsom said.

Similarly, farmers who sign leases to wind developers gain another steady stream of income, while still leaving most of the surrounding land available for production.

But the conditions also may be inflating a bubble, which if bursts could drag farm country into a recession, regulators and policy analysts have begun to warn.

'Not Time to Panic'

"The regulators are starting to ask a lot of questions in farm country," Charles Wendel, president of Financial Institutions Consulting Inc., said.

Jaret Seiberg, an analyst at MF Global, said few are predicting an all-out meltdown along the lines of the housing market crash late last decade, but he said there is reason to be concerned that farmers are making investments — and drawing credit from banks — based on an unsustainable surge in land values, as opposed to cash flows. And the trouble with that, as so many past bubbles have shown, is that prices never soar indefinitely.

"It's not time to panic, but this is something that deserves attention," Seiberg said.

Crop prices surged in the 1970s as grain demand from the former Soviet Union swelled. But the trend did not last, prices fell, and when rising interest rates at the time began to hit troubling levels, the two developments together jolted the Midwest farm belt, driving down land values nearly 30 percent in the 1980s. Recession followed.

Newsom said it has always been difficult to determine the true underlying value of farm land. But to gauge whether a bubble is forming it is important to follow grain prices carefully. As long as both the cash prices that farmers fetch for what is grown on their land are rising and the futures market indicates they will continue to rise, it makes economic sense for land values to rise as well.

"But if the cash market reaches a point where it indicates enough is enough, we could have a problem," Newsom said. If cash prices fell, he said, and land prices continued to swell, a bubble would likely be inflating.

"So there is a threat," he said.

Ethanol's Impact

Analysts and others now say that the ethanol industry could either advance to other, less costly sources than corn or — perhaps sooner — key government subsidies for ethanol will get crimped as lawmakers in Washington look to curtail spending. This could affect demand for grain — and the cash markets.

Earlier this month, Sen. Tom Coburn, a Republican from Oklahoma, put forth a bipartisan proposal to end the 45-cent federal tax credit for every gallon of ethanol blended.

At the same time, the process of putting up those wind turbines that have gone up across eastern South Dakota, southern Minnesota and other open areas of the Midwest may slow, as low prices for competing natural gas in the U.S. and uncertainty about government tax breaks are leading turbine manufacturers to scale back production, analysts say.

For instance, Suzlon Energy Ltd. last year cut staff at its plant in Pipestone, Minn., where the company makes parts for turbines. It now operates at less than half capacity.

Such issues have raised eyebrows among bank regulators, who are worried about lenders getting fazed by the bursting of another asset bubble just as they are struggling to recover from the housing bust.

During a Federal Deposit Insurance Corporation symposium in March, the regulator's chairman, Sheila Bair, said "the steep rise in farmland prices we have seen in recent years creates the potential" for serious trouble for both bankers and farmers, particularly if the ethanol industry falters just as interest rates are expected to soon rise.

Addressing the expectation of key interest rate hikes sometime in the year ahead to stave of inflation, Brian Briggeman, an economist with the Federal Reserve, said if rates on real estate loans rose from around 5 percent today to something closer to a historical average of about 7 percent, farmland values could fall by a third.

Were there a double-fisted shock of falling crop prices and rising interest rates, Bair said, local economies that depend heavily on farming could see their fiscal health rocked as they “tend to rise and fall” with the success of agriculture.

"I think we need to pay close attention," Newsom said.

source: solveclimatenews