Corn prices are down 36% from their June peak, but despite the U.S. government’s claims of a bumper corn crop this year, the current dip in corn prices is just a temporary abatement, as higher demand and a potentially smaller-than-estimated total crop are poised to push corn prices higher.

The U.S. Department of Agriculture (USDA) announced yesterday (Tuesday) that the U.S. corn crop could be the second largest in history, despite savage floods that decimated corn-producing regions in the Midwest.

The USDA increased its forecast for this year’s corn harvest to 12.3 billion bushels, up from last month’s estimate of 11.7 billion bushels as “perfect” weather and an aggressive planting schedules helped farmers to recover from June’s floods. If the crop comes in as estimated, it would be just 6% lower than last year’s all-time record crop of 13.1 billion bushels.

The increased forecast helped continue corn’s ease from an all-time high of almost $8 per bushel reached six weeks ago. Corn for December delivery gained 11 cents to settle at $5.28 per bushel in late afternoon trading on the Chicago Board of Trade. The USDA report projects that corn will average $5.40 a bushel for the marketing year that begins September 1.

But some analysts are skeptical of the sunny report and feel a bountiful harvest remains very much in doubt. The USDA estimate is 300 million bushels above average analysts estimates.

“The people I’ve spoken with, their views of the crop are certainly dramatically different than what these yields today say and what the conditions say … they’re much more cautious and much more conservative,” Rich Feltes, director of research for MF Global Ltd. (MF), told a panel discussion on the USDA report, Reuters reported.

Feltes isn’t the only one who feels the USDA report is overly optimistic after the worst flooding in 15 years ravaged Iowa and Illinois – two of the nation’s top corn-producing states.

“The thing that surprised me was the fact they increased harvested acres as a percentage of planted acres,” Tomm Pfitzenmaier, a partner at Summit Commodity Brokerage in Des Moines, Iowa told Bloomberg News. “I talk to people who tell me about how bad their drowned-out stalks are everyday.”

The Ethanol Effect

If supply cannot match the USDA forecast, corn prices will quickly be on the rise again. Those prices will also get a boost from the increased allocation for ethanol production.

The USDA report estimates that corn used for ethanol will increase to 4.1 million bushels this year, or about one-third of the total crop, from 3 billion bushels last year. The number of corn bushels diverted to produce ethanol will likely increase in the years ahead.

“It’s important to note that most of that unexpected production gain was offset by higher demand and the fact USDA pegged ethanol demand at 4.1 billion bushels this year infers to me there will be at least 4.5 billion bushels for the [2009 – 2010] campaign,” MF Global’s Feltes said.

U.S. regulators are also taking a closer look at commodities traders, causing some investors to sell for the time being, which is also putting downward pressure on current corn prices.

“Obviously the USDA has confirmed how nice the crop looks but in the final analysis we don’t think the net yields can be that high,” Gavin Maguire, analyst for E Hedger LLC, told Reuters.

“People are heading for the exits right now and asking questions later and when this ends, grain prices should begin rising,” Maguire said.

Source: Higher Corn Prices Ahead as Overly Optimistic USDA Report Misses the Mark