An Investigation Into the Effects of Supply & Demand Factors on the Producer

Price Path of Corn The Case of Canada

(1966 - 2014)
Authors : Isaac Jonas
&

Sean Holowaychuk 1

Abstract
This paper takes a macroeconomic approach to analyzing the factors that affect the producer price
path of corn in Canada. It examines the demand and the supply factors as fundamental
explanatory variables to the price variations in the corn market in Canada over a period of 1966 to
2014.

The authors are Master of Food and Resource(MFRE) Candidates at the University of British Columbia

CONTENTS
1. LIST OF ACRONYMS
2. OVERVIEW OF THE MODEL
3. INTRODUCTION
4. LITERATURE REVIEW
5. METHODOLOGY
6. DATA SOURCES
7. ASSUMPTIONS OF THE MODEL
8. PRESENTATION OF RESULTS
9. DISCUSSION OF RESULTS
10. LIMITATIONS OF THE STUDY
11. CONCLUSIONS
REFERENCES

1. LIST OF ACRONYMS
CIF - Cash in Freight
GDP - Gross Domestic Product
FAO - Food and Agricultural Organization
US - United States of America
USDA - United States Department of Agriculture
FAS - Foreign Agricultural Service
FOB - Free on Board
OPEC - Oil and Petroleum Organization

2. OVERVIEW
The purpose of the paper is to examine the effects of demand and supply factors on the
producer price path for corn in Canada. The dependent variable is Canadian corn price. The paper
examines the temporal and spatial effects attributable to the variations in exchange rate, gross
domestic product (GDP), world price, corn yield per acre, stock-to-use ratios per year, and world
crude oil prices are assessed over the period of 1960 to 2014. But due to data limitation, the
period is revised to 1966 - 2014.
3. INTRODUCTION
Corn (maize) for grain is the number one cereal crop worldwide in terms of production
(FAO: 2011). The annual global production increased from 643 million tons to 2.2 billion tons
between 1960 and 2010 (World watch: 2014). Globally, the major producers are the United States
of America(US) producing 41%, China (19.4%), EU-27 (7.0%), Brazil (6.9%), Argentina (2.8%)
and Canada contributes 1.2% (USDA:2010). In Canada, corn is grown mainly in the central parts of
Ontario , Manitoba and Quebec with each area contributing 61.7%, 6.4%, and 30.2% respectively
(Stats Canada:2014).
Fox (1953) points out on the importance of studying the price of commodity markets as an
economic variable. Accurate price forecasting is a valuable tool to different stakeholders in an
economy ranging from government, farmers and consumers (ibid). In addition, although Canada is
a price taker in the corn market given its relatively small contribution to the global market,
understanding the drivers of corn price would be a valuable tool for planning and policy
formulation. Corn is the third most important crop in Canada in terms of production (Stats
Canada: 2014). However, there has not been much detailed empirical study about price path in
Canada with specific focus to the producer price path of corn in Canada. This sparked the
researchers interest on the subject.
Corn is used for many purposes ranging from human consumption, animal feed, and
feedstock for industrial products to biofuels production (Stats Canada: 2014). The use of corn to
produce ethanol has been a source of debate with regards to the volatile corn prices since 2005.
Tenenbaum (2008) highlights that the increased diversion of corn and other grains to biofuel
production is a suspect to the recent food price spikes witnessed in 2008. Although there are
distinct causal agents for each commodity, markets are linked across commodities, and prices
tend to be cointergrated, especially over the long run2 and cited in Sumner 2009.3

2
3

http://ajae.oxfordjournals.org/content/91/5/1250.extract#ref-14
http://www.aae.wisc.edu/events/papers/DeptSem/2009/sumner.10.09.pdf

4. LITERATURE REVIEW
The paper refers to the work done by Sumner in his 20094 classic paper on the historical
perspective of global price path for corn and wheat from 1866 to 2008. The paper shows that as
opposed to the general view that food prices have been increasing over time, empirically, it has
been the opposite over the long run(Sumner:2009).When commodity prices increase, empirically,
they tend to revert back to below the original mean prices.5 The research also consults the article
by Dorosh and Valdes (19906) which explores the effects of exchange rate and trade policies on
agriculture in Pakistan. This provides a methodology to estimate the world price for a commodity
by finding the point when import parity for the period of review and the net imports are positive
by equating them to the export parity when net imports are negative. The report by Andrew
(19927) on the analysis of wheat policy in Pakistan equally provides the government perspective
of market intervention into the wheat market by examining the Pakistan case.
5. METHODOLOGY
The research began with an investigation into the producer price path of corn in Canada
relative to the price path of corn (maize) in the United States and the world. 8

The time series graph above shows that the producer price path of corn between Canada,
the United States and the rest of the world move in tandem.This got the researchers intrigued into
4

ibid.
ibid.
6
http://pide.org.pk/pdr/index.php/pdr/article/viewFile/1161/1136
7
http://www.biomedsearch.com/article/Wheat-price-policy-in-Pakistan/182272698.html
8
http://faostat3.fao.org/download/P/PP/E,
http://databank.worldbank.org/data/views/variableselection/selectvariables.aspx?source=global-economic-monitor-%28gem%29commodities#
5

the investigation. The question at hand being, So what is driving a noticeable spike in corn prices
from the mid-2000s onward? The possible explanation was the rising price of crude petroleum
and the US desire to release itself from foreign energy dependency and become more selfsufficient through the production of biofuels, of which corn would be a main input. The graph
below subsequently includes world crude prices in the time series.9

The above time series graph shows that the relative commodity prices of corn remain fairly
independent of world crude oil prices until roughly 2005, when biofuel production began, at
which point it appears to become directly correlated with world crude oil prices.
Further investigation into the information at hand alludes to a possible explanation for the
gap between the producer price of corn in Canada versus the US and the rest of the world. Our
investigation into the trend opened up room to consider other possible independent variables that
might influence the gap between these price points. They include:

ibid.

$USD / $CAN exchange rates

Changes in yield for Canadian Farmers
Changes in % of world production that is Canadas share.
Changes in Canadian GDP
Changes in Canadian stock-to-use ratios
Changes in world crude petroleum prices

6. DATA AND DATA SOURCES

The research draws the data from sources listed below.
1. Data are classified into three categories - Canada, US, & the World.
2. Currency exchange rate data are taken from the Sauder Business School Pacific
Exchange database. (http://fx.sauder.ubc.ca/data.html)
3. GDP data was extracted from Statistics Canada. (http://www.statcan.gc.ca/pub/81595-m/2011095/tbl/tbla.34-eng.htm)
4. Corn/maize prices for Canada and the US were extracted from Food & Agriculture
Organization (FAO). (Yellow No.2 FOB) (http://faostat3.fao.org/download/P/PP/E)
5. Corn/maize prices on the world market were extracted from The World Bank - Globel
Economic Monitoring (Commodities) (GEM)
(http://databank.worldbank.org/data/views/variableselection/selectvariables.aspx?so
urce=global-economic-monitor-%28gem%29-commodities#)
6. The data for beginning stocks, imports, exports, production, total supply, ending stocks
and yields, were taken from the United States Department of Agriculture (USDA)
Foreign Agriculture Service (FAS).
(http://apps.fas.usda.gov/psdonline/psdQuery.aspx)
7. Crude petroleum prices are from the World Bank Commodity Price Data Pink Sheet - It
represents an average of Brent North Sea, Dubai, & West Texas Intermediate crude oil
prices.
(http://databank.worldbank.org/data/views/variableselection/selectvariables.aspx?so
urce=global-economic-monitor-%28gem%29-commodities#)
Firstly, the compiled data is used to conduct further calculations in Excel. The exchange
rate data between Canadian and US currencies are used to compare all data relative to the US
dollar. This captures the attractiveness of Canadian corn purchases to foreign buyers as its
currency fluctuated.
We calculated the Canadian percentage of world supply of corn as a ratio of Canadian
production per year to world production per year. The assumption is if Canadas share of the
world market changes, to what extent would that influence the world or domestic price.
The Canadian yield ratio relative to the Worlds yield captures economic efficiencies in
Canada that may lead to productivity gains and comparative advantage, which may influence
price.
Canadas stock-to-use ratio measures how much of Canadas corn production was
efficiently consumed. It is calculated by adding beginning stocks, production and imports. Then
subtracting exports and using this as a ratio to consumption. This captures the changes in the
amount of corn on the market in a given year. Stock-to-use ratios and ending stocks would
influence a farmers decision as to which type of crops and how much of each to plant in a given
year.
Note: In the initial presentation in class there was an error in the calculation of stock-touse ratios. The initial calculation was done not taking into account that total supply already

included import and export figures. Therefore this significantly biased the initial analysis and
made the results ambiguous. However, this is rectified in this write up.
The Canadian GDP captures any consumer changes in supply that may result from the
income effect as households become more or less wealthy.
6. ASSUMPTIONS OF THE MODEL
The model makes the following general assumptions:
1. Canada is a relatively smaller producer in the global corn market hence it is a price
taker. We assume the Canadian producer price for corn is a function of the US price
($USD) as well as the world price ($USD).
2. An open market economy exists where transaction costs are zero.
3. Trade and transport restrictions are relatively homogeneous between countries &
regions. Prices are reported (FOB).
4. From the mid-2000s onward the price of corn worldwide becomes driven by world
petroleum prices. More specifically, US dominance in the corn market (biofuels) and
crude oil prices are the most important factors behind world corn prices.
7. PRESENTATION OF RESULTS
The table below shows a summary of the variables presented in the research. Due to a lack
of data for some sources, the research considers the data post 1966. This brings the total
observations to 49.

The initial investigations show that the price of corn in Canada would be closely tied to the
US price and/or the world price. And furthermore, that since approximately 2005, the price of
corn in the world and the US has been tied to world petroleum prices. Therefore, the assumption
is that there is a parallel relationship between all four of these commodity prices. The data proves
this point as there is a strong correlation between the US price, the world price and the price of
crude oil over time.

The process begins by eliminating all the correlated price variables in the model, since this
would result in biased results. The regression of the annual Canadian corn prices against US corn
prices and our possible other explanatory variables is as below.

The results show that the initial F-statistic is very small, which means that some part of the
initial model has a statistically significant effect on Canadian corn prices. From this there we use
backwards stepwise regression to eliminate variables that have p-values > 0.05. This would mean
that they are not statistically significant to the model. Subsequently, the backward stepwise
regression process results in the elimination of the Canadian percentage of world corn supply
(Cdn_Pct_World_Supply), and Canadian to world yield ratios (Cdn_Yld_Ratio). This leaves a fairly
statistically significant model. The table below shows p-values and as well as standard errors that
are relatively low.

Consequently, running the regression with the same independent variables but with the
world price substituted with the US price gives us the result below. The results shows that world
price makes the exchange rate coefficient insignificant.

The next regression using the price of crude oil as the independent variable instead of the
US price of corn is shown below. The table indicates that even though the price of crude oil may
have an effect on the price of corn, by this model, it makes the other independent variables
insignificant.

In the end, it is evident that the Canadian price of corn is a function of the US price, the
average annual exchange rate and the Canadian stock-to-use ratio. The correlation tests conducted
are as below. These detect the multicollinearity and, as when necessary, would adjust for the
anomaly.

Residual Analysis
The scatter plots of the three independent variables relative to Canadian corn prices are as
follows below. The US corn price has the most significant linear relationship with Canadian corn
prices.

The tests to detect homoscedasticity were undertaken. The scatter plots show that
residuals are not completely homoscedastic and they display a fanning effect as the data gets
larger.

The normal distribution graphs show that the residuals are not exactly normally
distributed around the mean. However, they follow the basic shape.

The Breush-Pagan test shows that we do not reject the null hypothesis of constant variance at a
95% confidence interval, however, it is close and we could certainly more convinced at 90% or
even 94%.

The RESET test for model misspecification passes the litmus test, and we do not reject the
null hypothesis that there are no omitted variables albeit by only a slight margin.

8. DISCUSSION OF RESULTS
The results show that, possibly due to geographical and economic reasons, the price of corn
in Canada is significantly linked to the price of corn in the United States. However, what accounts
for this gap in prices and lag price changes? From the model, ceteris paribus, on average, both
average annual currency exchange rates and Canadian stock-to-use ratios play a role in explaining
the gap.
The stock-to-use ratio is helpful in explaining the gap and lag that appears to be present in
the trend between the two price points. What appears to happen is that when Canada has excess
stocks the price of Canadian corn falls slightly. Which would be deemed logical. At this point
farmers make the decision on next years crops and they would logically substitute to something
which may be more profitable, such as soybeans. The volatility in agricultural commodity markets
complicates speculation. The deficits, all equal, would result in the world price increasing. This
would in turn affect a farmers decision on which crops to seed.
The exchange rate fluctuations tend to occur in tandem with changes in stock-to-use ratios.
An explanation for this would be that as Canadas exchange rate falls relative to the US, corn in
Canada becomes more attractive to foreign buyers, lowering the stock-to-use ratio. Conversely, as
the Canadian dollar appreciates Canadian corn becomes less attractive on the world markets and
stocks accumulate. All this is a part of the long run macroeconomic equilibrium effect.
Corn prices worldwide, and especially in North America, where biofuel production is most
significant, are definitely cointergrated to petroleum prices. The other footnote is reflected by the
coincidental simultaneous movement along with the dramatic rise in the price of oil in the mid2000s and then its dramatic fall beginning in 2012. According to the FAO Food Outlook report

(Oct.2014), since the recent dramatic fall in oil prices farmers have chosen to reduce corn
production by 20% and switch to more profitable crops, such as soybeans.
The other possible reasons for the spikes and downward trend on the graph may be due to
supply constraints. There was also increased speculation as a result of each downward or upward
trend (Krugman: 2008). There were supply constraints emanating from the political disturbances
in the Middle East. These range from the Seven-Day war in 1973, between Israel, Egypt and Iraq
and the Iranian revolution in 1979. Iraq and Iran are still the major oil exporters in the world and
also members of the influential Oil and Petroleum Organization (OPEC). This may have resulted in
higher crude oil prices since there has been a burgeoning demand for crude oil with
industrialization and global development.
There is also the biofuel story. There is a trade-off between producing corn for ethanol and
food. Babcock (2008) points out that the expansion of biofuel production in the US, Europe and
South America coincided with increases in food prices, oilseeds and vegetables (ibid). Could this
be a result of an increased substitution effect away from corn production for food and towards
ethanol? Well, that is another research question!
10. LIMITATIONS OF THE STUDY
The volatility in commodity markets, exchange rate fluctuations, and investor speculation
play a large role in determining market prices. This study is limited in that research is conducted
using average annual data. Reliable and comparable data is difficult to come by. Over time, lags in
decision making, especially related to crop selection may significantly influence farm gate prices at
harvest time. Therefore, a more robust study of the gap between Canadian and US corn pricing
could be conducted using monthly, or even better, weekly data.
Furthermore, the final model may show that the independent variables are statistically
significant, however from the RESET test, a more robust model would certainly need to be
developed to draw stronger conclusions.
11. CONCLUSIONS
Because Canada is a relatively small producer of corn in terms of world market share
(1.2%), it is a price taker on the world market (Statistics Canada: 2014). Therefore, farmers base
their crop decisions on very limited information about futures market prices. The overall trend is
that given the current world dependency on oil, and the policy decision of the United States to
expand ethanol production, corn prices will remain tied to world crude prices for the foreseeable
future. Moreover, the gap between the US producer price for corn and the Canadian producer
price for corn remains a function of the unpredictability of commodity markets, as well as
currency exchange rates.

12. REFERENCES
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http://www.statcan.gc.ca/pub/96-325-x/2014001/article/11913-eng.htm.
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Canada, Agriculture and Agri-Food Canada;Government of. Weekly Price Summary. promotional
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Government of Canada, Agriculture and Agri-Food Canada. Canadian Grains. N.p., 8 Aug. 2011. Web.
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