A return to more normal U.S. corn yields in 2013 could send new-crop prices spiraling downward, but persistent drought in some of the nation's top corn-producing states could have the opposite effect, says Purdue Extension Agricultural Economist Chris Hurt.

The USDA predicts the midpoint of U.S. farm prices on 2012 corn will be $7.60/bu. If yields are more normal in 2013, Hurt says prices could fall by $2.10 down to $5.50/bu. – the largest ever year-to-year drop.

"The previous largest drop in the annual farm price was 73¢/bu. for the 1986 crop," he says. "The percent reduction in 1986 was 33%, which would compare with a 28% reduction in 2013 if prices dropped to $5.50."

According to Hurt, late next summer a 2013 corn crop larger than 14 billion bushels would meet a usage base that has dropped to just 11.2 billion bushels. The market must then shift from rationing corn use from the current short crop to strongly increasing use. If corn usage were to drop that low, it would take sharply falling prices to encourage end-users to return to normal usage.

"However, some of those end-users, such as the ethanol industry, might be able to return to full usage at the flip of a switch," Hurt says. "The domestic animal-feeding sector and the export sector won’t be able to build usage as quickly, and increased corn production outside the U.S. will likely compete heavily with farmers for export business."

But normal 2013 U.S. corn production is nowhere near assured, especially if drought centered in the western Corn Belt and Great Plains states persists into the growing season.

Twenty-five percent of Minnesota, 42% of Iowa, 63% of South Dakota and 96% of Nebraska are in extreme to exceptional drought – the two worst categories. All four are among the top six corn-producing states.

"U.S. corn yields have been below trend for three years, and more farmers now recognize the possibility of four poor crops in a row," Hurt says. "This, of course, means that normal crops and sharply lower prices are far from a reality. Prices won't move sharply lower until crop production becomes more assured as the 2013 season progresses."

Futures markets already are taking into account the possibility of a short 2013 corn crop and building in a greater-than-normal weather risk premium. While the amount of the premium is unknown, Hurt says 50¢-$1/bu. isn't out of the question.

"As long as the drought threat remains as large as it is today, new-crop corn prices could stay higher by the risk premium," he says. "If the drought risk were to be eliminated, then new-crop prices would likely drop.

"The weather threat could be reduced if more rain arrives but can't be eliminated until next year's corn growing season reaches mid- to late July."

So while a return to normal production could mean $5.50/bu. corn, Hurt says continued drought in key production states could still translate to new-crop corn prices of $8.50/bu.

The uncertainty makes risk management difficult for corn growers.

"Farmers will have three key tools to deal with the financial risk from this wide range of possible outcomes: federal crop insurance, the new government farm program and their own marketing decisions," Hurt says.