Drought-hit US crops worse than feared, squeeze looms

   * Smallest corn crop in 6 years, 2 pct below estimates

   * Soy crop 4 pct below trade expectations

   * Lowest US corn use in 6 years, soy in 9 years

   * Russia wheat down 12 pct, China corn up 2.5 pct

   * Record soy crop makes Brazil No 1 in world

WASHINGTON - The worst US drought in more than half a century has battered the corn and soybean crops with larger losses than expected, causing domestic stockpiles to shrivel to near bare-bones levels, government data showed on Friday.

In the most authoritative statement yet on the withered US crops, the Agriculture Department, based on its first samples this season from parched, scorched fields, estimated the corn harvest would drop 13 percent from last year.

With production at just 10.8 billion bushels, the yield would be the lowest since 1995.

It would be the third disappointing crop in a row for the world's largest corn grower and main agricultural exporter.

The prospect intensified fears the world is headed for a repeat of the 2008 food price crisis. World food prices surged 6 percent in July, a U.N. agency said.

The charity Oxfam warned of price spikes ahead "with devastating consequences for those already struggling to get enough to eat." Oxfam urged steps such as a waiver of the US law requiring use of corn ethanol as motor fuel, to calm high prices.

 However, supplies of wheat and rice "are good if not high," private consultant John Schnittker said. "The talk of world food crisis seems unduly apocalyptic for now," he said.

The USDA slashed its estimate of the corn crop by 17 percent, following a big cut in July. Its latest estimate was 2 percent lower than traders had expected.

While near-record Chicago grain prices barely budged on the data, the numbers may add urgency to the renewed food-versus-fuel debate centered on the US ethanol mandate. About 40 percent of the crop will be made into fuel for cars and trucks.

International and domestic pressure has grown for curbing the program, but pundits say the policy has staunch Farm Belt support that is unlikely to waver in an election year. The Obama administration, like its Republican predecessor, has stood by the mandate, called the Renewable Fuels Standard.

 "Any attempt to change the Renewable Fuels Standard ... would simply be a knee-jerk reaction to the benefit of Big Oil," ethanol trade group Growth Energy said. It said ethanol output is falling due to high corn prices.

Livestock producers and meatpackers petitioned the government last week to reduce or eliminate the ethanol mandate because of the short crop.

Even with unexpectedly deep cuts to the government forecast for exports and ethanol use, US corn stocks at the end of next summer will shrink to only 650 million bushels -- a three-week supply, the slimmest margin in two decades.

US inventories of soybeans, a key component of livestock feed from India to Indiana, would be the smallest in nine years after the USDA said only 2.69 billion bushels would be harvested this fall, 4 percent less than traders had expected. Stocks will drop to 115 million bushels, the second-smallest since 1973.

Corn prices, which have rallied more than 60 percent since mid-June, briefly surged to a record when the USDA released its report. They later retreated as traders assessed signs that soaring costs were helping curtail demand.

Soybean prices held gains of nearly 2 percent, although some traders said the agency's dire forecasts may yet prove too pessimistic as late rains offer hope for soy plants.

 SECOND-GUESSING

The report is an abrupt reversal from just two months ago when farmers, making the largest corn plantings in 75 years, expected a record haul. Consumers worldwide were also hopeful that a robust harvest from the biggest agricultural exporter would help end a period of depleted global stockpiles.

Then came the weather. More than 60 percent of the continental United States, including prime farm and ranch territory, was under moderate to exceptional drought this week.

July was the hottest month on record, beating the worst month of the Dust Bowl era in 1936. Half the corn crop is in poor or very poor condition, the worst ratings since the drought of 1988; a year ago, 60 percent was top-rated.

Now, however, many fear record-high prices and meager stockpiles will rule commodity markets for at least a year more -- and it may worsen if growing signs of shortages prompt some countries to impose export bans or make panic purchases, as they did during the dramatic price spike in 2008.

Bangladesh said on Thursday it had extended a ban on exports of most varieties of rice until next June to ensure domestic supplies. China said it would release corn and rice from government reserves to pad supplies until the fall harvest.    

The impact of the drought has been increasingly apparent over the past eight weeks, but the USDA's report was the most thorough in measuring the damage. It interviewed more than 28,000 growers and tested yields in thousands of fields. It says there is a 10.7 percent margin of error for its estimate of the corn crop and 11.4 percent on soybeans.

Even so, traders in Chicago immediately began second-guessing the figures. The USDA forecast an average corn yield of 123.4 bushels an acre. Traders had expected a yield of 127.3 bushels an acre.

 "There's room for these corn numbers to come down more. For those of us who have been in the field, the crop numbers are likely to fall further," said analyst Dan Basse at AgResource Co. Some said the USDA was overestimating the number of acres that would be harvested this year given the damage.

On soybeans, forecast to yield an average 36.l bushels per acre versus expectations of 37.8 bushels, the debate was over the impact of recent rains at the tail end of the season.

"The story on beans right now is that the weather is improving. It's going to be interesting to see if we can stabilize this yield or improve it," said Brian Basting of Advance Trading.

 BLACK SEA DIMS

The USDA also highlighted declining conditions across the Black Sea, which have fueled a nearly 50 percent surge in wheat prices even though the US crop was barely touched by drought. The USDA revised up its forecast of season-ending wheat supplies by 5 percent, to 694 million bushels.

The USDA lowered its forecast of Russia's wheat crop by 12 percent and Kazakhstan's by 15 percent because of hot, dry weather.

Other grains also looked in more robust supply globally, with China's corn crop revised up 2.5 percent from a July estimate and Brazil's boosted 4 percent, topping the United States as the world's largest grower.

 Global wheat consumption will rise slightly as more of the grain is used as a substitute for corn in livestock feed. Corn consumption would fall by 4 percent worldwide, with the smaller US crop accounting for three-quarters of the decline.

Less corn will be used in making ethanol due to drought, the USDA said. It lowered its estimate by 8 percent for 2012/13, to 4.5 billion bushels.

World food prices rose by 6 percent in July, driven by surging corn and sugar prices, the UN Food and Agriculture Organization said. The index is below its February 2011 peak but higher than in 2007-08, when fear of shortages drove up prices and prompted export bans in some countries.