Matching demand with supply over the next 11 months will be a difficult task. There is a fine line between necessary demand reduction and the possibility of demand destruction.
USDA economic models offer guidance on the necessary demand reduction per sector. How end users ultimately choose to deal with supply shortages is another matter. These uncharted waters might contain unintended consequences with long-term effects.
In theory, the free market will wean out the less profitable and less efficient end users. An across-the-board cut of 15% from 2010/11 usage would be ideal, but that might necessitate government intervention. We’ve been there, done that, and it didn’t work well. A free market is not necessarily a fair market, so some sectors might suffer more than others. A look at USDA’s demand sector reductions for the year ahead shows the seriousness of the problem.
• Feed and residual for corn has been cut 20% from 2010/11 and 30% from five years ago, which suggests major implications for livestock producers.
• Corn for feed, seed and industrial uses is less, primarily because corn for ethanol has been cut by 500 million bushels to 4.5 billion bushels. Profits from DDGs are somewhat offsetting the losses in ethanol.
• Exports are projected to take a 30% hit from two years ago and a 50% reduction from five years ago.
On a Cliff. Total production is more important than guesses at yields and harvested acres. Should subsequent production reports suggest a variance of 300 million bushels in corn (3 bu. per acre), ending stocks could vary between 353 and 900 million bushels, leaving a fine line between demand reduction and demand destruction. An 11 billion bushel crop might prove $8 corn was
high enough. A 10.4 billion bushel crop would require more demand reduction through higher prices, making demand destruction a possibility.
The long-term implications of our historically high prices entice our competitors to expand. It has been estimated that 10 million hectares are available for production in the former Soviet Union if the incentive (price) is there. In the meantime, demand destruction in the U.S. would likely fall on the backs of the livestock sector, suggesting higher meat prices and the opportunity for our competitors to fill the void.
While we might need as many acres next year, I can only imagine what our carryover stocks will look like with higher yields, stable acres and reduced demand. There is risk in trading futures—as well as extreme price risk looking forward. The story continues to unfold in the supply-driven bull market, and the last chapter has yet to be written on how we deal with a severe domestic shortage of supplies. The progress will be assessed with each quarterly stocks report, and the January report will be key in determining whether we can make it through the year or if demand destruction is a reality.
- October 2012