A closer look at the global dynamics of drought-driven corn and soybean prices, the ethanol industry and the concept of rationing supplies to meet demand.
By Ron Mortensen, Dairy Gross Margin, LLC
The drought of 2012 has become so serious that the corn and soybean markets must confront the concept of rationing—allowing prices to rise high enough to reduce demand. Chances are there will not be enough crop around to meet everyone’s needs.
For corn, there are three main components to demand: feed/residual, ethanol and exports. Currently, the most attention has been devoted to ethanol production.
It could take reductions of nearly 20% of the industry, which means 25 large plants may need to shut down. A few plants have already shut down or gone to hot idle. Reductions of about 900 million bushels of corn use may be needed to get the supply and demand tables to balance. There may well be excess renewable identification numbers (RINs) to allow this reduction to occur.
Rumors continue to swirl regarding the Renewable Fuels Standard (RFS) and whether or not (or when) a waiver will be requested. If an official waiver is requested, EPA will take comments from the public for 90 days. The last time a waiver was requested was in 2008 by Texas Governor Rick Perry. It was denied. The rules are such that getting a waiver is very difficult.
What if the EPA does reduce ethanol requirements? Refiners have become more dependent on ethanol for the octane boost to get low-grade gasoline to meet the requirements at the pumps. Ethanol is the cheapest octane booster around, so refiners could bid up the price of ethanol, making it profitable to produce. So, how much does ethanol demand really decline?
From a feed standpoint, if ethanol production is reduced, more corn or soybean meal will be needed to replace the DDGs. This is relevant for both the domestic feed situation and exports. Exports of DDGs have been strong, especially to China, so these would need to be replaced with corn or soybean meal.
For feed demand, USDA did provide some data in the grain stocks report on June 29. It showed corn stocks at 3.148 billion bushels. This was close to expectations and implies feed use during the third quarter of the marketing year was close to last year’s number. There is less corn available for feed for the fourth quarter, so presumably there will be more wheat feeding. Remember there was a time when wheat feeding penciled out, so cattle and hog feeders did book wheat.
The stocks report showed lighter stocks (on a proportional basis) in Illinois, Minnesota and Nebraska compared to last year. There are implications of tighter basis levels for Illinois and surrounding states because of the sizable processor demand centered in Decatur, Ill. These tight basis levels could continue if the Eastern Corn Belt crop size keeps shrinking.
A small U.S. crop could mean liquidation, slaughtering sows and cows, besides feeding animals to lighter weights.
For exports, the U.S. may be saying, “Thank goodness, Brazil grew a huge corn crop.” While price has recently reduced the pace of U.S. exports, there is a large, cheaper crop available from Brazil. This will be a welcome supply for foreign buyers seeking a source of supply in the face of the potentially smaller U.S. crop. Brazilian corn may find its way into the US. as some southeast chicken feeders are already talking about having made purchases.
Foreign buyers can simply try to scrape by with smaller purchases. And China figures in here, too. The Chinese may cancel or re-sell the new crop corn they had purchased earlier.
Over on the soybean side of things, there is a potential new wrinkle regarding soybean meal. Due to the sub-par monsoon, India last week announced it would drop the import tax on soybean meal. This would allow for soybean meal imports for the first time in history. This is dramatic when a traditional soybean meal exporter turns into an importer. The meal would most likely come from China (likely crushed from U.S. soybeans), which has excess soybean processing capacity. Indian meal prices have doubled since the spring, while U.S. prices are only up 30% to 40& in the same timeframe.
Reduced soy production in Argentina and Brazil is also rippling through the markets up in the U.S. Reduced supplies down south means increased demand up here for both whole bean exports and crush. Many think soybeans and meal will be tight until March 2013 as the U.S. will need to supply the world. This makes the current U.S. crop in the field very important. However, it will take very large South American production before the soybean market is truly comfortable with supplies.
Ron Mortensen is a founder of Dairy Gross Margin, LLC, which was formed in 2006 to sell Livestock Gross Margin Insurance to dairy producers. Mortensen’s firm is now licensed in 23 states. He is also president of Advantage Agricultural Strategies, Ltd., which he founded in 1985, to provide individual risk management advice for farmers and agribusiness using futures, options and cash trading strategies. Contact him at 515-570-5265 or firstname.lastname@example.org.