NEWSLETTER EXTRACTS
May - June 2008
Australian Grain Market Report
What has changed since last quarter?
Since the end of the last quarter, there have been some significant moves in grain values, and rampant food inflation is shifting sentiment toward bio-fuels. CBOT wheat futures have risen from +$12/bu to $9/bu, while corn prices have risen to over $7/bu on US crop concerns. Soybean and canola futures have pulled back off their highs despite new records in crude oil, as speculative interest has diminished as the ongoing credit crunch and threats of commodity market regulations have seen non-commercial investors sit on the sidelines.
In the past quarter, bio-fuels have been linked to high levels of food inflation, placing pressure on governments globally to rethink support of bio-fuels and attack global food price inflation. G-7 leaders have expressed a desire to halt the decline in the $US as one strategy to halt the ongoing rise in food prices.
Locally, feeders have switched out of expensive wheat and into barley and sorghum, but feeding activity remains very depressed. Local old crop cereal prices fell sharply, led by wheat, and all other grains have followed suit to some extent. Prices have recently strengthened on US corn crop problems and scarce local cereal supplies.
Sorghum values have improved on the back of a rise in corn prices. But crop estimates vary widely and feeders are buying hand-to-mouth. With the rally in corn prices, export demand is picking up, which should move local values back toward export parity and support local values.
What do these changes mean?
Poor US corn crop prospects and strong ongoing demand will have a major impact on export parity levels for Australian grains in the coming year. Record crude oil prices look set to underpin ongoing strong demand for bio-fuel crops and by increasing production costs, should also underpin firm values across the grain complex.
Rising production costs will also underpin our prices at very strong levels during the forecast period. Unless priCes remain strong, global plantings may pull back and tighten stocks further. We assume that support of bio-fuel industries will continue in the short-term and plateau in 2009, and these policies will remain supportive of higher grain prices over our forecast period.
But once global growth slows, the $US strengthens and crude oil prices ease back, what happens to commodities? Until global markets are confident that they have arrested the decline in grain stocks, we believe prices will remain well supported.
The lift in global wheat production, and a rebuilding in stocks, has brought the large premiums for wheat back to more traditional levels, but the ongoing decline in stocks of all grains will limit the extent to which wheat prices can fall from here. The desire to rebuild wheat stocks should hold prices above normal premiums to feed grains during 2008.
International corn prices will largely dictate the levels for other Australian feed grains. We expect our coarse grain prices to be supported at around current levels. Some of the reduction in export demand for US corn will flow through to demand for Australian grains. We will first see this in the form of greater demand from Japan for Australian sorghum in late 2008.
We expect that the $A will peak sometime during the second part of 2008 and therein, become supportive of Australian grain prices. The main risk to our forecasts appears to be that high crude oil prices and rising inflation crush global growth. But does that necessarily flow onto lower commodities? Stocks of all grains are still declining; the world needs to eat; and rising input costs are increasing the risk/reward scenario for global food producers dramatically. Any efforts to support the $US will work in our favour.
Available now!
The ProFarmer June 2008 Australian Grain Market Report has just been released. It includes discussion on food price inflation, analysis of international markets and their likely impact on Australian grain markets, and discussion on local crop conditions, production forecasts and planting updates.
The report provides forecast prices of each of the major grains by state for the year ahead and a state-level 10-year grain price history for the major grains. It is well suited to Australian corporate agribusinesses.
If you are interested in subscribing to ProFarmer, please contact the office on 1300 302 143.
Ph: (08) 6389 0722 / 1300 302 143 (outside Perth metro area)
Email: profarmer@profarmer.com.au
Layman's Guide to Grain Marketing Products - Part I
We have gained plenty of new subscribers over the past few months and thought it appropriate to start a series to review the full suite of grain marketing products currently available to local growers.
With wheat market deregulation and big changes in global grain markets, the product environment will likely remain dynamic through much of this year. But that said, the basic product principles will continue to apply, with changes likely ‘cosmetic’ in nature.
Grain marketing can be as complicated as you make it. Over the past 10 years, an extensive range of products has developed. Some of these products are ageless, while others are transitory due to changing market circumstances. Each of the product groups has generally evolved from the inadequacies of the previous generation of products.
How is grain priced?
Australian grain prices are driven by movements in three independent pricing components. Any local grain price can be broken into its three pricing components: futures, currency and basis. So, making up today’s Multi-G forward contract price of A$338/t port is today’s Dec 08 forward $A/US rate of $A=91.84US¢, CBOT Dec 08 wheat futures close of 840US¢/bu and basis of +4US¢/bu.
Each of the major grain marketing product groups has been designed to manage some form of price risk. New generations of products have been structured to provide flexibility in the management of production, delivery, quality and pricing risks. The table below identifies the risks associated with each of these products and the pricing components they allow you to manage.
Forward contracts
The first product group that includes fixed grade and multi-grade contracts are forward cash contracts priced in $A/t. They are the simplest of the marketing products but are the least flexible, expose you to production and delivery risk and force you to fix all three pricing components (CBOT, $A and basis) at the same time. Multi-grade contracts reduce the quality risk by allowing delivery of a number of grades, whereas with fixed grade contracts, you are also exposed to quality risk.
Futures markets
A major problem with forward contracts is that they are inflexible. If you can’t deliver for some reason, the seller is often subject to significant ‘washout costs’, stemming from poor market liquidity. Futures markets were designed to overcome this. A futures contract is essentially a standardised forward contract, and futures markets provide a marketplace for a large number of buyers and sellers to trade contracts that are relevant (not generally the same as the grain they are buying and selling) to their businesses. Futures markets are transparent and regulated, which enhances liquidity by providing market integrity and confidence.
In practice, direct trading in futures markets by Australian growers is limited – although ASX futures volumes are steadily increasing, many growers find managing futures positions difficult and time consuming. The real importance of these markets is that they provide a fulcrum around which many of the other grain pricing products offered to Australian growers are derived.
Commodity swaps
Commodity ‘swaps’ are simply products derived from futures markets and offered by local intermediaries (major local banks) in a ‘farmer-friendly’ way. These products can be offered in $A/t (rather than US¢/bu like CBOT futures) and do not involve the margin requirements associated with futures markets (advantage over ASX futures). Swaps based on both international (CBA, Rabo, ANZ, NAB) and local (CBA, ANZ) futures markets are offered to Australian growers by major local banks.
Based on a Dec 08 CBOT close of 840US¢/bu (A$336/t, converted at Dec forward rate of $A=0.9184US¢), the banks were offering $A/t swaps of A$327-334/t. The difference between the converted futures price and swap is the bank margin (they also make a margin on the $A/US rate they charge). The margin compensates the bank for administration and position funding costs, and provides some return on equity. If using futures or basis contracts, you will still need to manage ‘basis’.
We’ll look at the remaining product groups next week. In coming weeks, we will also look at each of the major groups in more detail, and explain the difference between production and delivery risk.
Australia Heading for Record Plantings... if it Rains
According to ProFarmer subscribers, Australian grain growers will plant record wheat, barley and canola crops this year.
Wheat plantings will rise in every state, for a 13% increase in the national plant. If this survey is representative of the national move (if realised), it would equate to plantings of around 13.9m ha – well above the previous record level of 13.1m ha in 2004/05.
QLD is planning the biggest increase in wheat acres (+35%) – growers are hoping to take advantage of good sub-soil moisture levels. The ambitions of QLD growers may be contained if it remains dry through the end of May and much further into June.
Solid increases in plantings are also being pencilled in across NSW (+15%) and WA (+15%). Growers across the southern cropping states of SA (+8%) and Vic (+2%) are planning more moderate increases.
The survey period was early May; therefore, responses may have been influenced by ongoing dryness across the majority of cropping areas in these states.
Australian growers may attempt to wrong-foot the international market with plans for another large increase in chick pea area (+63%) – counter to falls in plantings anticipated in Canada. The extent of this increase is inconsistent with the moderate lifts currently forecast by Pulse Australia (+5%).
Our WA growers say they will lift lupin area (+4%), which was a bit of surprise, as the consensus was that area planted would retreat.
Hefty increases in winter crop area will be funded by a fall in sorghum plantings in QLD. Falls in oaten hay plantings, and in specialty crops, will allow larger plantings of everything else in VIC.
Similarly, reductions in hay plantings (both for grain and hay) will allow increased seedings in WA, but the bulk of the increases will be the result of a fall in fallowed area and shifts away from livestock. Larger area in NSW will come from a reduction in fallow and a shift from livestock to cropping. Falls in specialty crops in SA will allow big increases in cereals and canola.
The rise in barley planting intentions surprised us, as it almost rivals the increase in wheat plantings, at 11%. Like with wheat, this would lead to record plantings of 4.8m ha versus the previous record of 4.6m ha in 2004/05. The biggest lift in area will be in WA (+14%) and SA (+16%), but lifts will occur in most states, with the exception of QLD where growers are favouring wheat.
The increase in cereal plantings of 2% and 5% for wheat and barley, respectively, foreshadowed by VIC growers appears a little disappointing, but should be read in the context of a 10% lift in canola sowings.
Nationally, our survey is foreshadowing a large lift of around 40% in canola plantings – this is double the increase being forecast by the Australian Oilseeds Federation (AOF) and would again lead to record plantings of nearly 1.5m ha to eclipse the previous record of 1.46m ha in 2000/01. The big rise in canola plantings across NSW (+66%) counters AOF forecasts, as does the lift in Vic plantings. AOF is suggesting a rise in SA, but our survey reckons area will fall slightly (-2%).
Price Needs to Ration Corn Demand in the US
The recent flooding in the US Midwest – in particular, in parts of Iowa (the largest corn growing state), Illinois and Indiana – has heightened concern about US corn production at a time when demand is at a record high. From June through August, the supply side of the supply/demand equation dominates price discovery in the corn market. Due to the flooding, the market expects sharply lower US corn production and has risen sharply, setting a new record almost each day last week.
While it may be the speculative funds that have driven prices sky-high, the overall economic argument states that prices need to rise to ration demand to the perceived available supply. US projected corn stocks were already forecast at very low levels and production problems exacerbate this situation to a point where if demand is left unchanged, the US will run out of corn (seriously). Now, this will not happen. What will happen is that prices will rise to a point where demand is rationed to the available supply.
While the anticipated corn production number in the US will change by the day, it is the demand side that we wish to have a look at today, as it will take over as the price driver from September onward. The three major sources of demand for US corn are exports, feeding and corn-for-ethanol.
Export demand
The USDA expects a significant reduction in US exports in the coming year and ProFarmer expects even further reductions from here. By the time an end user pays nearly 800¢/bu for corn and ships it home at say another 250¢/bu, you have corn at over 1050¢/bu landed, say, in Japan/Korea (US$413/t). These users can buy Black Sea wheat currently landed at $370/t Korea.
The prospects of a record world wheat crop (up 52mmt on last year and growing), and increased non-US coarse grain production of 25mmt and very high transport costs will turn buyers back to more traditional, cheaper sources. Expect the export demand for US corn to drop significantly this coming year. The below chart displays USDA US corn exports over the past 30 years.
US domestic feed demand
With corn above 700¢/bu, it is not profitable to feed a range of animals in the US. Cattle feeding is suffering huge negative margins, with hogs little better. Record feed costs are forcing sow liquidation across North America and will eventually put the squeeze on pork production.
The US cattle feeding industry is facing its most severe conditions in over 30 years due to sky-high (record) feed costs. While this leaves the feedlot industry under severe financial pressure, it is also reportedly seeing increased breeding herd reduction. Investors in cattle feeding are fleeing, leaving the feedlots themselves as the major owner of cattle. This current cycle could well last into 2009. The lower herd numbers will eventually lead to higher meat prices in 2009/2010. The following chart illustrates USDA estimates of US domestic feed demand. The USDA is predicting a sharp reduction in feed demand in 2008/09, which may be tough to meet.
Industrial use (majority ethanol)
The biggest growth in US corn demand is the ethanol industry. With government support, the industry was seen as a means of both assisting corn prices in the landlocked states (like Iowa) and lessening the US dependency on foreign oil. Growth in the industry has been stellar, although it now faces serious headwinds – both political and economic. The chart below displays growth in corn use for ethanol over the past few years. Of note – the industry is expected to use more than one-third of the US corn crop in the coming year.
Still, negative ethanol margins are the big talk currently; the perception is that new players are delaying plant openings and some current players are slowing production or even shutting down for a period. This may have a significant impact going forward, particularly if crude oil price falls significantly. The chart below illustrates that ethanol producers are under pressure – inefficient plants would be in a worse position. Of course, it will take sustained margin pressure to seriously curtail corn use in ethanol; however, the USDA is currently forecasting a 25.4-mmt increase in corn use for ethanol. Should this even be cut by a third, it would significantly reduce demand.
Demand rationing
Corn price will be on a mission to ration corn demand for ethanol use. Feed use won’t likely be rationed as greatly as forecast. While policy changes could also reduce demand, politicians will unlikely pay anything other than lip service to the issue in the near-term. They may waive some of mandates, which would help take some pressure off.
In reality, economics will dictate. Ethanol margins are largely affected by the cost of corn and natural gas, and the revenue from ethanol and DDG (Dried Distillers Grain). As much as rising corn prices dent profitability, so do falling energy prices.
