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Karl Plume
CHICAGO: When all is said and done, predicting the damage
done to US corn and soy crops from the worst drought in half a century may have
been the easy part.
With the harvest imminent and plants mature, most traders are
fairly confident they have a handle on this year’s supply.
Whether corn yields are 120 bushels an acre or 130, it’s
clear that demand will outstrip supply, possibly by a wide margin. Demand, in
trade parlance, will have to be “rationed”.
What’s far less clear — and harder to discern now than ever
before — is just how much less food, feed or fuel will be made from corn as
buyers cut back. From food companies to livestock ranchers to ethanol plants,
the calculations are complex: Can end consumers withstand higher prices? Can
they sustain production with cheaper grain alternatives?
For traders, that complexity is multiplied. The
unpredictability of dry weather is nothing compared to the vagaries of
consumption by livestock producers, exporters, ethanol makers and other
industrial users that turn corn into scores of products including plastics,
adhesives, explosives and pharmaceuticals.
So after two months of relatively steady price gains as every
passing hot, dry day withered the crop a little more, some are bracing for a
bumpy spell in which traders attempt to second-guess the price point at which
demand is rationed.
“Demand occurs in so many different categories that it’s a
little hard to get your hands around,” said Darrel Good, a respected
agricultural economist with the University of Illinois and a foremost authority
on the topic.
“The thought process is pretty clear, but quantifying things
is pretty subjective.”
The US Department of Agriculture cut its 2012/13 US corn crop
forecast by 4.011 billion bushels, or 27 percent, over the past two months and
slashed its estimate of corn use across all demand segments by 2.55 billion
bushels, or 19 percent.
US inventories at the end of next summer are now expected to
fall to 650 million bushels, a 17-year low and considered near the bare minimum
required to prevent an unprecedented scramble for the last kernels. As recently
as June, the USDA had forecast 2 billion bushels.
Few traders expect those numbers to be final, with the agency
fine-tuning for months to come.
In theory, the mystery of demand should offer opportunities
for smart traders to capitalize on volatile markets. In practice, the evidence
needed to quantify demand can be so disparate and piecemeal that it defies
order.
US export sales are the easy part, strictly reported on a
weekly basis. For everything else it’s a case of scouring data on livestock
slaughter rates, chicken egg sets or sow liquidation; anticipating government
policy on ethanol; or seeking private market intelligence on how much wheat is
replacing corn among pig farmers.
Cargill said this week that it was delaying the announcement
of its 2013 sweetener pricing, suggesting the agribusiness giant may be anticipating
difficulty in sourcing corn.
The change in sentiment from a supply-induced panic to a
period of demand uncertainty is already weighing on prices. From Friday through
Tuesday, corn for December delivery on the Chicago Board of Trade (CBOT) fell
4.2 percent to post the biggest three-day drop since June 13, just days before
traders first fixated on the drought.
From mid-June to mid-July, corn embarked on a remarkably
orderly rally, surging for several days and then pausing for another push.
Rarely did prices close at their daily maximum.
Never did they fall more than two days in a row. For the past
two weeks, however, they’ve just bounced around.
“The first phase is unidirectional, where the market goes
into a little bit of a panic mode, trying to price the day-to-day weather,”
said Malinda Goldsmith, a partner at agriculture-focused and Dallas-based Four
Seasons Commodities, where she oversees a $50 million portfolio that gained 10
percent in July.
“Then you get to a point where the demand gets to be
destroyed. And the market gets more choppy. Then you get into a very volatile
period, which is the one we’re in now, where we have sharply higher, sharply
lower prices.”
She concluded: “Now it’s going to get dicey.”
Modeling demand for food is a tricky task in the best of
times. It is generally regarded as largely “inelastic”, meaning consumption
tends to resist the effects of higher prices.
Historical assumptions can provide a useful guide.
But the growing role of the ethanol industry – which consumes
40 percent of the US crop — has introduced a new set of variables. Even setting
aside the possibility that President Barack Obama could offer a waiver of
ethanol blending quotas this year, corn traders must now take stock of New York
gasoline prices, Brazilian sugar exports and ethanol credits.
“We really didn’t have ethanol when we had this kind of a
shortfall in production in the past, so how that sector will respond is
something new,” Good said.
“There’s a lot of difference of opinion out there in how much
corn will eventually get consumed for ethanol.”
The USDA cut its forecast of corn use for ethanol in the
2012/13 marketing year by 400 million bushels this month to 4.5 billion
bushels, the lowest in four years. At that rate, output would be short of the
government’s 2012 mandate of 13.2 billion gallons (50 billion liters).
Some analysts say the estimate is too low. Rising oil prices
mean ethanol is still cheaper than gasoline in some places, encouraging
refiners to maximize its use in blending.
Production cuts by an estimated two dozen plants – mostly
older, less-efficient facilities located further from the corn belt — have
helped boost margins enough to sustain output.
“I think we’ll see a fairly aggressive pace of demand
rationing in the export sector first, followed by feed, followed by ethanol,”
said Shawn McCambridge, analyst with Jefferies Bache.
But others questioned whether use may decline further, citing
a recent slowdown in ethanol production blamed on poor plant margins amid this
summer’s historic rally in corn prices.
Calls for the suspension of a government mandate on ethanol
blending could be a swing factor, with the United Nations chiming in on the
debate last week.
“I think the ethanol could be lower than (the USDA estimate)
... If the price of ethanol increases, which I think it will given the higher
cost of production, it may not be as competitive an octane source,” said Bill
Lapp, president of Advanced Economic Solutions. Demand may be nearer 4 billion
bushels, he said.
Overseas demand is another part of the puzzle. While
theoretically made easy thanks to US government rules that require exporters to
report all sales within a week of a deal, predicting the pace of annual
shipments is tricky work.
The USDA has already cut its outlook for 2012/13 exports to
the lowest in 28 years, at just 1.3 billion bushels. It slashed 300 million
bushels in each of the past two months.
Because this year’s supply distress is domestic, unlike
during the price spikes of 2008 and 2010, many importers are simply buying from
other producers such as Brazil, which yielded a record corn crop this year.
But many of them have also begun more aggressive campaigns to
replace corn as a source of livestock feed, relying on feed wheat instead.
