July 16, 2014
America's perfect feed crop growing year?
Excellent weather, record crop yields imply looming oversupplies of corn and soy. Harvest time will be deflationary but higher costs for land, fertilizer and fuel have jacked up price floors.
by Eric J. BROOKS
An eFeedLink Exclusive Commentary
As this article's title says, barring any unexpected changes in weather, 2014 is turning out to be a perfect year for America's corn and soy crops. In mid July, the USDA not only was most of America's corn crop in excellent shape but it was almost in the best condition of almost any crop ever recorded.
With that news, CBOT corn and soy futures wilted to below US$4/bushel and US$11/bushel respectively. They are down more than 25% from their 2014 highs and could go even lower. The question we try to answer here is how low they could go when they bottom out.
Biggest deflationary pressure on corn in decade
2012's drought-stricken yields of 123bushel/acre are forgotten, as is frustration at how US corn yields were stagnant for more than half a decade near the 150bushel/acre range. In its July WASDE report the USDA put its corn yield estimate at a record 165.3bushels/acre. Given this year's lower corn planted acreage that would make for a corn crop of 352.1 million tonnes.In theory, with corn losing significant planted area to soy, that is down 1 to 2 million tonnes from the previous year's record crop. In practice, market observers believe that the USDA's record corn yield estimate is very conservative and that the harvest could be a much larger, record breaking one.
For example, Darrel Holady, analyst with Country Futures notes that, "There is a lot of talk about corn yields moving above 170 bushels/acre as conditions throughout the US are simply too good with very little geographic area indicating any significant problems." Holady openly speculated; asking, "Could this be the year that [farm] management, genetics and weather come together to produce a national yield above 175bushels/acre and takes a shot at 180 bushels/acre?"
Even by the USDA's conservative corn yield estimate, corn inventories, which were a slim 20.9 million tonnes in 2012-13 and which close out August at 31.7 million tonnes, will jump up to 49.1 million tonnes at the end of 2014-15. That would be the largest inventory since 2005, with only that year's ending stocks and the over 100 million tonne surpluses of the mid to late 1980s exceeding it.
The only saving grace is that with demand higher today than back then, the stocks-to-use ratio would climb from 2013-14's 9.2% to end 2014-15 at 13.5% -certainly deflationary, but not disastrously so.
But if yields rise to 175bushels/acre, all other things remaining constant, the resulting 372.8 million tonne crop would jack up closing 2014-15 inventories to approximately 70 million tonnes. The stocks-to-use ratio would then climb into the late 20th century normal range of 20.6%; an era and inventory figure synonymous with decade of ultra-low corn prices.
While yields could go as high as 180bushels/acre, inventories cannot go too far above 70 million tonnes for one simple reason: Since January, the USDA has adjusted its 2014-15 American corn feed consumption estimate down nearly 2%, from 134.6 million tonnes to 132.1 million tonnes.
The USDA was correct in lowering its corn feed estimate to take into account the PEDv epidemic's impact on hog inventories. Nevertheless, the projected 2% cut in feed corn demand can be easily counterbalanced by the fact corn's cost has fallen 25% since the second quarter and is down 10% from its January price. Coming at a time when US broiler, cattle and even pork rearing margins are high, the overall increase in livestock feed demand will counterbalance the lower hog feed consumption caused by PEDv.
Having said that, even if harvest time closing inventory estimates only rise into the 55 million to 60 million tonne range, the resulting 16% to 18% closing stocks-to-use ratio would be the most deflationary pressure corn has faced since 2005's 23% stocks-to-use ratio –which caused CBOT corn to stay below US$2/bushel for more than two years.
Big harvest, palm, rapeseed, fishmeal, El Nino undermine soy
Downward price pressure is also being felt across the oilseed and protein meal complex. When corn fell by more than soy, American farmers opted to plant more of the latter. After nearly losing the top soy producer position to Brazil two years ago, bloated acreage and high yields have put America on track for a whopping record harvest of 103.4 million tonnes, eclipsing Brazil's record crop of 87.5 million tonnes and America's previous record of 89.5 million tonnes.In the process, this year's exceptionally thin 3.8 million tonne closing inventory triples to a projected 11.8 million tonnes in 2014-15. On one hand, the resulting 12.2% soy stocks-to-use for 2014-15 is not too deflationary. But with US soy stocks fully recovering from their record lows and the world stock-to-use ratio rising to over 30%, the deflationary pressure on soy is even stronger than what corn is going through. Especially since two-third of this soy is stored in fellow top exporters Brazil and Argentina.
This is happening just as projected Chinese soy imports, while a record 73 million tonnes, fall to 85.6% of world soy inventories. That is well below the 90% threshold, which is the proportion where Chinese soy demand starts exerting inflationary pressure on CBOT soy futures.
China is on course to have a record rapeseed crop, Canada a near record crop, while the EU harvest will be the largest in five years and second largest ever. This follows record rapeseed harvests in China and top exporter Canada the previous year. After falling from record highs in 2012, Canadian inventories are more than doubling, and projected to rise 132% and end the marketing year at 388,000 tonnes.
Even palm oil has stopped supporting the market. It rallied 15% in the first quarter, when Malaysia and parts of Indonesia went over two months without rain. With both countries biofuel demand rising sharply, it was thought the drought would constrain supplies.
Furthermore, although the drought subsided, the meteorological consensus was that a strong El Nino was forming in the equatorial eastern Pacific Ocean. That implied that a serious drought would return later in the year, causing annual palm oil production to fall sharply. As things turned out, the Pacific Ocean water off South America barely rose to a high enough level to qualify as a real El Nino, quickly reverting back into its normal temperature range soon thereafter.Furthermore because the early year drought lasted less than three months, the palm trees produced additional fruit to partly compensate for the previous two months without rain. Palm farmers stepped up their cultivation in response to high prices and regular rains resumed. This kept early year output losses to a minimum. With the long-term forecast now calling for normal rainfall to continue through the end of 2014, the USDA expects Malaysia and Indonesia's palm oil output to increase 4.9% and 8.1% respectively.
Although biofuel-friendly government policies are causing both Malaysia and Indonesia's domestic palm oil demand to exceed the harvest increase, 85% of their output is exported. With the world oilseed market bloated by record harvests and bulging inventories of soy and rapeseed, palm oil exports are expected to grow by less than 5.3%, less than their combined 6.7% increase in production.Consequently, since peaking in March, palm has fallen over 16% to the US$750/tonne to US$760/tonne range. It is lower in price now than when the drought-induced rally started in January. Should regular rainfall continue in Southeast Asia, palm oil looks set to continue falling in price. With palm fundamentals turning deflationary, the entire oilseed complex is joining soy in the deflation.
The situation prompted Citibank commodity analyst Sterling Smith to declare that, "Fallout from Friday's [July] USDA WASDE report weighed heavily on prices as this portends to a large vegetable oil supply in coming months."
Priced near US$2,000/tonne, only fishmeal provides soy some protein meal market support. Even here however, the prognosis is deflationary: Anchovy fertility is inversely proportional to water temperature. With the El Nino threat disappearing, the prognosis is now for anchovy supplies to either bottom out or recover later in the year. That will probably cause fishmeal to fall in price later in the year, so that the only remaining source of soy market support looks set to give way within a few quarters.
How low can they go?
In the 2000 to 2005, pre-feed inflation era, a corn pricing model that used factors such as harvest size, exports and the stocks-to-use ratio would show that with the stocks-to-use ratio rising from 9.2% in 2013-14 to a projected 13.5% in the next marketing year, corn would fall somewhere above US$2/bushel, as that was close to its production cost at that time.
But several factors have raised corn's production cost by 60% to 75%, depending on the geographic growing region. For example, potash, urea and di-ammonium phosphate fertiliser cost approximately 90%, 170% and 140% respectively more today than their average price than during the 2000 to 2004 period. In corn and soy producing Midwestern states such as Illinois, Indiana and Iowa, US farmland costs approximately 170% more in 2013 than it did in 2004.
In Brazil, which has accounted for most of the increase in corn and soy supplies, farm land costs are rising even more quickly. On one hand, Brazilian farmland in mature corn and soy growing regions like Mato Grosso increased at roughly the same inflationary rate they did in America's Midwest. On the other hand, in Brazil's frontier states where most new farmland (and the world's new corn and soy supplies) are brought into production, land has risen in value twice as quickly and can cost more than it does in the United States.
With fuel costs having doubled over the past decade, the high production costs on new Brazilian farmland are further bloated by fuel costs, which have also doubled over the past decade. This is particularly true in the case of Brazil, which has transport costs several times higher than those of the US Midwest.
Consequently, the rising cost of fertilizer has impacted corn more than soy, as it requires more fertilizer. On the other hand, with most new farmland destined to be brought into soy production residing in Brazil, the higher farmland inflation found in frontier Brazilian areas and their higher transport costs means that these factors have impacted soy production costs more than those of corn.
Nevertheless, this situation carries strong implications for the world corn and soy markets: Not only has the cost of many feed crop inputs risen strongly over the past ten years; their cost has risen most sharply in South America, where most of the global increase in corn and soy supplies is coming from.
Classical economics declares that the over the long run, the price of a commodity whose production is expanding cannot go too far below its marginal cost, as that is the level required to bring new supply into existence. The consensus is that with the above mentioned input costs higher than before, it costs US$3.50/bushel to bring new corn supply into existence. Similarly, a 2012 Standard Bank study estimated that a soy price of C$9/bushel is required for newly cleared Brazilian farmland to break even.
Of course, a market panic could temporarily send corn and soy below their respective US$3.50/bushel and US$9/bushel cost floors, which would discourage the impending South American growing season from expanding supply too much. Conversely, the weather suddenly go terribly wrong during corn's pollination period, temporarily sending it over US$4/bushel, at least until harvest time arrives.
Nevertheless, given idyllic growing weather on one side, and rising cost floors on the other, we can expect corn and soy to find price floors near US$3.50/bushel and US$9.00/bushel respectively.
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