Covid-19 is having a major impact on the grain sector as energy implosion is cutting ethanol and bio-diesel demand, reports Chad Burlet.
In last month’s letter we mentioned some early signs of improving economic activity in China with the caveat that, “…it took two months of very draconian steps by the Chinese government to achieve those gains. If the United States is faced with the same challenge, I don’t know that we’ll be able to eliminate the freedom of movement for tens of millions of our citizens.”
Unfortunately, we very quickly learned that we could and would. Unprecedented times brought unprecedented actions. We have shut down much of our economy and a majority of the country has been told to shelter in place.
The U.S. and global shutdowns have had a dramatic impact on energy prices. Crude oil prices were above $65 per barrel in January and below $20 per barrel earlier this week. Saudi Arabia made an early attempt to get OPEC and Russia to reduce production to offset the lower demand, but when the Russians balked the Saudis increased production and started a price war. U.S. gasoline prices have plummeted, making ethanol uneconomic to produce and uneconomic to blend.
Goldman Sachs (GS) has issued some very dire economic projections. They see second quarter U.S. GDP “growth” down 34% and they see unemployment hitting 15% by mid-year. Globally they think we are headed for a deep recession. That economic reality led to unprecedented volatility in equities and a general risk off mentality in the trading community. This was evidenced by a 300,000-contract drop in agricultural futures open interest in March, putting us 800,000 contracts below a year ago.
With 40% of corn’s demand coming from ethanol it was the grain contract most negatively impacted by crude oil’s implosion, dropping 7.5% for the month. Bio-diesel suffered a fate similar to ethanol’s, which led to a 6% drop in soybean oil prices. At the other end of the spectrum were wheat and soybean meal. Wheat was first led higher by domestic demand as millers produced more flour for bread and pasta to feed the homebound consumers. Shortly after that, China unexpectedly bought 485 thousand metric tons (KMT) of U.S. Hard Red Winter and Hard Red Spring wheat. The final push to wheat’s monthly highs came when Russia and Ukraine both announced limits on their April through June exports. For the month, May Wheat futures closed more than 8% higher and gained 71¢ on May corn futures. Very simply put, Americans were consuming a lot more carbs and a lot less ethanol.
Soybean meal was the beneficiary of supply chain disruption. Brazil’s loading of soybean vessels was slowed by heavy rains in January and February, which took China’s port stocks to a 10-year low. As Argentina’s crushing plants and export elevators were slowed by Coronavirus concerns, Chinese and European meal users scrambled for coverage. That buying frenzy rallied meal prices and crush margins everywhere. May soybean meal futures ended the month more than 5% higher and in so doing they took May Board Crush from 95¢ to $1.18.
As we were wrapping up the month the National Agricultural Statistics Service (NASS) gave us their March 1 stocks report and their spring planting intentions report. The corn stocks report confirmed excellent first half feed demand, which should provide a much needed 250 million bushels offset to the lost ethanol demand.
The planting intentions report showed a whopping 97 million acres of corn, almost 3 million more than the average of analysts’ estimates. Combined corn and soybean acres were a record 180.5 million acres. The market is limited in its ability to price acres out of production by the support programs that are in place. Favorable crop insurance prices were locked in during February, and the Farm Bill provides a second safety net via Price Loss Coverage.
The icing on the cake may be a third Market Facilitation Payment. The $2.2 trillion Coronavirus Aid, Relief and Economic Security Act (CARES) that was signed last Friday included $15 billion for the Commodity Credit Corporation which was the conduit for the last Market Facilitation Payment.
To benefit from crop insurance, Price Loss Coverage and Market Facilitation Payment you have to plant to play, making most U.S. acres very price inelastic. The market will have more success in switching acres than it will have in idling acres. Looking ahead our risk of being buffeted by macroeconomic winds will remain greater than usual. If the prediction of a deep recession is correct, then demand will suffer.
Disruptions in supply chains appear inevitable and price spikes (up and down) will ensue as suppliers and users scramble to recover. U.S. and world balance sheets are generally comfortable, but the northern hemisphere planting and growing season is just starting. It is a market that should be approached more opportunistically than strategically.
Chad Burlet is Co-Founder (along with Bob Otter), Chief Trading Officer, & Principal, Third Street Ag Investments, LLC
