Prepared by CoBanks Knowledge Exchange Division

April 2014

Market Update

Navigating Old Crop Demand and New Crop Potential

by Dan Kowalski
Senior Manager Knowledge Exchange Division

Crop and Biofuel Market Overview Recent demand for U.S. grains has been exceptional, rendering a tighter domestic supply situation, even as global markets remain well stocked. This has boosted prices across the complex, but also signicantly reduced carry in the corn and wheat markets, and intensied the inversion in the soybean market. The weakening contract spreads will negatively impact elevator operators, but increased farmer selling, and thus increased elevator ownership, will partially offset the spread weakness. Lower expectations for South American corn and soybean production further contributed to the early 2014 price rally, and record second crop soybean plantings will act as a wild card in the markets until June. With a better understanding of current U.S. inventories, however, and with export demand on the decline, weathers inuence on the upcoming crop will take an increasingly prominent role in market direction. Ethanol prices climbed along with the grains complex in Q1 as rail disruptions slowed ethanol deliveries and created pockets of shortage in key demand markets. As the rail situation begins to normalize, and ethanol output rises, prices will ease. Rice and cotton are poised to make a comeback in the Mid-South in 2014. After domestic supplies for both crops reached levels not seen in over a decade, growers are expected to plant fewer acres to corn this spring in favor of cotton and rice. Abundant world supplies of both crops, however, will limit upward price movement through the remainder of the calendar year.

Corn The winter months are typically pretty quiet for the grain markets. In 2014, they have been anything but. Many producers shrugged off sale offers as prices dropped to near $4.00 in January. Farmers reluctance to sell in turn lifted basis levels around the grain belt to historical highs. Meanwhile, export and feed demand continued to surprise to the upside, even as it was becoming clear that Brazil and Argentina will disappoint in their corn production. The result was a slow, yet persistent, 20-plus percent rally in nearby futures. As prices ratcheted higher, producers seized the opportunity to market the crop in the bin, as well as a portion of the yet-to-be-planted 2014 crop. The sudden increase in selling sent basis tumbling in many locations, trimming the benet to farmers making cash sales. The corn market has also added in some expectation that Ukraine and Argentina (the worlds third and fourth largest corn exporters) will sell less corn this year than originally thought. Argentinian farmers are holding their grain as a hedge against the drastic currency devaluation there, and orders for Ukrainian grain are expected to remain lower than usual as buyers shy away from political risk. U.S. livestock and poultry producers also fed more corn than expected through the winter months, in part because of the spread of high meat prices and relatively low corn price. But Mother Nature encouraged even more animal feeding by ushering in the coldest winter temperatures in three decades.

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Figure 1. 2013/14 U.S. Soybean Export Commitments

MMT 45 2013/14

40

2012/13 35 5-Yr Avg 30

25

20

15 Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul

Source: USDA-FAS

As the spring planting season gets under way, the market will have plenty of information to trade on, both domestically and globally, which is likely to keep prices volatile. The USDAs initial report on crop acreage indicated that 91.7 million acres of corn are expected to be planted in 2014. That would be a 4 percent decline YoY, and the fewest U.S. acres planted to corn since 2010. Forecasts calling for above average rain in April and May across much of the Midwest raise the question of whether more acres could be shifted away from corn and into soybeans. In South America, far fewer second crop corn acres have been planted versus last year, as soybeans price advantage looms large. The lure of a 2.9 soybean/corn price ratio in the July contracts is causing many Brazilian farmers, who typically plant corn after soybeans, to ignore the disease and pest pressure risks of back-to-back soy crops. In comparison, U.S. producers are attempting to navigate planting decisions under the guise of a roughly 2.4 soybean/corn price ratio for the late 2014 contracts. The key factors that will inuence price direction over the next quarter will be the size of Brazils safrinha corn crop, political developments in Ukraine and Russia, export activity, and spring conditions which inuence the timing and early expectations for the 2014 crop.

The impressive rally in corn prices, which began in late January, seems justied by the change in consumption estimates and a projected smaller carryout. Since the beginning of the marketing year, USDAs export estimates for 2013/14 have risen 33 percent and the estimated ending stocks have fallen over 20 percent. The USDA Q1 stocks report further conrmed the markets tightening expectations. However, we expect that it would take a signicant deterioration in U.S. growing conditions, or some unforeseen shakeup in the global demand or ethanol picture to increase and sustain prices well Aug above the $5.00/bu threshold into the summer months. Despite the larger than anticipated demand for U.S. corn this year, domestic inventories remain more than adequate, and global supplies are ample. Substantive downward revisions to the carryover, though, have lifted the price oor for the remainder of the season. Barring an unforeseen reversal, 2013/14 prices are unlikely to fall below $4.30/bu for a sustained period of time. Soybeans The soybean sector has experienced a similar, albeit less dramatic, surge in demand and prices. The USDAs projected volume of exports is 13 percent higher than it was in September, and nearby futures rallied 16 percent from late January to late March. Chinas orders for U.S. soybeans have surpassed all expectations, despite the ongoing harvest of a record crop in South America. (See Figure 1.) Having experienced signicant delays in Brazilian soybean shipments last year, China changed its sourcing strategy in 2013/14 by frontloading its orders from the U.S. China has bought so many soybeans in the rst half of the marketing year in fact, that it now has stockpiled huge supplies, and is attempting to resell or cancel several Brazilian shipments before they leave Brazils ports. Some of these shipments, ironically, are likely to be redirected to the U.S. for delivery this summer, to shore up its increasingly tight supplies.

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Chinas negative crush margin and now abundant supplies have signaled the sudden shift in appetite, which likely has formed a near term peak in prices. Signicantly cheaper South American supplies will weigh on the market, absorbing most of the export demand for the remainder of the marketing year. Major declines in domestic biodiesel production will also contribute to setting a ceiling on prices through the summer months. Due to the loss of the biodiesel blenders credit in December 2013, U.S. biodiesel production is projected to fall 16 percent YoY in the rst half of 2014. There has been talk in Washington that the Senate has the votes to reinstate the blenders credit and make it retroactive to January. Any effort on the part of the Senate would likely be wasted, however, given that the bill would not have enough support in the House to pass. Now that the USDA has issued its March stocks report and initial estimates for 2014 acres, U.S. weather and planting progress are poised to take center stage in the market. Since the start of the price rally in late January, the soybean/corn price ratio for the 2014 crop has been relatively steady, weakening only slightly from a high of 2.5 to 2.4. Initial

estimates by the USDA peg 2014 U.S. soybean plantings at 81.5 million acres, a 1 percent increase YoY. Weather, and to a lesser degree, price movements will determine the nal mix of corn and soybean acres. Over the next few months, prices will be most impacted by USDAs acreage and crop progress reports, China order cancellations, and the volume of U.S. imports from Brazil. The limited U.S. supplies will ensure that inverses in the market remain steep, encouraging old crop sales in the near term, rather than in the summer months. Barring the development of poor U.S. growing conditions, soybean prices will likely uctuate below recent highs, within a range of $13.30 and $14.90 through Q2 of 2014. The building of supplies domestically and globally, however, is setting up 2014/15 to be much more bearish. Wheat Wheat has followed the same domestic trends of strong exports and tightening supplies. Since the start of the marketing year last June, USDA export estimates have climbed 21 percent and ending stock estimates have fallen 15 percent. Global wheat production and trade will set new records this year, thanks in large part to the EUs record high wheat exports in 2013/14, up more than 50 percent YoY. Supplies of most classes of U.S. wheat are more than adequate, with the exception of hard red winter wheat (HRW). HRW production typically makes up about 40 percent of total U.S. output, and after drought reduced the crop size by 25 percent in 2013, stocks have been cut nearly in half versus a year ago. Despite the reduced crop and higher prices, HRW exports are expected to be up 18 percent this year. World demand will now shift to less expensive origins for the remainder of the marketing year, but persistent drought conditions will keep the markets attention squarely on the Southern Plains. The 2014/15 HRW crop has emerged from dormancy, but has received limited precipitation across Texas, Oklahoma, and Kansas. Spring rains could
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Figure 2. Share of U.S. HRW Wheat Production Exported

Mil Bu 1,200

44%
1,000 800 600 400 200 0 2008/09 2009/10

61% 39% 52%

38%

60%

2010/11
Exports

2011/12
Non-Exports

2012/13

2013/14

Source: USDA-WAOB

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Figure 3. U.S. Ethanol Production and Stocks

300 290 280 270 260 250 240 230 220 210 200 600 800 900

Production (Mil Gal/Wk)

Stocks 1,200 (Mil Gal)

1,100

1,000

700

foreign origins should be expected for shipments over the coming quarter. To push wheat markets to new highs would require an intensifying U.S. drought situation in the Southern Plains or unanticipated persistence in demand for U.S. exports. Barring these occurrences, Chicago wheat is likely to trade in the range of $6.20 $7.20 in the coming quarter, and the premium for HRW is expected to remain above 50 cents. Ethanol

Source: U.S. EIA

still deliver an abundant crop, but until the crops size and quality become clearer, prices are likely to be volatile. Drought conditions have also become serious in Western Australia, the largest production area in the country. The degree to which drought persists in the U.S. and Australia will have an impact on markets. Chicago wheat futures soared 26 percent from late January through mid-March, so a risk premium was certainly added to the market. That risk premium included concerns about Ukraine and Russia, which together account for approximately 16 percent of the worlds wheat exports. Risk factors also include the fact that large volumes of U.S. wheat have continued to ship overseas, months longer than expected. (See Figure 2.) And nally, U.S. wheat is entering its critical development phases, with winterkill yet to be properly evaluated, and the Southern Plains drought yet to be remedied. As time passes, the market is paying less attention to the Ukraine situation, which has helped to cool prices. Several forecasts pointing to signicant rainfall in the Southern Plains through April and May have also lessened weatherrelated concerns. Global wheat fundamentals are also highlighted by sufcient supplies, and more reliance on

Conditions for ethanol protability in the rst quarter of 2014 shaped up to be the most favorable in years. Ethanol production and inventories remained below expected levels, narrowing the price spread between ethanol and gasoline. (See Figure 3.) Rail disruptions created ethanol shortages, particularly on the east coast, causing ethanol prices to double in just two months to a seven year high, and rise well above the price of gasoline in nearby futures. Rail backlogs are subsiding, and as they do, ethanol prices will decline markedly. Corn and soy prices increased over the same period that ethanol and distillers grains (DDG) price moved higher. But corn, soybeans, and soybean meal did not rise enough to offset the gains in DDG prices, which have been priced at near record levels in relation to corn and soybean meal. Ethanol exports in January also rose to the highest level in over two years, as drought conditions in Brazils sugarcane growing areas prompted a sudden boost in overseas orders. Ethanol producer margins have been excellent, exceeding $0.50 per gallon in most cases, and surpassing $1.00 per gallon for the most efcient producers. Plant production is still expected to rise through the second quarter, which will lift stocks, lower prices, and trim plant margins. The rise in prices has already quelled export interest, and export orders going into the summer will remain subdued. With prices at multi-year highs, there is also market chatter that Brazil will be shipping ethanol
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to the U.S. this spring and summer. Brazils drought is showing signs of relenting, and the Brazilian sugar crop will soon be harvested. Much of that crop will be converted into ethanol, and priced below U.S. levels. All of these factors will provide downward pressure on U.S. prices and plant operators. Nonetheless, average plant margins will remain in the black through the second quarter, but below the lofty levels of Q1. Beyond Q2, the futures market is steeply inverted through the summer and beyond, signaling that ethanol prices in early 2015 will be half of what they are in late March. Greater corn surpluses in Q4 are almost certain to act as a drag on ethanol prices. In Q2-2014, the EPA is still expected to pass a nal ruling on the RFS proposal announced in November of last year. If the proposal to reduce 2014 corn ethanol blending requirements to 13 billion gallons is upheld, it will send a bearish tone through the market. Nevertheless, the ruling will have little direct short-term impact on the industry, with the exception of a near term decline in prices. The longerterm impact would result from a lack of incentive to invest in the infrastructure needed to dispense higher ethanol blends. Rice For growers that chose to plant rice in 2013/14, it has been a very protable year. Total U.S. acres planted to rice in 2013/14 were the smallest since 1987, but yields were record high. Aided by elevated prices for other grains, a decline in rice production of 5 percent, and marginally higher domestic use YoY, season average farm prices are expected to end up 9 percent, at $16.50 per hundredweight. In particular, California medium and small grain prices have risen substantially on concerns about 2014 acreage declines due to ongoing drought conditions. In the two months since late January, California rice prices have rallied 35 percent, marking the most rapid increase in rice prices since the spike in 2008. U.S. prices have also been buoyed by an improvement in overseas demand. Vietnam has been engaged in a temporary stockpiling program, and the Philippines has recently bought large volumes of rice in government-to-government deals. Looking ahead to the 2014/15 crop, U.S. rice acres are expected to bounce back from the lowest level in 36 years. The increase in rice prices and decline in prices for

competing crops should bring about 500,000 acres back into rice production in the Mid-South. All of the additional acres will be in long grain rice, boosting long grain acreage by about 25 percent. Persistent drought conditions in California are expected to slash medium and short grain rice plantings there by 20 percent. If total U.S. average yield comes back in line with trend this year, however, it will decline by roughly 3.5 percent versus last year. This would curtail the rebuilding of supplies, allowing stocks to build only marginally. In global rice markets, Thailand continues to dominate the news. Under extreme political pressure, and in the midst of a national crisis, the Thai government recently shifted its stance from being unwilling to accept signicant losses on rice sales to now being willing to sell at any price. With Thailand now eager to sell, their monthly exports through the summer are expected to be nearly twice the level of last year. This has set off a price war with Thailands largest Asian competitors. Thai prices have now fallen below the point of breakeven for Indian and Vietnamese producers, and have lured most buyers away from those markets. This decline in Asian prices is exacerbating the spread between U.S. and world prices, which has been historically wide for the past two years. Now at a six year high, the U.S./world spread will limit any U.S. price rallies through 2014, as a continual widening of the spread would put U.S. exports at risk. Despite the current panic selling in Thailand, and the falling world price, the 2014/15 world rice situation is expected to remain largely the same as 2013/14. The stocks-touse ratio is expected to end at versus year ago levels, at around 23 percent. Average prices are forecast to slide in 2014/15 by about $0.70 per hundredweight to $15.80. A reduction in prices and larger supplies should induce more sales both domestically and internationally, with both domestic and export sales projected to rise 4 percent. Asian exporters, however, could gain market share from the U.S. if prices there continue to falter. Cotton The U.S. cotton market in 2013/14 has been dened by tight supplies and a steady, signicant rise in prices. Current marketing year (August-July) exports will fall to the lowest level since 2000/01, but taking into account that
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Figure 4. U.S. Cotton Exports as a Share of Supply

30 25 20 15 10 5 0

Total Supply

Exports

Source: USDA-FAS

domestic supplies are the smallest in 30 years, sales to overseas buyers have been quite strong. (See Figure 4.) As a result, U.S. ending stocks are also forecast to fall to the lowest level since 2000/01. The multi-decade low in supplies, in combination with a resurgence in speculative buying, has pushed prices much higher through the marketing year. Nearby futures rallied 25 percent from November to mid-March to exceed $0.93, and prices are expected to remain elevated in the near term as the market rations the remaining inventory. Trading could become quite volatile in coming months as the market digests acreage reports, weather, and crop conditions reports. Barring serious drought conditions and exceptionally high abandonment in Texas this summer, downside price risk is signicant for the second half of 2014.

The USDAs initial estimates indicate that growers are expected to add 700,000 acres, or 7 percent, to planted area in 2014. Most of those additional acres will be planted in Texas, and thus, a commensurate increase in production would assume an improvement in drought conditions and far fewer abandonments than last year. With much larger supplies expected to come online by the fall, and fewer export sales in 2014/15, the domestic stocks-to-use ratio could climb from 21 percent in 2013/14 to as much as 35 percent in 2014/15. The discount of polyester to cotton has been steadily widening since 2011, and now rests at about $0.80 per pound. The elevated cotton prices have turned mills away from using cotton, so as the rally intensied, the Asian yarn market has weakened. Heading into the nal few months of the marketing year, the price inversion of about $0.11 per pound between old crop and the 2014 crop will continue to slow export sales and incentivize cancellations or deferrals to the new crop year. China, which still holds 60 percent of the worlds cotton stocks, is estimated to cut its imports in 2013/14 by half YoY. China is likely to reduce its imports by another 10 percent in 2014/15, as it aims to shrink its record-large stockpile. World supplies and consumption are expected to rise marginally in 2014/15, keeping global stocks-to-use at, around 19 percent.

Million Bales

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Disclaimer: The information contained in this report has been compiled from what CoBank regards as reliable sources but is provided for general informational purposes only and is not advice. CoBank does not make any representation or warranty regarding the content, and disclaims any responsibility for the information, materials, third-party opinions, and data included in this report. In no event will CoBank be liable for any decision made or actions taken by the user while relying on information contained in this report.

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