The commodity conundrum
We have an interesting perfect storm occurring that has created the current commodity conundrum. The supply of protein is inadequate to handle current demand, so protein prices are robust. We had phenomenal weather this year throughout many of the growing regions of the world; the United States and Brazil had near record crops for corn, soybeans and wheat. The U.S. row crop farmer is teetering at or below break-even costs for the first time since 2006. The percentage of the world crop that it takes to sustain ethanol production is at an all-time high. The dollar started showing more muscle than it has in years, and the rest of the world economies are very anemic, reducing demand. We have been preaching globalization for years; the current market reinforces that. The commodity business is truly a roller coaster and here we go again.
Poultry producers are able to act much faster because of their shorter growing cycle, enabling them to increase production to take advantage of demand and steal market share from other proteins. Pork suppliers are still recovering from the PEDv outbreak. The cycle time for production increase in pork is approximately nine months, whereas production time for beef is approximately 18 months. The market futures traders sense oncoming increase in supply for beef and pork as producers increase production to take advantage of inexpensive feed ingredients and good markets.
We had in 2014 one of the best summers for growing crops, which resulted in record supplies. In early July 2014, the price of corn took a dramatic downturn because of projected record crops. At this point, only approximately 10 percent of the 2014 crop was committed for. The record crop, which has now been harvested, is now over 80 percent committed but was produced with higher priced oil-related inputs and many millions of acres of rented land. The 2014 break-even points were approximately $4 per bushel for corn, $10 per bushel for soybeans and $6 per bushel for wheat. Prices for these committed crops were hovering right around costs for these three commodities at the end of 2014. Looking ahead to 2015, 20 percent of the 2015 crop is already committed for at a cost just above the farmers’ break-even level with the projected farmers’ break-even costs lower in 2015. With projected higher post-harvest prices in 2015, those who are already committed to corn prices just north of $4 per bushel for 2015 are making a wise decision if all things remain as they are.
Ethanol and oil
Ethanol producers are squeezing more energy out of every bushel of corn. They are getting more efficient than ever, making ethanol production more viable. The supply of ethanol has also affected world demand for oil. Late in 2014, the price of oil took a dramatic drop. The recent downturn in the price of oil establishes a pattern because oil is the key driver that influences futures market participation. Traders have a tendency to get out of the entire commodities market when they abandon oil, which in turn creates a downward vacuum typically resulting in lower commodity prices across the board. This phenomenon is affecting beef prices and has a trickle-down effect on all other commodities. If oil prices hold consistent to the end of 2014 (presstime was early December), we will have lower input costs.
Demand for oil globally is the most significant factor, and the U.S. consumes roughly 25 percent of world oil production. Oil was at a record low at the end of 2014, going back to 2009, which breaks down into a number of factors. The renaissance of U.S. oil production brought about by fracking technology, vertical drilling, oil shale recovery and ethanol production have resulted in oil imports being reduced from 60 percent in 2005 to 33 percent for 2014 demand. That, combined with the slowing of the world economy and no reduction in supply, has resulted in the current glut resulting in low prices.
OPEC historically cuts production to balance over-supply. Many oil-producing countries use oil as a means of balancing their federal budgets and have become dependent on high oil prices in order to balance their budgets. Typically, countries such as Iran, Venezuela, Algeria, Nigeria, Ecuador and Iraq are the most susceptible to oil prices below $100 per barrel to balance their national budgets. Even Saudi Arabia requires a $93-per-barrel revenue on oil in order to balance the federal budget. Some say OPEC is hoping that this price crisis will reduce U.S. expiration as a result of losses, improving OPEC’s long-term outcome.
The commodity challenge
Statistical analysis shows the aforementioned commodities move up and down in price together. As seen in 2008, a significant portion of the value of the market is driven by speculators buying. Mathematical modelers have developed formulas that predict price that include: the exchange rate, the price of agricultural inputs such fertilizer, pesticides (which are 50 percent related to price of oil), diesel fuel, the value of other key commodities and weather. The latter has a dramatic effect on the supply of crops. I tell my friends in the business, if you understand the market and what it is going to do next you can certainly make big profit from creating the right position.
I know some of my friends in this business have determined they are personally responsible for their record profits. However, I stress, in these low-cost cycles, don’t raise supply if you don’t know where that product will be sold or you’ll just drive the market right back into the ground. If everyone keeps a cool head and observes good economics, the party can continue for another year. Don’t get greedy; just get wealthy.