Name the grain; corn, soybeans, and even wheat, and analysts and traders can rarely provide an outlook without discussing energy demand. Traders joke that if they had a dollar for every time they have said “ethanol” throughout the last year they probably would not need to brave the commodities markets. So how should grain traders factor in the global need for renewable energy sources? Maybe the answer is to learn as much as possible about the need for renewable energy going forward, without getting lost in the present.
“A lot of people are excited about corn and ethanol, but we say this is not the driver, not yet anyway,” says Michael Lewis, global head of commodities research for Deutsche Bank in London. For instance, in the near term, instead of ethanol driving corn, Lewis points to the increasing possibility of China becoming a net corn importer as influencing corn’s bullishness. He says the fact the United States is still a net corn exporter and the lack of a large contraction of U.S. corn exporting signals ethanol demand is not yet the main driver.
Lewis points out while corn and wheat prices may be viewed as high, they are still significantly below all- time record prices. However, he says corn and wheat have the potential to experience record highs similar to what has occurred in the energy and metals sectors. “With all the problems in the energies, traders may find a new home in grains,” he says.
THE FUTURE MATTERS
With talk of renewable energy affecting grains because of ethanol demand, there is an enormous amount of focus on the future of corn — future production, future use and future prices. Deferred corn futures contracts are on the rise. The question, though, is how much and at what price will the commercials be buying at the beginning of 2007? While no one can predict the exact specifics, Darin Newsom, senior analyst with DTN, points out an economic rule that traders may want to keep in mind: a change in supply typically means a short-term change in price, but a change in demand typically means a change in the long-term price. Newsom reminds us that in late September the current corn contract traded around $2.47 per bushel, the Dec. 07 contract traded at $2.92 and the Dec. 08 contract was at $3.11.
“The ability for corn to stay near $3 for that long is certainly trying to say something from a technical view,” Newsom says, explaining that if you add the change in demand this may spell a long- term rise in corn.
How big is this growing demand for corn use in ethanol? The United States Department of Agriculture’s Sept. 12 crop production report estimated corn used for ethanol will increase by 25%, from 1.6 billion bushels in 2006 to 2.1 billion bushels in 2007.
The good news is if you look at current supply numbers, corn is abundant. This year’s harvest is predicted to produce the second largest crop on record. “We don’t have a shortage today. We won’t have a shortage in six months. But we don’t know what things will look like a year from now,” says Martyn Foreman, senior economist and corn market analyst for Doane Agricultural Services. Foreman explains stocks of corn will decline in the 2006-2007 marketing year and again in 2007-2008, but adds it is the market’s job to attract more corn and next spring favorable acres will be required. “But if we have any problem at all, for instance a weather scare or change in the export situation, this thing could really tighten up,” Foreman says. Traders may also want to keep in mind that unlike feed use and exports, ethanol plants’ use of corn is less flexible. Foreman explains that for the most part ethanol plants need to keep running regardless, and as result the plants may bid substantially higher than what livestock feed buyers would. So do all these factors foretell a supply shortage? According to Foreman new technology, including further genetic modifications to corn seeds, provides a favorable avenue to offsetting potential supply problems.
WHERE’S THE WHEAT?
Improved seed technology, more attractive subsidies and the demand for ethanol has not only increased corn acres, but also took acres away from wheat. In the 1970’s the United States was known as the breadbasket for the world, accounting for more than half of world wheat exports. While according to the U.S. Wheat Associates the United States still exports more wheat than any other country; our market share for global trade today is now 24%. “A lot of people are shifting wheat acreage into corn,” explains Alan Knuckman, WizeTrade ThinkTank’s commodities expert and president of Commodity Explorer. Knuckman points to better subsidies in corn as one of the major reasons farmers have moved away from wheat.
Acreage switching for grains is a regular factor for wheat traders, but this year the main story for the commodity has been weather. Major wheat growing regions across the world, including the United States, Australia and Argentina, have been damaged by drought. Weather scares combined with tight supplies drove wheat to $4.46 by early October. “We have seen a nice rally this year, based off of weather. Drought has pushed the market higher,” Newsom says. And as for shifting acres to corn from wheat, Newsom, who grew up in Kansas, says some states like Kansas are still better suited for growing wheat than corn. “I see an increase in wheat acres next year, which will lead to lower prices at this time in 2007,” Newsom commented in late September.
In addition to tightening wheat supplies, wheat exports have not gone up with prices. “Wheat exports are falling close to its lowest levels since the 1970s,” Lewis says. So if the United States is producing and exporting less wheat, what are other countries doing? Analysts say Europe, Argentina and Australia have increased their wheat output. But maybe even more interesting is that even wheat is being affected by the global demand for renewable energy. Wheat, like corn, can be used as a source for ethanol. For Europe, considering its abundance of wheat, using wheat for biofuel simply makes sense. But the question then becomes: corn on a global basis is a feed grain, wheat on the other hand is a milling grain; should a food grain be used to produce ethanol?
Emmanuel Jayet, senior softs analysts with BNP Paribas, whose analysis include corn, wheat and oilseeds, has looked closely at this question and presented his research on the effects of the emerging European biofuels industry on the wheat market at the 2006 Global Grain conference in Geneva, Switzerland. Jayet says a lower grade of wheat should be used for producing ethanol. But he explains Europe’s production of ethanol from wheat will change the balance of European wheat trade. Some countries in Europe have a surplus of wheat and serve as exporters while other countries in Europe import wheat.
Of course, the future producers of wheat for ethanol in Europe will be the wheat exporting countries. As for global implications, Jayet says, “We will see an overall increase of the importing requirements for the importing countries in Europe. These importing countries will have to import more wheat [from] overseas.”
While the amount of wheat affected by this biofuel demand may be small — in Europe only one million tons of wheat were used to produce ethanol in 2005, and in the next four years 8 million tons of wheat are expected to be used to process ethanol — this change may impact prices. “Just because it is a small amount of wheat does not mean a small impact on prices,” Jayet says. Europe on average produces 120 million tons of wheat, making up approximately 20% of the global wheat output. Like other countries, though, the success of Europe’s renewable fuel market will depend on government support. Jayet explains that currently each European country’s biofuel program differs. “In the future subsidies will be the same or roughly the same amount throughout Europe,” says Jayet, adding the future of ethanol is dependent on using ethanol in low level blends.
While wheat and corn prices have soared this season, soybeans have not provided traders the same moves. “Take all of the bullish talk in corn, turn over that coin to the back side, and [that] is what you see for beans. Soybeans have nowhere to go but down,” Newsom says. By early November, Newsom says he sees beans drifting down to $5.00 per bushel. “I see beans dropping another 40 to 50¢ this year,” Newsom explained in late September, adding that next year the bean market will likely witness a sideways- to lower-trending market.
Steve Nicholson, senior economist and oilseed analyst with Doane Agricultural Services, agrees the short term beans have a little more down side and likely will trade sideways into winter. However, he explains Argentina is poised to produce a larger crop in the 2006-2007 marketing year. He adds, “Brazil will have a smaller area planted to soybeans next year, but if they return back to an average yield, Brazil stands a chance to produce a record crop.”
From a technical standpoint, Knuckman explains, ”We haven’t seen beans stay this stable for some time. Looking at beans they have been trading in the 50¢ to 75¢ range the past year.”
So with world soybean carryout at record levels, weather not playing a huge factor and an overall quiet bean market, what if anything could put volatility back into soybeans?
Once again the answer lies with energy demand. According to the U.S. Department of Agriculture, biodiesel production will chip away at soybean oil inventories taking the end of July ’06 stocks of 3,130 million pounds to 2,644 million pounds by the end of September 07. “Biodiesel fuel is the wildcard for beans,” Knuckman says, adding this wildcard will not come into play in the immediate future. “Biodiesel may have been in the driver’s seat early in the year, but the markets are telling me it is not in the driver’s seat at this point.”
However, there has been talk that South America has been switching from soybean acres to corn and sugar acres to meet energy demand. According to Nicholson, the shift in South American acreage away from soybeans has many factors and is not simply about energy demand.
Nicholson explains South American farmers have become frustrated with beans throughout the years because costs for maintaining the commodity continue to go up, largely due to the challenges of fighting disease, such as Asian rust. “There are alternatives that produce better profits, such as sugar cane and corn,” Nicholson says.
Carla M. Bauch is a freelance writer in Chicago.