From the June 01, 2007 issue of Futures Magazine • Subscribe!

Following the numbers in grains

The most important number in all the grain markets is a big one — 11.635 billion. That’s the United States Department of Agriculture’s (USDA) estimate of the bushels of corn to be used in the 2006-07 marketing year (Sept. 1, 2006 to Aug. 31, 2007), according to its April 10 Supply & Demand Report.

At that level, 2006-07 corn use will be 1.1 billion bushels larger than the 2006 U.S. crop. End-users will tap into stored stocks to meet demand and draw 2006-07 corn carryover down to less than 1 billion bushels.

And in the grain markets, tapping into carryover supplies to meet demand is bullish. Big demand and a smaller-than-needed crop was the combination that launched the corn rally after price lows were cemented in place for July 2007 corn futures by an August to September 2006 double-bottom (see “Launching pad,” below). That’s when a good growing season deteriorated after a drier- and hotter-than-normal post-pollination period across the Corn Belt. Bushels lost to a less-than-ideal end of the growing season turned a relatively minor drop in estimated 2006-07 carryover into the 1-billion-bushel-plus carryover slashing expected now.

Another number to be aware of: 2.15 billion — the number of bushels of corn expected to be turned into ethanol in the 2006-07 marketing year. The 2.15 billion bushels represents a 34% one-year demand increase from a single corn-use category. It became popular to call the corn-for-ethanol demand surge a never-before-seen event. That’s not quite accurate. The export demand surge in the 1970s was very similar in scale and in its pace of expansion.

But there is a difference, export demand is very unpredictable and unreliable; domestic demand is more predictable and reliable. That’s why it’s easy to pencil in an even more aggressive increase in corn-for-ethanol use for the 2007-08 marketing year.

Pro Farmer expects 2007-08 corn-for-ethanol use of 3.15 billion to 3.25 billion bushels, a nearly 50% single-category increase in corn demand.

The one-billion-bushel increase in corn-for-ethanol use expected in 2007-08 fired the next stage of the corn market rally. Buying refocused in December 2007 corn futures as the market realized the need to increase corn plantings to feed the ethanol beast.

To supply the market with an extra one billion bushels of corn, it takes about 6.5 million harvested corn acres at a national average yield of 153 bushels per acre. But that’s just half the battle to keep carryover from sliding even lower, another 1 billion bushels of corn, and another 6.5 million harvested corn acres, is needed to offset the year-to-year drop in beginning stocks.

Of course, demand rationing also will happen in 2007-08 to take some pressure off supplies. Lower livestock and poultry numbers and an increase in alternative feed supplies will force U.S. feed and residual use down 75 million to 100 million bushels from 2006-07 levels. Exports also will be cut about 50 million bushels as a result of price rationing.

Corn-for-ethanol use, however, likely will not be slowed by higher prices, at least not in the year ahead. Input costs for ethanol producers are up from a year ago, but government-backed incentives are still in place and increasing gasoline prices are pulling ethanol prices up, keeping ethanol-producer margins in the black. Ethanol will be the demand-driver in corn through the 2007-08 marketing year, keeping supplies tight for at least another 12 months.

The next number: 12.58 billion bushels. Price rationing will erase some usage in 2007-08, but add 1.05 billion bushels more to corn-for-ethanol use, and Pro Farmer puts total 2007-08 corn use at 12.58 billion bushels. Compare that to total estimated supply of 13.5 billion bushels and carryover remains stubbornly locked at just under 1 billion bushels.

The total supply estimate of 13.5 billion bushels includes big assumptions. First, it assumes all 90.45 million acres that growers intend to plant with corn in 2007 actually get planted. Using historical averages, about 9% of those acres will go to forage or be abandoned, leaving harvested acres at 82.3 million. Second, it assumes a national average corn yield of 153 bushels per acre. With millions of acres from outside traditional corn-growing areas added to the mix in 2007, reaching a national average yield that high is a stretch, and will take a nearly ideal growing season.

The 12.15-million-acre one-year increase in intended corn acres surprised many when the USDA released the March Prospective Plantings Report. While impressive, these were the easy acres to move into corn production. With corn demand likely to pass 13 billion bushels in the 2008-09 marketing year, even more acres will need to be planted with corn in 2008, and those acres will be more difficult to switch to corn than the massive switch seen from 2006 to 2007. Barring an explosive weather-driven rally in summer this year, the acreage battle is already positioning December 2008 futures to start the next leg up in corn futures (see “Inside corn,” below).

SOYBEANS

The soybean market has a big number that’s not so bullish: a record-large carryover of 615 million bushels. Fundamentally, it’s exceedingly difficult to build a bullish scenario for soybeans with a carryover that large hanging over the market. Still, soybean prices participated in the battle for 2007 acres, supporting old-crop prices long enough to trim the USDA’s usage estimates and to build carryover to record levels. The same is true for global carryover. At the end of 2006-07, the equivalent of roughly one year of Brazilian production will still be in the bin.

The soybean market is in serious need of a demand-building period. That’s a nice way of saying current $7.00-plus futures prices are too high. To clean up burdensome U.S. and global soybean supplies, prices must turn lower to encourage use or acres must decline to reduce supplies, both in the U.S. and Brazil.

That connects the dots between the corn and soybean markets. The 2007 surge in corn plantings came mostly from an 8.36-million-acre cut in intended U.S. soybean plantings.

The USDA’s March Prospective Plantings Report revealed growers intended to plant just 67.14 million acres of soybeans in 2007. At 42 bushels per acre, the acreage reduction from a year ago represents about 350 million bushels of production potential. It’s a significant amount of soybeans, but carryover would still be at levels most would not consider bullish.

So, with carryover at levels that an eight-million-acre drop in planted acres can’t fix, why are bean prices above fundamental fair value? Give some credit to an ethanol halo. The ethanol industry was built by farmer investment, production incentives and usage mandates. While years behind ethanol, the biodiesel industry is receiving production incentives, is picking up farmer investment and will likely benefit from increased usage mandates in the near future. The ethanol halo represents the risk that biodiesel could soon experience a boom of its own. The surge to significant levels of biodiesel production won’t likely happen in the 2007-08 marketing year, but it is coming, and that optimism is helping to hold bean prices at inflated levels.

Another factor: Beans can handle one year of planting at just 67.14 million acres. But two years of sub 70-million-acre bean plantings would likely tighten carryover too much. So if 2007 planting intentions are repeated in 2008, soybeans will be dealing with a set of price-bullish fundamentals. But a repeat of 2007 planting intentions isn’t likely. Corn will be demanding even more acres to meet bulging 2008-09 usage estimates, pulling even more acres away from soybeans.

That’s why the stage is already set for a major 2008 acreage battle — corn will need more and soybeans can’t afford to lose any more. The 2007 acreage battle generated extreme volatility in corn and soybean futures; the 2008 battle already promises to be harder fought with even more price volatility. And keep in mind, acreage battles don’t happen in down-trending markets (see “Inside beans,” below).

WHEAT

Wheat won an acreage battle in 2007, and it won it even before the corn and soybean markets woke up to the fact a battle was being fought. By mid summer 2006, wheat prices (2006- and 2007-crop futures) were rallying on confirmed drought-hammered hard red winter wheat yields. Growers sold 2006-crop supplies and aggressively forward contracted 2007-crop bushels to capture profit potential, locking up about three million more winter wheat acres than planted in 2006. Some even locked in 2008 crop sales on the rally, securing those acres for wheat next year as well.

Wheat growers’ plan was working great until Easter weekend 2007. A hard freeze left the winter wheat crop in limbo and dependent on May-June weather to allow the crop to essentially start over. Yield potential was lost, likely landing the market between average and poor on the supply and demand table for 2007-08.

And as soybeans’ price potential is tied to corn, so is wheat’s, especially for soft red winter (SRW) wheat. Export demand for SRW is poor and carryover is burdensome. While futures prices found spring 2007 support on crop uncertainty, the cash market continued to price SRW as feed in competition with corn. If corn prices rise, SRW (Chicago futures) will rise; if corn prices fall, SRW prices will decline to stay competitive in the feed market (see “Inside wheat,” below).

It’s clear the corn market is built on a solid set of numbers: large and growing demand. And expanding demand is the real deal in the corn market.

The first upside price target for December 2007 corn futures is the contract high at $4.29-1/2 per bushel. If plantings fall below the 90.54 million intended acres or if yields fall short of 153 bushels per acre, representing roughly a 12.5-billion-bushel crop, the need to ration use will become more urgent and new-crop corn futures should start the move to that upside price target. If production potential climbs much above 12.5 billion bushels, December 2007 corn futures could comfortably move down into the $3.25 range and hold near that level while demand is assessed. With carryover expected around 1 billion bushels at the end of the 2007-08 marketing year, that’s tight enough to prevent a slide much below $3.25.

It really is a numbers game and the higher total corn use climbs, the higher the price volatility, the higher the need for at least trendline yields in all crops and the higher the average annual price for corn, soybeans and wheat. There...all the numbers sifted down to just one — corn demand.

Chip Flory, editor and publisher, Pro Farmer newsletter, has been providing news, analysis and perspective on agricultural markets for 19 years. Chip’s focus is on fundamental factors and helps develop marketing plans for the Members of Professional Farmers of America.

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