The 2010-11 corn market had an important job to do and it got the job done. It had the responsibility of making sure there was an adequate amount of leftover corn to provide some supply cushion for the 2011-12 marketing year. According to the U.S. Department of Agriculture’s (USDA’s) September Quarterly Grain Stocks Report, the market did its job. Barely.
Old-crop ending stocks of 1.128 billion bushels are barely enough supply cushion for a tough 2011 growing season. The uncertainty of the 2011 corn crop started almost a year ago when growers began making planting decisions. The rationing process continued into the spring of 2011 when a soggy and cool planting period resulted in one of the slowest planting seasons on record.
The historic drought in the Southwest was joined by a drier-than-normal growing season in key areas of the eastern corn belt. Rain was far from plentiful in the western corn belt, but soil moisture was enough to help the crop hold onto near-normal yields.
With each of the uncertainties of the new-crop growing season came increased urgency to destroy another portion of old-crop demand to maintain an adequate supply cushion. That created a runaway corn market, climbing to all-time highs as U.S. livestock and ethanol producers and importers of U.S. corn scrambled to buy the corn they’d need until new-crop supplies arrived.
The uncertainty climaxed in late August. At the time most analysts still anticipated a national average corn yield above 150 bushels per acre. When Pro Farmer estimated national average yield of 147.9 bushels per acre at that time, crop uncertainty was replaced with a realization that the 2011 corn crop would fall well short of the hoped-for 13.0 billion bushels needed to feed a corn-hungry world for another year.
Another stocks report; another limit move in corn
The Sept. 29 Quarterly Grain Stocks Report gave corn futures their first chance to try out the new 40¢ daily trading limit, and bears got the job done. But the limit-down move was set in motion long before as hedge funds and speculative traders washed out long positions in grain and other commodity markets. At the end of August, macro-economic issues began to chase speculative longs out of corn, soybean and wheat futures. It was a bad combination of margin calls, Greek debt and a bigger corn supply, a wicked brew for a limit-down price reaction.
In reality, old-crop corn carryover (the new-crop supply cushion) of 1.128 billion bushels is far from adequate. The 2010-11 (old-crop) marketing year started with a supply cushion of 1.708 billion bushels — and the market rallied to an all-time high as it rationed use to keep some bushels in the bin for 2011-12. On Sept. 1, corn began a new marketing year with 580 million fewer bushels in the bin than a year earlier.
Fundamentally, corn is entering the marketing year with a more bullish set of fundamentals than last year. That does not guarantee another highly volatile year of trade with another moon-shot for prices. It does, however, leave the market vulnerable to a repeat performance.
USDA has some work to do
USDA’s National Ag Statistics Service (NASS) is in charge of survey work: Things like Grain Stocks, Acreage and Crop Production reports for grains along with Quarterly Hogs & Pigs, Cattle on Feed and Cattle Inventory reports on the livestock side. For two years, the Grain Stocks Report has been the most controversial. In September 2010, corn stocks were 300 million bushels above the average pre-report trade estimate, prompting speculation that NASS had counted 2010-crop corn moving back through time into the 2009-10 marketing year.
In September 2011, corn stocks were about 170 million bushels above the average pre-report trade guess, again spurring an outcry that something is wrong with the Grain Stocks Report. When questioned about how the market could be so off base, NASS Statistics Division Director Joe Prusacki responded, "The market’s expectations were out of line with our numbers."
That’s only half true. Yes, the market anticipated Sept. 1 corn stocks of about 960 million bushels, but those expectations were based on the World Board’s carryover estimate of 920 million bushels delivered just two weeks ahead of the Grain Stocks Report. So yes, market expectations were out of line with the NASS survey results — but so were USDA’s expectations. That — not market expectations — is what’s making the Grain Stocks Report one of the most controversial reports in USDA’s lineup.
At an October meeting of the National Chicken Council, Chairman of USDA’s World Ag Outlook Board (World Board) Gerald Bange told attendees he has trouble explaining the discrepancy between his agency’s Sept. 12 corn carryover estimate of 920 million bushels and NASS’s Sept. 1 corn stocks of 1.128 billion bushels.
Bange told the group, "If you have a stocks number that big, it implies something drastic happened in... the feed and residual category." He reportedly also noted that the larger-than-expected Sept. 1 wheat stocks indicated lower-than-expected wheat feedings in the quarter — something very difficult to explain with the apparent drop in corn-for-feed use.
For reference, cattle numbers in the quarter were (on average) about 5% higher than year-earlier and hog numbers were 1% above year-ago levels. The bigger livestock inventories had traders anticipating an increase in either corn- or wheat-for-feed use.
Bange then pointed to ethanol’s positive profit margins and distillers’ enthusiastic production of the biofuel in the quarter as another reason the bulge in corn stocks came as a surprise.
The conversion rate
The "easy" way to calculate the number of bushels of corn used to produce ethanol is to count the number of gallons coming out of the facilities as reported to the Department of Energy. It would be "easy" if USDA’s World Board were using the right conversion rate for ethanol production. As it stands, the World Board assumes production of 2.7 gallons of ethanol per bushel of corn.
In reality, today’s higher-efficiency ethanol facilities are averaging about 2.83 gallons of ethanol per bushel (some get more than 2.95 gallons). A 2.83-gallon-per-bushel conversion rate is a 4.8% efficiency gain over the World Board’s assumption. At the USDA’s corn-for-ethanol use estimate of 5.02 billion bushels, the 2.83-gallon-per-bushel conversion rate would drop corn-for-ethanol use to about 4.78 billion bushels.
The 240-million-bushel difference between the World Board’s extrapolated number and what might (stressing "might") be actual corn-for-ethanol use has to be accounted for somewhere. That somewhere is the residual component of the feed & residual category. So in reality, nearly 250 million bushels of corn potentially could move from corn-for-ethanol (accounted for in the food, seed & industrial category) over to feed & residual use. Doing that would make feed use better align with the 5% more cattle and 1% more hogs we have on feed heading into the final quarter of 2011.
That’s a lot of detail to get to this conclusion: Trust the number.
For one thing, NASS isn’t going to say "Oops," and change its Sept. 1 corn stocks estimate to pre-report expectations of 960 million bushels. The old-crop carryover number we have to work with is 1.128 billion bushels — that is not going to change.
The market did its job, which was to have the biggest supply-side cushion possible for the start of the 2011-12 marketing year; that was 1.128 billion bushels. Also, the market somehow reduced enough demand to force total corn use down to 13.057 billion bushels in the 2010-12 marketing year.
That’s another number to trust: 13.057 billion bushels of use. Looking back to the start of the 2010-11 marketing year, front-month corn futures didn’t close above $6 until Christmas 2010. After that, the front-month corn contract spent the entire marketing year above $6, including the first close of more than $6.50 in mid-January; the first close over $7 in mid-February; and the first close over $7.50 in early April. Old-crop futures peaked at $7.99 ¾ on June 10; fell back to $6 by July 1; and rallied back to $7.75 on Aug. 31 before prices collapsed through September and early October as the 2011-12 marketing year began.
Front-month corn futures spent nine months above $6 and came within a silk of $8 and end-users still used 13.057 billion bushels of corn.
In the 2011-12 marketing year, USDA expects total use will be just 12.76 billion bushels — nearly 300 million bushels fewer than were used in the high-priced 2010-11 marketing year. To force demand down 2.3% from last year, commodity economics tell us the average price for the 2011 crop should be higher. That means the lower prices drop this fall, the higher the price potential later. What constitutes low appears to be a drop under $6. In fact, one long-time cattle-market observer says, "Cattle feeders bought $5.80 cash corn on the drop below $6 like they used to buy $2.80 corn when prices dropped back under $3.00. Feed users and ethanol producers view sub-$6 corn as a gift."
Importers had the same reaction.
In the World Board’s defense, its estimate of 12.76 billion bushels of total corn use came with the assumption that prices would rise to slow down demand. In the September Supply & Demand Report, a national average on-farm cash corn price of $6.50 to $7.50 was estimated. The midpoint of that range is an amazing $1.80 above the estimated average cash price in the 2010-11 marketing year.
The problem with that demand-price combination is the market through the first month-and-a-half of the 2011-12 marketing year barely participated in the effort to cut 300 million bushels from the year-earlier usage level. The price slide gave end-users an excellent opportunity to cover anticipated needs deep into the marketing year, making it more difficult to slow the usage pace later in the year. It’s worth saying again: The deeper prices drop this fall, the higher the price potential later (see "Can the corn market do it again?" below).
Cattle on feed numbers likely will decline through 2012, but hog numbers will remain about 1% above year-earlier levels through the year. Even looking through the muddied usage issues created by the too-low ethanol conversion rate assumed by the World Board, it’s hard to imagine cutting feed and residual corn use much from the 4.7 billion bushels estimated by USDA. There may be some corn movement around the usage estimates, but it really will be tough to force use below 12.76 billion bushels.
But based on current supply assumptions, demand must be cut to 12.56 billion bushels to maintain corn carryover of 1 billion bushels (see far-right column in corn table). To do that, Pro Farmer expects a wild price performance ranging between this fall’s low of around $5.50 (anticipated), back up to all-time high prices to destroy even more demand. Much of that destruction most likely would happen in the export market as global livestock producers make the switch from corn to wheat as the primary feed source.
Looking further out to the 2012-13 marketing year, the market needs a normal growing season and a national average yield within five bushels of trendline yields to increase demand while building carryover to a more comfortable 1.5 billion bushels. That need of a normal growing season is a repeat of this year. If acres or yield fall short, the market once again will be forced to cut use severely to maintain an adequate supply-side cushion.
Beans still growing
Ahead of the October Crop Production Report, Pro Farmer had seen enough evidence to increase the soybean yield estimate by 0.5 bushel, to 42.3 bushels per acre. That increases 2011-12 soybean supplies, but just by 40 million bushels. Pro Farmer also sees 2011-12 soybean exports well above USDA; but that is partially offset by a slightly lower new-crop crush estimate (see "Soybean S&D outlook is comfortable," below). The result is a fairly comfortable carryover estimate of 170 million bushels. If the market decides it needs a 200-million-bushel carryover (far right column), just a marginally higher national average cash price would be needed to cut 35 million bushels from expected use.
Wheat looking to clean up surplus
Wheat trade between the three major exchanges is diverging: Chicago’s soft red winter wheat market is trading as feed with price action directed by corn.
Kansas City’s hard red winter wheat dealt with drought in 2011; it could do so through the 2012-crop seeding season in the fall of 2011; and it likely will face another La Nina growing season (typically dry) through 2012.
Minneapolis’s hard red spring wheat market was short on supply, but long on quality in 2011. Demand for the crop’s excellent milling quality is high, pushing the lowest-volume market to the highest price. That market will maintain a premium to the other flavors throughout the 2011-12 marketing year.
But the reality of the wheat market is corn is calling the shots. For wheat prices to rally, corn will have to lead the way. Sideways price action in corn isn’t enough; wheat prices would drift lower in that environment. But, if corn prices do see another volatile year of trade in the year ahead, wheat should be a willing participant.
What is clear is that it’s still a corn world.
Global production of these three major crops will rise and fall, but demand estimates already have been cut by USDA to levels that won’t fall much lower. Global macro-economic uncertainties will divert the markets’ attention from time to time, but the simple reality of the grain markets is corn trade must find a way to slow down use even further than USDA’s projections. That won’t happen at early-October prices, and this will become only more difficult the longer the market waits to slam the door on end users one more time.
Garbage in, garbage out?
What if the problem isn’t in USDA’s World Board ethanol usage assumptions?
When it comes to tough questions about USDA’s data, there’s rarely an easy answer. Market expectations for Sept. 1 grain stocks were established by USDA’s carryover estimate made just 18 days earlier. So, was the stocks data wrong or was the Sept. 12 carryover estimate misleading?
Another potential USDA misstep: Are we sure the animal inventories are right? Based on the number of cattle in feedlots and the poor economic conditions, record-high boxed beef should not be trading near record-high levels... but it is. What if cattle and hog inventories have been overestimated?
Another spot to review is the crop size. If the 2009 crop was overestimated and the 2010 crop was underestimated, that would clear up many of the grain stocks discrepancies.
Conclusion: Something isn’t right. Figuring out what it is should be a top priority at the USDA.
Chip Flory is the editor and publisher of the weekly Pro Farmer newsletter. Flory plays an active role in developing market outlooks for the Pro Farmer membership. Learn more at www.profarmer.com.