NEWSLETTER EXTRACTS
October-November 2008
It's all about Capital Flows
• It has all been about capital flows rather than grain market fundamentals over the past quarter. For the past couple of years, grain markets have been the beneficiaries of outside money inflows into futures markets, primarily by commodity index funds but also by speculative funds. Heavy inflows during the June quarter pushed markets back to near record levels, but as credit market woes deepened, access to capital for hedge funds dried up.
• Credit woes turned to absolute panic about the health of the financial market system and saw fund managers cut commodity market positions to shore up liquidity. Weaker commodity prices then encouraged investors to redeem investments, precipitating further heavy falls. In the short to medium-term, while such uncertainty pervades markets, it is unlikely that commodities and grains will be unable to escape the market’s wrath.
• If US Government backed measures succeed and market turmoil settles, soft commodities will start a long grind higher. But for this to happen, financial markets will need to recognise that soft commodities are different from commodities generally.
• Energy and metals prices will likely remain under pressure as secondary impacts of the recent turmoil flow through to sharply lower growth, at least for 2009. It may take a significant supply shock, commodity index fund re-engineering or a period of time for investors to regroup before soft commodities are able to detach from the trend in commodities generally.
Wheat prices to be pressured lower?
• Wheat has done well to maintain levels around $6/bu despite outside market pressure, the recent harvest of a world record crop and sharply lower corn and bean prices. Generally poor grain quality in Europe, worries about Canadian quality (the season is late and it has been wet) and problems with southern hemisphere crops are raising the spectre that milling wheat availability will be tight again.
• But if the Australian crop comes in above 20mmt (likely in our view) and as Aussie grower selling commences, we expect that wheat prices will be pressured lower, particularly if corn remains in the low $4/bu. Another large northern hemisphere wheat crop is being planted in near ideal conditions and markets will start to relax as Australian supplies become available.
• The key to wheat holding current levels is corn. Corn has come under heavy pressure as the US crop has successfully navigated a difficult season and as supplies of coarse grain across Europe have risen. This has been followed by speculative and index fund liquidation. Also, lower oil prices have reduced ethanol processing breakevens. However, with crude stabilising around $90/bll, and corn in the low $4/bu, margins are stabilising and this should support corn for ethanol demand. Ideas about the size of the US crop are mixed and any surprises to the downside will support a near-term rally towards $5/bu, in the absence of further outside pressure.
Oilseeds held hostage
• Like corn, oilseeds will remain hostage to the forces of outside markets. The funds still hold long positions in corn and soybeans and these markets are also sensitive to crude oil prices and forward growth projections. But if global growth jitters subside, the key to higher oilseed prices may also be corn values. US stocks of both commodities remain uncomfortably low and there is a need for both commodities to start building a buffer in case of a crop failure. A large lift in US soybean plantings has contributed to a lift in global oilseed production but notwithstanding larger production, strong growth in demand has seen end-stock projections fall.
• Production has stagnated across South America and the fall in values to close to costs of production and the credit crunch won’t do anything to kick-start larger production through a lift in plantings. Short-term opportunities for a lift in oilseeds are tied to results of the US harvest and the extent of South American plantings. Heavy canola production in the Ukraine and Canada will hit markets in the next few months but this should coincide with a lift in Chinese demand and a willingness to extend forward cover at much lower landed costs.
Barley supply in question
• Barley is on a similar trajectory as wheat. Stocks will rise moderately this year, but there are questions about the availability of malt stocks, with quality issues evident in Europe and Canada. Plus, significant barley growing areas across Australia are still in trouble, with large supplies out of Australia far from guaranteed. Malt prices should remain firm until good supplies out of Australia are evident. But feed barley has been caught in the crossfire of larger production across Europe and competition from ample supplies of feed wheat and cheap corn.
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Fertiliser prices tumble lower
Few markets have been spared the onslaught of de-leveraging in the past few months and while fertiliser was a little slow to catch on, it has now also been hit savagely by declining demand (due to previously high prices and falling grain prices), the credit crisis and oversupply. Now that prices are crashing, buyers are staying on the sidelines.
Massive falls in bulk freight rates are also making landed prices much cheaper, which is not yet encouraging buyers (as they see prices continually falling) into the market, although it will once they think the market has bottomed.
Both phosphate and urea prices have tumbled, following agricultural commodities such as corn, wheat and soybeans lower. With the market in freefall, buyers remain reluctant as they expect cheaper prices.
Farmers have also been reluctant to spend on fertiliser at the high prices when the commodities they grow were rapidly falling in price. With the credit crisis, buyers also want to limit the amount of capital tied up in fertiliser stocks.
The build-up in fertiliser prices was not dissimilar to grains. Initially, supply was thought to be short (and it probably was) and prices rose rapidly. High grain prices meant farmers could chase the prices higher for a time and no doubt, speculators got in on the act. Then, as in grains, Governments started to intervene (like China raising tariffs to stop exports or India providing subsidies to farmers) and prices rose further.
Then, as is generally the case in markets, prices rose to a point where demand slowed and supply kept going. This led initially to an oversupplied market, which when combined with falling grains prices and a credit crisis, has brought down the house of cards.
Urea
The urea price is plummeting – there is no other word for it. Producers of urea are spellbound as weak sellers out of the Middle East and India reduce their selling ideas, putting pressure on sellers in Russia and Ukraine.
Urea ex the Black Sea is in the vicinity of US$330/t and India is at US$350/t FOB. Consider that the market reached over US$840/t FOB NOLA in early August this year and is now closer US$350/t FOB and you get an idea of the dramatic decline.
Everyone in the market is now wondering where the floor is in the price. Considering prices are returning to 2007 levels, the floor is probably close. The following chart displays historical urea prices.
Still, the market probably has little reason to rally as the hangover in stocks in Russia and the Middle East should keep prices capped for some weeks. Still, considering the rising costs to produce almost any commodity (including urea), there is little doubt that the trade will be working hard to calculate urea production costs as once the price falls below that level, production should slow down and the market will eventually come back into balance.
We suspect the market is probably closing on those values now. The lower prices should eventually also attract buying interest as consumers look for a bargain. When you consider bulk freight markets have fallen dramatically, then the landed cost is substantially (no really – humongously) lower that is has been.
The other consideration is that while the urea price initially took off and left ammonia as the cheap cousin, the opposite is now true (in the North American market at least), with urea trading well below ammonia levels. The ammonia market is still very high in comparison but with falling urea prices, buyers are staying out of the ammonia market out of concern that this market is in for a major correction lower.
DAP
Phosphate prices are also falling due to a lack of buyers. Europe is seasonally quiet (spring is when activity rises); North America is quiet; South America will have credit problems (and summer crops have mostly been planted); and China has its own export tariffs in place, leaving India the only major buyer.
In India, government subsidies to producers may hold price up and India should provide a reasonable home for surplus DAP on the world market in the near-term. Some producers are also cutting back output. Mosaic – one of the world’s leading phosphate producers – is reducing its production levels in an attempt to take excess supply off the market.
Still, prices are weak. While DAP FOB Tampa rose to over US$1200/t in early August, the price is now closer to US$850/t FOB. The chart below displays some historical comparisons.
China have been a large player in the DAP market and should exports resume out of China in 2009, some additional price pressure could be brought to bear on
the market.
But not in A$ terms
While international fertiliser prices in $US terms have tumbled, the effect in $A terms has been significantly less and even this effect may take a little time to filter through into the marketplace. The 30% fall in the $A, and the way fertiliser is traded, have minimised the impact. However, price falls will come to some extent once the international action flows through in new imports/import parity price settings. The below chart displays the above $US values but in $A terms.
So, the above chart tells us that while the $A has fallen significantly, we should start to see some downward movement in local urea prices. How well this occurs will depend on competition in the market place.
Australian production still falling?
While the USDA saw fit to boost global crops and end stocks last week, plenty of local production uncertainty still reigns.
It is estimated that around 20% of wheat crops in the SA and VIC Mallee and northern Wimmera will get cut for hay, Many more crops will be grazed and of the crops with harvest potential, yields are still sliding badly. Crops are sitting on nil moisture – it was 30 degrees and windy last Sunday and there is no rain in the 14-day forecast and more hot weather in store for this weekend.
Further south, crops will need rain soon to hold strong yield potential. We have taken the sword to wheat production forecasts in SA and VIC and, despite improving production potential in NSW and QLD, this will drag down the national figure to 21mmt.
The other major concern is the extent of frost damage in WA. Loss estimates of 600-800,000t across all grains need to be read in context with yield building rains in late September. We have chosen to leave our WA canola forecast unchanged and only trimmed our wheat forecasts, betting that the September rain has largely offset production losses from the frost. We have made a material revision to our barley number to recognize that barley crops seem to have been most affected and that the frost hit crops were in large barley growing areas.
Harvest has commenced in the far northern WA wheat-belt, with solid yields (crops are said to be yielding better than expected) but there have been some screenings issues. At the current spreads to lower grades, it will pay to grade affected loads. See www.efarming.com.au for a wrap of harvest activity in WA.
In sth QLD and NSW, production potential is building as good rains in Sept/Oct (what!… Oct rains) extend a late season for another month or so. A big chunk of sth QLD and northern and central NSW received +50mm in September, with falls of another +25mm so far in October for parts of NSW. This will help to offset poor crops in western and south-western areas of NSW. Crop yields should be consistent across QLD but wil vary greatly across NSW.
We have cut both our barley and canola estimates. Although barley seems to be fairing best in SA and VIC, yield losses are apparent. In WA, barley copped the brunt of the frost. We have left our WA canola estimate unchanged but pulled back estimates across SA, VIC and NSW. AOF reduced its Australian canola estimate to 1.5mmt (from 1.65mmt) this week. We think they are too high in NSW and VIC.
The below table illustrates the state-by-state wheat crop production forecast.
Falling feedstock prices help the biodiesel industry
Funny how things change so fast yet the more they change, the more they stay the same. Several months ago, the whole fuel vs food debate was in full cry. Commodity prices were rapidly rising and governments were backing away from bio-fuel as “food inflation” caught the headlines. Fast forward several months and commodity prices are falling, the food/fuel debate has gone underground for the time being (the media has a whole financial crisis to play with) and some governments are back to supporting the industry as a means of supporting the commodity price.
Nowhere has this been more evident than in Asia. Crude palm oil prices have fallen rapidly in the past few months (much faster than energy prices) and in countries like Malaysia and Indonesia, the bio-diesel industry is again looking brighter.
Malaysia exported a record 37,874t of bio-diesel in July, with the steep fall in feed stock prices the main reason. From January to August, exports have totalled 101,835t, compared to 95,103t the entire previous year. According to the Government, Malaysia currently has capacity for 902,000t, with another 372,000t under construction. Still, capacity utilisation is only around 9-15%. There is talk that Malaysia will impose a 5% blending mandate sometime soon.
Indonesia still plans to introduce a 2.5% blend into transportation and industrial fuel although it’s been delayed at least once before. Indonesian production is running around 150,000t but is expected to double in 2009.
The chart below displays heating oil (diesel), soybean oil and palm oil futures. Note that palm oil futures are well down and it is now pricing itself into the fuel equation, whereas since 2007 it has largely been priced as food.
In other parts of the world, the EU is scaling back its bio-fuel requirement. The European parliament has placed a limitation on the use of “so called” first generation bio-fuels (made from corn/veg oil) and also requires bio-fuels to cut greenhouse gas by 45% relative to gasoline or diesel.
This is more of an environmental focus but also pushes the industry into future thinking. Currently, EU bio-diesel continues to suffer from double subsidised US imports although again, cheaper feedstock is allowing some manufacturers to break even.
In the US, bio-diesel producers have generally been in unprofitable territory. Capacity utilisation is estimated at 24% and should produce some 600 million gallons this calendar year, with total capacity estimated at around 2.6 billion gallons per year. There are some 160 plants in the US, although not all are currently operational (32 currently shut down and 132 currently producing – those producing have a capacity of 2.2 billion gallons). This number has not changed significantly in the past 12 months and with the current credit issues, it is unlikely to change much in the near future.
Currently, there are only 13 new plants under construction, which, when finished, (some if ever), will add another 365 million gallons to capacity (assuming old plants are not closed).
The graph below on the right y-axis shows current soybean oil usage and potential soybean oil usage should the industry run at total capacity. If at total capacity, it would consume 80% of US soybean oil production. This is never going to happen.
The industry tends to live on the $1.00/gallon credit given to blenders, especially when soyoil (the feedstock) rises above 50¢/lb. Still, plants remain open to pay their fixed costs and to outlast their competitors and be ready for an industry turnaround. The Renewal Fuel Standard in 2009 will set a base of 500 million gallons of bio-diesel based fuel, which will help support the industry. The chart below provides a rough estimate of the gross margin for bio-diesel in the US.
Looking at the future
The bio-diesel industry faces enormous challenges, both short and longer-term. Bio-diesel will have to continue to compete with food use and while cheaper palm oil in south-east Asia might allow the industry there to blossom for a few months, invariably the next production downturn (or too much demand) will push prices above the economically sustainable level for the fuel industry. When it does, you will find governments back-peddling again.
ProFarmer perspective:
In our view, bio-diesel in the US does not have an economic life outside of the US Government mandates. The US simply does not grow enough soybeans to support the kind of capacity available, and it probably never will.
Combine this with the fact that credit will be increasingly difficult to get for new projects, and capacity will likely decrease over time, not increase. In the short-term, the food versus fuel debate has gone off the radar; however, it will re-emerge again and probably not that far down the track. There is a recognition that while these first generation fuels have carved out a market, there is a need to progress to second generation (crop waste, etc.) and third generation (products created through synthetic biology) fuels that move bio-fuel further away from the food chain.
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