The Long Term Impact of Oversupply

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Ben Buckner, AgResource Grain Market Specialist:

Okay. Good afternoon. Midplains Ag and everyone in that part of the country. This is Ben Buckner from Ag resource company in Chicago. This is the third of our series of webinars. And not a whole lot has changed, but as we have seen the markets evolve over the last three months, everything has kind of come to fruition as expected. Most of that is due to, I think, broadly favorable US weather patterns, what we should continue for another 10 days. And so there's just not a lot of excitement. There's also not much of a weather story anywhere. Everything looks pretty good. Maybe there's some heat and dryness in Ukraine that needs to be watched, but otherwise I think we're looking at trend or above yields in the US, Canada, Europe, the Black Sea, China and even down the road, perhaps Australia and South America.

And so there's still this sort of bearish landscape for the future, especially for corn. And really only two grains are above January values. That is sorghum and rice, and that is due to Chinese demand for US sorghum and US [inaudible 00:01:34] and world [inaudible 00:01:36] demand for rice. Chicago corn is down 14%. Beans are down 9%. [inaudible 00:01:40] is down 12% as of today. US ethanol industry of course, it added to the bearish 2020, '21 US and the world corn stock outlook and price outlook decline, and domestic corn bride to February and to June. And we're still not seeing it full recovery at the moment. So, we think that USDA probably will have to cut another 75 or a 100 million bushels of corn from both its US old crop and new crop consumption forecast. It really, until there is a COVID-19 vaccine available, we think that the economy and gasoline consumption especially will plateau at a level of 5%, 7% below last year.

And so it's really taken a lot of raw material growth story away. That growth story did exist a 100 days ago, and now that has gone. The world corn market too will be defined by already large and rising competition for exports. And so as we debate the precision of US yield forecast, whether the first and second half of July, production everywhere else and in South America, those crops already being harvested then, so that growing season has done. And so these combined major exports will have a lot of supply. And we've even seen Brazil really start its corn export program in the month of August, and it continues into December and January. So if you think about the competition for world corn trade in the October, November, December, period, it's going to be steep. And so you're only going to find demand if you're an exporter through weaker basis, pot basis or flat price.

So that's just not a bullish phenomenon for the market longer term. And now there's this uncertainty over the US-China phase one deal, which was one of the silver linings of the US and global ag market outlook in 2020 and 2021. But now we're blaming the virus on each other. China told US meat exporters over this weekend that it will require signed affidavits that COVID-19 is not in the shipped products between new exports. And that's a legitimate fear and we think this could spread to other commodities in other countries. But for now the point is that US meat exports, China are coming to a grinding halt. Will they all demand the same affidavit on soybeans in the future, and does it spread to other countries again? And so that's one sort of unseen impact of spread of COVID-19 that we're seeing for now and essentially in the future.

Fortunately, the USDA is there to help US farmer. And so 2020 total farm revenue was forecast to being near on change the last couple of years. But up to 45% of that will be through government systems programs, and that is a record percentage. So a huge cash influx will provide income to the farmers to help them try to store as much as their new crop harvest. But we're seeing, assuming normal weather, production capacity exceed storage capacity by a pretty big margin. And so what can't be stored will have to be sold. And so we think now it's [inaudible 00:04:36] Midwest to wait autumn, summer as new storage ways are need to be found, basis will go down. A longer term bullish trend demand of 25% drop in the US dollar or a supply loss from a major region, whether that's Europe in the case of corn or vegetable oils or China, really, maybe East Asia, parts of Southeast Asia, but that's probably unlikely because again, we're now through the half first summer almost, and we don't see any major problems for production.

So the loss of supply will have to be a 2021 phenomenon. The outlook very broadly. Corn is the most bearish. Soybeans await Chinese demand or political uncertainty, while the wheat markets awaits final Black Sea wheat production totals. But those Black Sea wheat yields seem to be getting larger as we really harvest to stock. And so like the last webinar, we started out with this, and we still have these broad deflationary trends. And it's still hard to be bullish if anything really. And there has been a nice pot since the doldrums of COVID based lockdowns, but raw materials appeared to be reaching some sort of plateau. And then this makes sense given 13% unemployment, which could be getting bigger as savings are drawn upon, maybe that impacts the stock market.

And so in very generally, we don't think that there will be more demand for raw materials than there is current. And that probably doesn't change, like we mentioned last time, until there is a COVID-19 vaccine. And a big part of raw material space, of course, is crude oil. The energy markets have rallied, but that seems to be because of future tightening of supply, not anything happening in the near term cash markets. You can see that crude oil inventories, strategic reserves are at a record high, 541 million barrels. So that's a 15% on the year, and it's still rising. We can see that recounts, and the US have been decimated or record low. OPEC extended its record 10 million barrel per day crude production cut into the end of July, and so mathematically we can see a tighter crude market 12 months from now. But it doesn't seem to be the case currently.

And we're all be watching for the impact of perhaps the second wave of the virus returning to the world autumn, fall. It's certainly not there. And so again, this highlights just that raw material markets as a whole, those indexes will probably be pretty neutral at lower prices than in the recent years. We mentioned unemployment in the US 13%. The Fed is pumping lots of money into the economy, and that has been very helpful. Unfortunately, we're not seeing any inflation because the velocity of money, M2 money, which includes everything that even somewhat liquid. No one's spending that money. And so this measures just the change in dollar spent on the same amount of goods. And we're seeing that this has been a longterm trend, but until spending and the velocity of spending ramps up, I don't think that we'll see inflation. And so that's just a further headwind to the raw material space.

And now checking in on this post, peak COVID cover. It's happening. This is all good news, but it's just happening at a pretty slow pace. So this shows a restaurant bookings year over year in the US and globally. And they're very closely tied together, but even as of June 20th, restaurant traffic was still down 60% in the US and across the world. This number probably does continue to get better. It's very difficult to be bullish of food markets until we get to 0% change or even down 20% from the previous year. Maybe we can hit that through the summer travel season at summer, but thereafter it probably changes. And again, we think all of this stuff plateaus somewhere measurably below year ago numbers.

And we're keeping an eye on the return or the lack of any curve flattening in some of these states that have reopened perhaps premature. So, we can see new confirmed cases of COVID-19 record on June 22nd in Texas. And so again, no curve flattening. And what does this mean for the economy? It seems true even in California, which has been really, really tightly locked down for a longer period of time, but still alive. So, as we learn about know ecosystem of viruses, COVID-19 is not a specialty disease that requires very specific conditions to live. It just lives in human beings that are alive. And so until this thing is dead or eradicated via vaccine, there will be these questions about demand growth.

And so whether states or the nation goes back into lockdown... That it's purely a political move, and we don't think that politicians or the public really has the appetite to go back into lockdown. So maybe this is something that we just live with, but I do think that there will be a measure of caution on behalf of a lot of the population and of course people who are sick or out of any kind of spending game for two or three weeks. And so this is still here, and it has not gone away. We just want to highlight that and that Black Swan can fool us once, but we do not like to be fooled twice.

Gasoline consumption is recovering along with restaurant traffic, but still down 9% from last year. And again, do we think we'll plateau maybe 4-5% down from last year based on negative US and world economic growth projected through the end of calendar year 2020. Ethanol production looks very similar. The recovery has been pretty impressive, and it's happened faster than expected, but to meet the USDA's projected ethanol demand draw, 4.9 billion bushels, weekly ethanol production needs to average 295 million gallons per week starting in July. The latest data released this morning showed production through last week at 262 million gallons, so there still is a lot of work to do to prevent a further swelling of old and new crop stocks in the US and globally.

I think COVID-19 too has not impacted bio-diesel production as much, but it has eliminated growth. So the October to March year based on soy oil marketing year it's down 95 million gallons or about 10% from last year. Calendar year bio-diesel production in [inaudible 00:10:45] has not changed. But where does the demand growth come in soybeans? It's not China. It's certainly not the bio-diesel market. And it's certainly not the meat market based weak meat production group. In speaking of China, we need them to step up by now. This has been a talking point for a long time. We don't think China meets that target, but if that target is still in play, through April they have spent officially about $4 billion on USA ag goods of all kinds, and they need to meet 36 billion by the end of 2020, this pace needs to change considerably.

Now, some of these numbers will get higher. China's bought now up to 2 million tons of soybeans in the last 30 days, but that will all be calculated once those beans are shipped. And those are mostly for new propositions. So, I think we'll see China spending on ag goods to stay fairly weak probably into data released in June, July. And we don't think that they get to the $36 billion target given that there's potential change in the US administration coming later this year. And partial because of China. I think the trade war started off a lot of unseen consequences. We've seen the US ag balance of trade being negative more often than not. So on a value basis, the US has been a net importer of ag products in three of the last four months. And as of April, the value of ag imports exceeded exports by a pretty sizable $730 million. So you can see that the US ag trade balance was a pretty sizable part of US GDP growth, to be honest, prior to 2018. Now we're really struggling just to keep net exports sustained on a month to month basis.

And as we start to look at weather for the first half of summer and into the month of July, again, like I mentioned, it's just hard to find a real bullish weather story. It will be fairly warm. The discussion already in the markets is centered on overnight temperatures in the upper 60s perhaps looks 70s, and that's been a talking point. Really in a sense that's what it's suspected to have drawn down corn and soybean yields in 2010, but we've also gone through a pretty warm overnight temperatures as in 2016 and 2017. [inaudible 00:12:59] no material impact on corn yields. But aside from maybe as we reach into July, soil moisture looks to be pretty adequate. And again, we've got corn pollination probably do in the principal corn belt in the next three or four weeks. And so we'd need to see a major change in its trend if there's going to be a weather threat and known supply loss.

And one of our big things since the beginning of summer is the upper at atmosphere worldwide, which has been very, very fast move. So the jet stream moving across the United States has been very, very fast, and that just gives us changeable weather patterns. So if we do see some, high pressure ridging promoting heat and dryness for a few days, it just can't be sustained because of the jet stream is moving so fast. We will bring in a different weather pattern every three to five days. And that's what's given us pretty good weather so far today. So anyway, five day preset ending June 23rd has been pretty heavy. Eastern part of Nebraska, Iowa, really into the whole central part of the Midwest. Especially where Iowa borders all surrounding states, it's a really, really concentrated corn area and soybean area. We can see one to three inches pretty widespread there. Even prior to this, there wasn't any major lasting dryness, talk about outside of the western plains. And so soil moisture anomalies as of June 23rd mostly positive, especially for the primary corn and soybean producing areas.

And there's more to come. Even know as human based forecast this morning includes pretty heavy rainfall across the Eastern Great Plains, Iowa, Wisconsin, Missouri, even Illinois. This is the 10 day European model forecast, which has been the better performing model all summer. But we still have additional modest boots and soil moisture across most of the Western corn belt into the Southern Midwest, Midsouth, whole of the Delta and Southeast. So the far southern corn crops started pollinating several weeks ago, but now it's starting to pollinate in Southern Illinois, Kentucky, and Tennessee, and under some pretty favorable conditions. So it will be warm, not excessively hot. Soil moisture will be very, very good. And those crops in the Midsouth should finish pollination really in the next 10 days. 10 day forecast looks pretty good.

So again, there's just hard to find any kind of major weather story. For the month of July for what it's worth, the CFS latest model forecast is pretty normal. Perhaps some heat east of the Mississippi River, but otherwise no glaring threats to production. We're also looking at a pretty favorable weather pattern in Canada, so that should add to high protein wheat supplies. Oilseed supplies too. We think that canola crop could be pretty big this year. So again, just highlighting this very difficult times, kind of bullish weather story worldwide. And now that we're through the first half of summer, so here's where we are. And this is where we've been. The corn market especially will be dominated by oversupply. There's no way of really changing that at this point. The question though is how the market solve this problem, I think, moving forward.

So here are just some weather scenarios for the 2020 crop year. Now, let's assume we do [inaudible 00:16:06] takes the top end of yield off of that national yield of 173 and a bit lower acres as a result of that. Assuming, we think, pretty normal demand growth, we still have in stocks at nearly 2.9 billion bushels best case. If we post a new record corn yield this year, 179, we add to feed residual use, but we come up with in stocks about 3 billion bushels. So in neither case, this corn need to be valued about 3.50.

And at what point do we start to switch acres both here and in Russia and Ukraine, perhaps in parts of South America, we think that that is solved through lasting period of low prices. I don't know if the goal of the market is to send the corn to 2.70, or if corn stayed at 3.20 for 12 months, both seemingly would accomplish that. Trimming acres, finding all available to me, but that is the story for corn over the next eight to 12 months. Major export of corn stocks [inaudible 00:17:05] in 19%. Again, the market will be defined by competition for export demand. Major export and corn production is growing significantly. Growth in total world trade is not growing that much at all. So we have more bushels competing for less demand growth in terms of trades.

And there's oversupplies. What does it mean? We're starting to compare what it's probable size of crops against storage capacity that we know as of now. And so we think that on-farm storage will only be able to store it just over 60% of the combined corn wheat and soybeans supply in the US in 2020. So this has been trending downward as yield surged and investment in storage outside of the primary corn belt has actually been in decline over the last decade. This will have, I think, a meaningful impact on the cash markets for the foreseeable future. Isolating Illinois, for example, big crops can't be stored, they'd have to be sold, and so there was a broad relationship with whether we can store the crop in basis levels.

This slide shows how much of the corn and soy crops can be stored in Illinois. First harvest basis. Harvest bids do already reflect this, but this suggests that corn basis will be 25, 35 below Chicago futures for the foreseeable future. This is where bids are currently for new crop, but those bids probably won't change. They're not just being floated out there to grab supply or to encourage selling in the nearby positions. This is a valid basis for the central part of the Midwest. So basis will probably be weaker than the last several years.

And this is really the crux of the argument in terms of over supply and its impact. So this shows the stocks to use versus average cash price curve for corn and where the USDA forecasts are. We don't have any major problem with these forecasts. The 2020 season average cash price of 3.20 for corn looks a bit high, but we can see that this curve gets very, very flat as stocks to US growth. And so, as it approaches infinity, let's say that the curve doesn't move very much at all. In that sense, the 3.20 cash corn price is probable. But we did want to highlight just how dislocated it is from the curve as it stands now. And it gets us into this argument of despite having corn at 3.40 in December, is this a place that should be sold? Should we be looking at capturing revenue if December corn does go to $3 or 2.80? Neither price is very attractive, but we'd rather be a part of capturing that 40-60 cents than ignore it.

And we also look at this chart from context of 2021 crops and the premium to the curve here. And so in spite of not being very attractive we are urging producer clients to be very proactive in marketing for this year and for [inaudible 00:20:13] because as we're growing supply and the US has oversupply of corn, there's still no mechanism to change those globally. Because the South American economies aren't shambles, especially because of COVID and because of the lack of political leadership, currencies in Argentina in Brazil have really, really weakened over the last 30 days. So this slide has been shown up before at Midplains webinars, but we wanted to point out that still corn is six times more expensive than it was in 2014 in Argentina. In Chicago, it's down about 40%.

And so this shows the difference between prices then and pricing now in the US, which are down. There's still massive profitability in South America, and the same is true in Brazil. And the real has only gotten to record lows in the last month. So it makes more sense, and growing corn in Brazil makes more money than it has ever made even at today's prices at world trade. And the USDA surprisingly this early has acknowledged this. They forecast higher seedings and yield and production in South American corn belt sheets for 2021. So these are the crops that will be planted this October and November. Even in the last June, USDA raised Brazilian corn production by 1 million tons, which was an unusable usual move, but does make sense given the weakness in the real.

And so assuming normal weather, South America will produce a record 157 million tons of corn compared to 151 million tons this year, which is also a record. And so ever expanding production outside of the US is the story unless the US dollar collapses by 20-25%. So production elsewhere is getting higher. We will probably have a record corn crop this year. This shows the difference between growth in corn production of the major exporters in growth in total world trade. So over the last three years, world corn trade has rallied to new records in each year and outpaced growth and production of the major exporters. But for the first year, so 2015, 2019-20 export of production will be nearly 15% from the previous year. World trade will be up only 4%. And so there's this discrepancy between what we're producing and what is being consumed. And probably the US will be forced to store corn. And Brazil, Argentina and Ukraine will be awarded export business starting in October.

We mentioned that the value of government systems, which is very, very nice and helpful will be at record levels. So this is from FYDRS, 2019 and 2020 forecast direct farm payments. But we think it's probably gets closer to 45 or 50 billion. So by far record. Particularly as this is an election year, the farm lobby is probably stronger than it is during election year, especially presidential election year. So I don't think that the farm will be ignored. It would just be simply government payments. And so more and more over farming for these government payments. So, it's good and bad, but we do want all [inaudible 00:23:32] clients to have everything lined up, all paperwork done and ready to collect every possible amount of aid that's given.

So we also think that this oversupply is going to be a [inaudible 00:23:48]. And so we don't think that corn acres will be cut by more than 8 or 9 million, maybe not by more than 5 million, but assuming harvested corn acres in 2021, because of the lasting period of what prices are cut by nearly 9 million acres, normal trend yield will put us at 180 bushels an acre for probable yield next year. Because we're carrying so much corn over into the next crop year, we're still looking at 3 billion bushel in stocks. And so it's just going to be very hard without a demand driver to solve this problem of over supply. And so that's the message that we want to deliver in this webinars, that everything looks pretty bad now, but there's just not much to change it in the next 12 or 14 months. And so, again, I highlight this. If you think about where December '21 futures are, 3.70 or better. I think that's a sell anywhere close to 3.8 because of it's premium to what probably will be seasoned average cash prices of 3-3.20.

Even if there are yield pickups here or in South America, it's just very, very hard to alleviate oversupply without something new like the ethanol program. We don't see anything like that. Perhaps Chinese may would help the US market, but now we're fighting with China, and so we're not sure phase one deal will actually be executed to completion. And so that's kind of a message, and it's not a good message, but oversupply and a lack of demand growth sort of argued for the last period of low prices. And so it does pay to be proactive in marketing in this case. Selling out of the money calls will provide nickels and dimes added to revenue. Again, 2021, these corn futures could be 70 cents of weather premium at the moment, which goes away over time if there are no major issues. And so that is kind of a strategy at that resources. It's being active and looking forward for opportunities. So again, I thank everyone for attending this, and we are always here to help with questions and marketing strategies. Just please reach out at any time. Thank you again.

Richard Uhrenholdt, Midplains Ag:

If you have any questions for Ben, be sure to email, get them to us, or you can email Ben at buckner@agresource.com.

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