In the eye of the storm

by Arvin Donley
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Against the backdrop of crude oil futures reaching $134.35 per barrel and wet weather delaying planting in the U.S. Corn Belt, Sosland Publishing Co. held its 31st Annual Purchasing Seminar June 8-10 in Kansas City, Missouri, U.S.

Approximately 650 executives from throughout the food industry attended the meeting to learn how the commodity markets may evolve during the rest of 2008 and into 2009.

"It’s not a coincidence that this year’s seminar attendance was the largest ever, given the magnitude of the impact soaring commodity prices are having on food companies, consumers and economies around the world," said Sosland Publishing President Mark Sabo in his opening remarks.

The prevailing sentiment from the seminar speakers was that end users of commodities such as corn (maize), wheat and soybeans shouldn’t expect relief from high prices anytime soon.

"Commodity inflation is a reality," said William Lapp of Advanced Economic Solutions, Omaha, Nebraska, U.S. "We are in the midst of a tremendously challenging environment in terms of higher commodity prices."

Corey Dencklau, director of grain products for Gavilon LLC, Omaha, said a "perfect storm" of factors have conspired to drive grain and oilseed prices higher. They include but are not limited to:

• market speculators, with few other attractive investment options, investing large amounts of money on commodities;

• an increase in biofuels mandates and production worldwide;

• a growing middle class in China that now has the money to spend on meat products, which means greater demand for grain-based animal feed;

Add to that the widespread flooding of the Midwestern U.S. in June that threatened to wipe out millions of acres of corn, soybeans and wheat, and the stage is set for a very bullish market over the next few months, Dencklau said. For the current year, up to 5 million acres of corn were at risk of abandonment or of not being planted because of the weather, he said.

There’s also concern about yield loss. Jon B. Davis, chief meteorologist for the Chesapeake Energy Corp., Chicago, Illinois, U.S., said the fourth wettest spring in the past 114 years caused planting to be delayed in many areas. The stage is set, he said, for the latest corn crop pollination l since 1995. "The risk is higher because of the lateness of the crop and the potential for hotter, drier weather in July and August," he said. "I would be stunned if there is not an issue that afects yield this summer."

Dencklau noted that the U.S. ethanol industry, which use s corn as its primary feedstock, is starting to suffer from corn prices hovering consistently in the $7-to-$8-per-bushel range.

"Ethanol producers are still profitable at $6.25 (per bushel.)," Dencklau said. "With the increasing prices of corn and the widening of the cost of ethanol versus unleaded gasoline, margins are now negative. When profitability drops below zero, plants cut back production."

In I late l June, VeraSun Energy Corporation, the second-largest ethanol producer in the U.S., announced that it was delaying the startup of operations at several of its plants.

Dencklau noted that the trend in U.S. ethanol production has been for annual output to exceed the Renewable Fuels Standard mandate. But that may change if the price of corn remains high in the long term.

"The RFS gives guidance, but economics dictate how much ethanol is produced," he said.

The spike in corn prices and the impact it is having on food prices in the U.S. has led several politicians to petition that the RFS be waived for one year to stabilize demand and lower prices.

William Lapp of Advanced Economic Solutions said a change in the RFS mandate, which will require another 9 million acres of corn over the next seven years, is probably inevitable.

"I believe there will be some sort of reform, whether it’s a reduction in the mandates, changes in the blenders’ credit or reduced tariffs on ethanol imports," he said.

Steven Freed, director of research for ADM Investor Research Services, Inc., Chicago, Illinois, U.S., disagreed. "I think the EPA (Environmental Protection Agency) will only change the RFS in the case of a disaster. I don’t expect Congress to change that mandate anytime soon."

As of June, the ethanol industry was projected to use 4 billion bushels of corn in 2008-09, which is 30% of the domestic use for corn, Dencklau said. In 2007-08, 2 billion bushels of corn were used for ethanol production.

With demand for corn growing, Dencklau said the U.S. will need 9 million more acres of corn in 2009 than the projected 87 million acres in 2008 to meet demand.

Lapp said one possible solution is for the U.S. government to free up more Conservation Reserve Program (CRP) acres. In September, 1.2 million acres are being moved out of the program and will be eligible for crop production. Another 8 million acres of CRP land is scheduled to be transferred back into production in 2009 and 2010. Lapp said it might make sense for the government to make all 9.2 million acres eligible in September 2008.

"That would be one way to help resolve this imbalance," Lapp said.

Freed predicted that wheat values would "attach" to corn, even though wheat currently was being overvalued at the Chicago Board of Trade, where it traded in the $8.50-to-$9.50-per-bushel range in June.

From a supply standpoint, there is good news in that key wheat producing regions such as Europe, Canada, Australia, Russia and India are expected to increase their output over last year. World wheat production is forecast to reach 615 million tonnes, compared to 606 million a year ago. For the first time in four years, world wheat ending stocks are forecast to increase to 124 million tonnes, compared to 110 million tonnes in 2007. However, world wheat usage is expected to be a record 642 million tonnes.

He also noted that the total global demand for corn, wheat and oilseeds will exceed total planted area for the combined crops.

"For the first time, total demand for those products is higher than what was planted," Freed said. "If we expand the demand curve 2.5% per year, which is our recent growth, the spread between demand and acres gets wider. We need to plant more acres and increase yield technology or prices will remain firm."

Because of the weak dollar, wheat prices are lower in the rest of the world than in the U.S. Freed said the larger wheat crop and smaller corn crop will necessitate the increased feeding of wheat, especially soft red winter.

Despite only modest growth in U.S. biodiesel production, soybean oil prices surged to record high levels in 2007-08, propelled upward by a smaller soybean crop than expected, said Paul Meyers, vice-president of commodity analysis for Connell Purchasing Services, Berkeley Heights, New Jersey, U.S.

The U.S. Department of Agriculture (USDA) in June estimated U.S. soybean planted area in 2008-09 at 74.5 million acres, up from 63.6 million acres last year, which was the smallest area this decade. The USDA also noted that soybean stocks in all positions as of June 1, 2008 were at 676 million bushels, down 38% from June 1, 2007.

Soybean oil use in biodiesel production, which nearly doubled in 2006 from the year before, climbed less than 10% in 2007 and may increase even less than that in 2008, Meyers said.

Stocks of soybean oil, which had been at burdensome levels throughout 2006-07 and early in 2007-08, have begun to give ground more recently. As a result, cash soybean oil premiums have rallied form historically depressed levels prevailing earlier in the crop year.

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