Cash Grain Observations
Market shifts point to tight supplies, varied demand
The 2012-13 growing season and marketing year will go down in history as a year of extremes. The American farmer experienced the worst drought in a half century and a second straight year of sharp price increases for grains. Along with these higher prices came higher volatility, whipsawing grain prices and straining margin accounts; and, after two years of disappointing production, basis have ratcheted up yet again to historic levels.
Not only did the drought affect how much grain was produced, it directly affected its transportation to market. Just one year after severe flooding along the Mississippi River left farm fields buried with silt and debris, the grain industry finds itself navigating some of the lowest water levels since 1988. The extremes witnessed throughout the year have exploded basis to record highs, and shaped unique regional basis trends. The following article outlines the distinctly different trends between corn and soybean cash markets and presents a basis wildcard that could offer opportunity by mid-February.
Strong Basis in Iowa
In the wake of the drought, the average U.S. spot corn basis, the difference between the cash price and the future price for corn delivered this month, has moved 13 cents higher than the same time last year during the 2011/12 marketing year, and 30 cents higher than the four-year average. Soybean basis is no exception, and on average has posted a 19-cent gain across the United States compared to the 2011/12 marketing year.
Figure 1 displays a heat map of basis changes observed December 2012 compared to December 2011. The first major change to note is that Iowa and Eastern Nebraska have enjoyed the strongest basis gains over the last year. These basis gains can be attributed to a 19% and 17% drop in corn production throughout Iowa and Nebraska, respectively. This sharp drop in production has shifted the percentage of corn grown in Iowa, which is used to produce ethanol, to roughly 69% from 56% the previous year. Meanwhile, in Nebraska, the amount of corn used for ethanol jumped to roughly 58% from 48%.
Despite weak margins, the ethanol industry continues to demand corn for delivery this month; and has resulted in stronger basis throughout Iowa and eastern Nebraska. Unfortunately, Illinois corn basis didn’t benefit as much despite also having a strong ethanol presence. This is a direct result of significantly weaker export demand, and the uncertainty surrounding a Mississippi River closure near Thebes, IL. Without stronger bidding competition from the river markets, ethanol facility bids will remain more competitive, allowing them to source their supplies without an aggressive bidding competition.
Soybeans: The River Effect
During the first portion of the 12/13 marketing year, which began on Sept. 1 2012, the pace of export sales has differed greatly between corn and soybeans — resulting in much different cash market landscapes between the two grains.
While corn sales have lagged this year, soybean export sales are running roughly 184 million bushels ahead of the pace needed to meet the U.S. Department of Agriculture’s (USDA) expectations of 1.345 billion bushels forecast in the December 2012 Supply and Demand report. Not only has the export market booked strong sales volume, but exporters have also loaded and shipped the bushels faster than anticipated. Foreign Agricultural Service (FAS) has reported cumulative export sales already meeting 88% of the USDA’s export demand forecast with 61% already inspected for shipment.
This compares to a four-year average of 70% sold and 46% shipped. Figure 3 displays the one year change in soybean basis between the 3rd week in December 2012 and the same period in 2011. This map clearly shows the impact strong export demand has had on river basis. Areas that have not been threatened by river closures, such as the lower Mississippi and the Ohio River, have experienced above average basis improvement by $.24 or more since last year. River terminals north of St. Louis experienced below average basis improvement of only $.14 cents or less due to the uncertainty surrounding river navigation. With the river at risk of closure, many elevators aren’t as motivated to bid aggressively for soybeans if a cost-effective way to ship them to the Gulf isn’t guaranteed.
On Dec. 17, 2012, contractors began removing the “rock pinnacles” near Thebes, IL, which has forced river closures between 6 a.m. to 10 p.m. every day. Barges have been able to pass only during the night and early morning. Removal of the most threatening rock pinnacles at Thebes, IL, is scheduled for completion around January 13, which adds around two feet of depth. Additional runoff from winter storm Gandolf is also forecast to raise the river depth to around 12.5 feet from only 3.8 feet on January 9. Considering the pace of river work, and the additional runoff from the winter storm, it looks more like we will be safe from any significant river closure until mid-February.
For a while now, basis has been depressed at river terminals north of St. Louis because of the possibility for river shutdowns. Now that the river seems navigable for at least another month, we expect to see basis rise quickly at those river facilities. The impact will not only be seen along the river, but will ripple throughout the countryside.
Figure 4 displays the impact to basis after barge rates spike $.20 and shows how a rise in transportation cost along the river is transferred along into the countryside markets. Though in Figure 4 we are observing a negative impact on basis, we believe the improving situation surrounding the river will impact the same areas in a positive way and could provide a basis selling opportunity for country elevators and producers within the Figure 4 “impact zone.”
Though the river situation is improving, and the Army Corps of Engineers is confident that there will be no Mississippi River closure; if the weather outlook deteriorates the situation could change quickly. If a dry weather pattern continues, we could easily find ourselves worrying about river closures in a month. Be wary that any basis improvement along the river could be short lived if the weather outlook once again takes a turn for the worse.
January WASDE Shifts Cash Market
Between Sept-Dec 2012 the national average cash corn price averaged $7.38, enough to slow the pace of export sales and trigger the USDA to revise their export forecast 200 million bushels lower than their previous forecast. However, according to the January World Agricultural Supply and Demand Estimates (WASDE) report, prices were not high enough to ration feed use within expectations, forcing them to revise their feed and residual number 300 million bushels higher.
In response to higher than expected demand the cash curve adjusted sharply following the report. On January 3, the U.S. average cash corn market had a $.09 carry between Spot and May delivery, but that quickly evaporated following the reports release. By the end of the day the carry only posted $.03 cents. The average U.S. cash market is now clearly moving toward an inverted market structure to draw any remaining unsold bushels out of the producer’s bins.
As corn prices move higher to curb demand in the feed sector, export sales will continue to suffer, putting pressure on corn basis at the river terminals.
The soybean cash market has already been inverted for quite some time as a result of tight supplies and strong domestic and international demand. Strong soybean export sales have supported basis strength along the river system. Soybean crush numbers have been off the chart with National Oilseed Processors Association (NOPA) reporting 157.3 million bushels crushed in November, the largest monthly total in three years. Iowa alone showed a 13% YOY increase in bushels crushed in November despite soybean production declining.
On Jan. 3, the national average carry between spot and May delivery was $(-.21) and the January WASDE report did little to change it. Demand this strong doesn’t necessarily warrant prices climbing back to the highs since much of the forecasted demand was expected to be frontloaded, but it does provide a strong argument for near-term price support at least until soybeans start coming out of the fields in South America. Look for soybeans to benefit most from any basis increases north of St. Louis since foreign export demand continues to be robust.
A Difficult Merchandising Environment
The 2012/13 marketing year has been more difficult than most for merchandisers. Not only has grain volume been sharply reduced, but common strategies of buying during harvest, storing it, and selling it later in the marketing year have also been squeezed. Figure 5 displays the national average spot corn basis calculated off the July 2013 futures contract. With basis currently sitting at exceptionally strong levels, it would appear that there is less room to capture basis improvement compared to past years. If you use last year’s maximum basis (the purple line) as a proxy for the upper target of basis appreciation, one can only expect a little over $.14 appreciation in the next six months compared to last year when we observed $.53 during the same time period. However, 2012/13 supplies are even tighter than last year, and we have only started the swing toward an inverse cash market. This suggests that we could easily trade above last year’s basis high as the futures market structure becomes more inverted.
One strategy to consider if you decided to carry unsold corn inventory into the next month, is to hedge that inventory off the July 2013 futures contract. By doing this you put yourself in a position to gain if the corn market continues to move toward an inverse structure which is typical in years when stocks are tight. However, this strategy would not work well if the corn market returns to a carry.
Despite the difficult merchandising environment there are still opportunities in the cash market, whether you find them north of St. Louis because of improving river conditions or by responding quickly to a shifting market structure. Keep a close watch on cash market movements from a national level to help identify and plan for regional opportunities.