Agricultural markets are smarter than oil

By Steve Kell

The past three months have seen the unravelling of empires as oil prices plummet and industry, government, and individuals struggle to balance the books as an energy-based economy struggles to react to the massive shift in prices.

There are theories being floated that the dramatic drop in oil values was deliberately contrived to damage the Russian economy and force Putin into submission, or that Middle Eastern terrorism is largely funded by oil, and therefore lower oil prices would imply less funding for radicals. However, although these conspiracy theories make for great dialogue, they simply fail to bear out in fact. The reality of the situation is that the massive increases in oil production, which were brought around by high prices, have simply created a market which has more supply than demand.

Since 2008, oil production in North America has almost doubled. In fact, the United States’ oil output has increased by over 3 million barrels per day (the equivalent of increasing as much as Canada and Kuwait’s oil production combined). It is really no small wonder why oil prices have collapsed, but rather why it took so long for the market to react to excess supplies.

Agricultural markets understand this lesson extremely well. Especially in February and March of each year, the futures and cash markets trade around the estimates of farmer’s planting intentions for the coming spring.

Between now and the end of March, we will see at least 5 “planting intentions” reports, which, based on typical yield estimates, will provide estimates of the coming year’s grain production. There are several reports from market analysis firms (such as FCStone and Informa) that come out in March but the USDA report carries the most weight.

The production estimates are laid against the known demand calculations, and by the end of March, grain markets are already trading at values which take into account future production, usage, and carry-out. Unlike the oil market, where prices did not react until after a prolonged surge in supply, grain prices will be reflective of the estimated September 2016 ending stocks by the time that we start planting Ontario’s 2015 crop.

My grandfather taught me that if you wanted to strike out on a straight plow furrow, you needed to pick out a target that is a long distance straight ahead. Grandpa’s been gone a long time now, and we don’t use moldboard plows anymore, but his advice is remarkably applicable to the grain market. If we’re going to build crop budgets and marketing plans for the 2015 production, they need to be based on estimated carry-out at the end of that crop’s marketing year. For example, we know that U.S. corn demand is currently about 13.9 billion bushels for 2015/2016, and that the trend-line yield estimate is 162 bushels per acre. In short, the United States needs to harvest about 85.8 million acres of corn this coming fall, which means that they need to plant about 93 million acres. As we approach the planting intentions report season this spring, that 93-million-acre target will be the tipping point on whether prices rise or fall. In the case of soybeans, the tipping point on planting intentions is at about 81 million acres based on last year’s yield.

In spring 2013 and 2014, the planting intentions estimates released at the end of March set the stage for the downward slide in grain futures prices through both of the following summers. Should planting intentions come in lower this spring, it will trend higher, but in either case, unlike oil, grain values will remain clearly fixed on anticipated supply. Weather events throughout the planting, growing, and harvesting season will impact the price as they tweak the supply estimates, but it is in the planting intentions that the grain market’s cards are dealt for the year.

In the enthusiasm-crazed oil business, investors got drunk on the early success of the post-2008 global recovery and over-invested in expansion projects with no real regard for the market’s ability to digest the supply. In that sector. The march forward from here is a painful slowdown where high-price producers get forced into shutdown, while their investors and employees endure the brunt of that pain.

Stable, steady old agriculture, much like my grandfather’s plowing, will just creep along, eyes firmly fixed on the long-term market potential and making the necessary adjustments to stay in line with its target.

Steve Kell operates a crop farm in Simcoe County and is a grain merchant for Parrish and Heimbecker Ltd. in Toronto.