Then there is the troubled energy sector. Yep, we’re talking precipitous drop. (But, hey, what hasn’t experienced huge price declines. It’s a big boat and everyone in nearly every sector is in this together.) Gasoline, for example, has had an incredible 75% price break from last summer’s high. When it was time to fill up at the pump or fill the diesel barrel, no one complained. Unfortunately, trouble was brewing for ethanol too as it also experienced a massive price decline; another of the key reasons why corn prices have declined so drastically. Yet, ethanol refineries have struggled to maintain profitability despite that monstrous drop in corn prices. With ethanol rack prices near $1.60, ethanol plants can pay roughly $3.40 for corn and breakeven. This situation has been made worse by the recent near $1 rally in corn futures when crude and gasoline future contracts continue their descent into new lows.
Ethanol demand has fallen off a cliff. A slowing economy has reduced the demand for all energies. However, the key reason behind the slowing ethanol use has been the steady increase of the ethanol/gasoline price spread. When crude oil and gasoline were trading at this past summer’s high, the price of ethanol was at a sharp discount to the price of unleaded (RBOB). Demand was soaring then for ethanol but not so much today. Ethanol is now priced, at least in the price of futures, at a near 60 cent premium. This is more than the amount of the blender’s credit, making it challenging to blend ethanol into even E-10. Local retail stations, where E-85 is available, report demand for the ethanol rich blend as only a fraction of summer-time levels. Most consumers have vacated the green fuel unless they can save at least 20% at the pump due to reduced mileage of the fuel. (Side note: This is another in a long list of examples of just how cash-strapped our consumer has become). With the national average gasoline price trading at nearly $1.70, ethanol would only be competitive if consumers could buy E-85 ethanol at $1.35 per gallon. Such a low ethanol price would mean corn would have to be priced at only $2.40 for the plants to breakeven. Without a doubt, one solution would be if EPA were to permit changing the blend levels from E10 to E15 or E20. But keep in mind another possible outcome of this situation could be a rally in gasoline prices and STEADY ethanol prices. Let’s explore that possibility.
The December/January price time represents the time when gasoline has a very strong seasonal tendency to bottom out. This chart, from Moore Research (known for their historical studies), shows the 5, 15, and 25 year historical price patterns for gasoline. Commercials will use the time-tested patterns to soon establish buying programs for the summer driving season. Fact is that the gasoline seasonal tendency is so strong that gasoline has rallied 14 out of the last 15 years from the middle of January to the end of March. The only year failing was 1997. The last 5 years, the market has averaged a 77% gain from the seasonal low to the spring high. Using 90 cents as the low, the high would compute out nearly 70 cents higher, or near 1.60 per gallon. I would also be remiss to fail to mention the impact a further deteriorating US Dollar may have on the energy market. Always keep one eye on the ‘ole greenback!
What about exports?
There is little doubt the bears have a legitimate concern with the current export pace. I tend to concentrate on the sales pace as opposed to the pace of shipments….you can’t ship something that is not sold. Nnetheless, the fact is the current export sales pace is really rather pathetic.
Export sales are accumulating at the slowest pace in 5 years. This has forced USDA to reduced exports in the most recent Supply and Demand outlook to an annual pace of only 1800 million bushels. Abundant and cheaper feed wheat in the world is one reason for the slow pace. Surely the credit crisis has negatively impacted our export sales also since the credit markets have seized up like a rusty shaft to a sprocket. Confidence has been destroyed, especially in bond rating agencies. Lenders suddenly didn’t know who they could trust to repay the lines of credit. These lenders focused more on return Of money as opposed to return On money. Buyers decided they could do without all the hassles of securing credit and elected to forego new purchases while waiting for the dust to settle. Grains are not the only thing not selling across the world’s seas.
Demand for nearly anything that is shipped internationally has dried up. As a result, the cost of shipping that product, the freight rate, has dropped like a rock. The best barometer for gauging the freight rate is the Baltic Freight Index shown in the chart to the right. Like many financial instruments in 2008, the BFI has been extremely volatile. Lessee’s, after the painful realization they had bought the top of the market and were finding their customers reneging, defaulted on their contracts with shippers. The freight rates dropped to a mere few thousand dollars per day. This means foreign buyers of US grains can get it delivered for a fraction of previous costs. Since freight rates have nowhere to go but up, this should help create new business in the weeks and months ahead.
November, in countless ways, was a rather tough month. It seemed as it everything was getting sold off, and basis is no exception. CIF corn prices firmed into early October only to be sold off throughout the entire month of November, weakened further by harvest pressures. We are now seeing some firming once again as demand slowly creeps back. Interior bids are being lead higher by the well established processors. Deep interior bids are not as fortunate as some markets are still gun shy to do business with what they consider to be financially weak ethanol plants in this post-Vera Sun world we live in.
Cash grain contacts tell me that many, many bushels went to storage this fall. As winter sets in and the bin doors go shut, I expect the best basis opportunities to be earlier rather than later this year. Commercials have been scale down buyers of corn, taking advantage of lower prices to accumulate ownership that they couldn’t
buy in the cash market. In fact, the commercials are net long 26,201 contracts as of the December 19, 2008 CFTC report. This is down from the previous week’s report of being net long 51,317 contracts! It is good to remember they are natural shorts in the marketplace. Commercials are usually only net long when they feel corn prices represent real value. The small traders are still short but the large traders (funds) are moving to a net long position from a moderate short position a few weeks ago. The commercial traders, after nearly being reduced to grain dust by the funds this summer, likely had a tremendous year after all.
As we look ahead to 2009, the crystal ball is clouded with many uncertainties. We have seen sharp days down in the grains for no other reason than a sharp sell-off on Wall Street. No doubt the dark storm clouds over our economy, as well as that of the world, will remain a formidable force to be reckoned with. Rising unemployment, a nagging concern destine to last well into 2009, seems likely to lead to further demand destructions. More toxic debt is yet to be revealed which could lead to more Wall Street sell-offs, which may lead to more selling of the grains. The key questions: 1.) When will all the bears be in? - as then no one will be left to sell it, and 2.) When will all the bad news factored in? Demand is down from last year, but how much of that is now “old news”?
Most analysts expect total usage to climb again into the 2009-2010 marketing year. Remember the last of the bushels to be produced from the seeds about to be planted won’t be used until August 2010. Therefore, the call for a return to increasing demand requires a respectable crop be, first, planted in sufficient acres and second, harvested in satisfactory yields in 2009. To be sure, the credit crisis as well as soaring input costs for corn will offer serious headwind to getting planted acreage increases. Informa (f.k.a. Sparks), recently released their preliminary acreage estimates. They expect acreage will drop by 4 million acres from 2008 into 2009. I believe them. Marginal acres will not be returned to corn due in a large part to the production costs. Also, the tightening of credit standards should
lead to additional corn acreage lost to cheaper-to-raise soybeans. These could become known as Banker Beans! As you can see in the Outlook projection on page 7, assuming the ‘08/’09 estimates are right (to be honest, further reductions in ethanol usage would not be surprising especially if profitability cannot be restored soon), a 4 million acre drop in corn acres along with a slight uptick in demand will drop ending stocks to under 400 million with a Stocks-to-Use Ratio of only 3.09%, which is simply too tight. Lower fertilizer prices should be a supportive factor that helps maintain corn acres but likely won’t be enough on their own to prompt more corn acres next spring; the market will likely have to help it.
I don’t expect speculators to return to the “blind buying” of days gone by. They are still licking open wounds. That probably makes a BIG recovery out of the question. While the market may be able to eke out a moderate spring-time rally, to turn 2009 into a profitable year, you may need to:
1.) Gain assurance from your insurance. Don’t bank on the truly outstanding yields of the last few years. Mother Nature still controls all the big trump cards despite your best agronomic skills. In fact, with the grain fundamentals dimming, a regional drought could be a real profit killer in that it impacts you but not the market.
2.) Be prepared to sell at lower levels than what you might REALLY want or, for that matter, need. You may wish to evaluate an option strategy (like the 3-way December option strategy on the previous page) now so you have the courage to sell at levels that are below your real desired price levels. But the options leave you in the game should the higher prices come to fruition. Then use a weather scare rally, weather-related or otherwise, to dump the short put options and roll the long call options higher.
3.) Guard at least some of those sales with an option strategy through the summer.
A lot is yet to play out in this extremely volatile environment. Your operation will likely emerge from this crisis stronger and ready to “take it up a notch” if you plan and anticipate. Be patient but nimble, conservative but aggressive. Be frugal with your expenditures. Reign in your capital expenditures. Defend your bottom line.
The long term fundamentals are still very promising. The key is surviving the short-term to get to those brighter times. It’s surely not a time for hero’s play.
Brian J. Brandt
Licensed Commodity Broker, Allendale Branch Office Manager
Licensed Crop Insurance Agent, Harvest Risk Management
(800) 280-5617 Toll-free Office
(815) 541-8982 Mobile
The risk of trading futures and options can be substantial. Each investor must consider whether this is a suitable investment. Past performance is not indicative of future results.