Tuesday, July 1, 2008

US cropping woes take out some down-side price risk

Floods in the US Midwest have certainly knocked a hole in US grain production, but seasonal conditions from herein will largely determine the extent of damage. Production will be lower due to planting losses, but how much lower will depend on the recovery of the crop and conditions through the crop yield forming phase in July/August.

How much down-side have US crop problems taken out of grain prices?
Reduced US corn production and the rally in US corn values mean that the US will keep more of its wheat and corn at home. We are already seeing the impact of this in greater Japanese interest in our sorghum, and a big Black Sea surplus is now pricing itself into north Asian livestock feeding markets.

Also, importers will be reliant on the Black Sea for a much greater proportion of supplies this year, which may add to market volatility. And now that there will likely be another reduction in all-grain stocks, markets will be more sensitive to potential crop problems in the Southern Hemisphere. Crops in both Australia and Argentina have been sown on less than ideal moisture.

But while we believe US crop problems have taken a big chunk out of down-side risk, we don’t think there is tremendous upside in the near-term unless there are more significant crop problems. Unless the US corn crop deteriorates further, we expect corn prices to fall back to a range between $6.50-7/bu. Wheat has now reconnected with corn and will trade between $1-1.50/bu above corn.

The key risks to grain prices now appear to be a retraction in oil prices or the imposition of restrictive measures on financial investor activity in commodity markets. Given that over 30% of the US corn crop goes to ethanol production and ethanol competes against gasoline, corn break-evens for ethanol production are sensitive to movements in oil prices. Tough measures to restrict the activity of financial investors in commodity markets would lead to some liquidation of long positions and pressure commodity markets.

The message?
US crop problems have now balanced up-side and down-side price risks and it is not worth taking on unacceptable levels of production risk to fix current prices. We already have 30% sold in 2008 and 2009 and this is enough considering the significant production risks that many are faced with. If financial investors are booted out of commodity markets, we are covered to some extent by our 2009 positions.

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