The year is concluding on a much-different but substantially more-profitable note for U.S. grain elevators than we had been expecting as recently as four months ago. The 2020 growing season began with a dramatic COVID-19-driven economic recession, considerable trade uncertainty and – following the March 31, 2020, Prospective Plantings report – expectations for a very-large U.S. corn and soybean crop. The season had a favorable start. Crop progress for the three major grains were much better than average for the past five years – until late July 2020. Then came the Iowa derecho weather event that inflicted damage on crops and grain storage facilities, followed by hot weather, dryness and crop stress. Fast forward to November and the World Agricultural Supply and Demand Estimates production estimates. Ending stocks had tightened considerably, confirming the recent price rally in U.S. grain prices and creating a very bullish picture heading into 2021.
Amidst the commodity price rally, grain elevators found themselves in an ideal trading environment because of an intersection of factors.
- Early in the 2020 growing season expectations for a large crop resulted in reduced estimates of average farm-gate prices at harvest – specifically $3.20 per bushel for corn and $8.40 per bushel for soybeans.
- As prices began rallying in the fall toward $3.75 and $10.25, respectively, growers began contracting with elevators in order to lock in what had previously been unobtainable profits for the 2020-2021 crop.
- Then as prices further strengthened, elevators were able to sell stronger basis – after having already bought basis cheaper – into a marketplace with robust demand from both local processors and export sales to China. The aforementioned grain-trading activities increased the need for borrowings by elevators to fund the mismatch between current cash outflows for grain purchases and delayed capital inflows such as payables from processors and exporters. While that has caused financial leverage to increase, CoBank views it as temporary and manageable by elevators.
In the near term corn and soybean prices should continue to be supported by several items.
- concerns about the size and quality of the Brazilian and Argentinian crops due to expected dry weather conditions related to La Niña
- strong export demand by China
- steady domestic feed demand
- stable U.S. ethanol production
While wheat prices had been on a bullish uptrend recently – driven by drought conditions in the western U.S., tighter U.S. supplies of soft-red-winter wheat and dry weather in key regions that compete with U.S. wheat exports such as Russia, Ukraine and Argentina – both cash and futures prices have pulled back recently. The relaxing of export quotas on exported Russian wheat and a return of Australian wheat production are additional bearish factors for wheat prices. The inversion of forward price curves, especially for soybeans, will continue to result in a backwardation market environment during early 2021.
Looking toward the start of next year’s U.S. spring-planting season, we expect the market to begin factoring in large planted-soybean acres in 2021. Should acreage and yield expectations increase beyond current trade estimates, cash prices might correct and therefore the forward curves could flatten. But as we discuss later, we see a great likelihood of futures price volatility and therefore lack a reasonable basis to make a call for normalization at this time.
The China Situation
In recent months China contracted to import a considerable amount of grain, which underpins USDA’s 32 percent expected increase in total U.S. corn, soybean and wheat bushels exported during calendar year 2020.
China’s appetite for U.S. grain is driven by several factors.
- There’s a need for animal feed – soybean meal and corn – as the country rebuilds its hog herd following the decimation caused by African swine fever.
- There are local crop shortfalls due to flooding and COVID-19 production disruptions, which has increased the price of local grain.
- There’s an increase in purchasing power resulting from weakness in the U.S. dollar relative to China’s yuan throughout 2020.
- There’s an apparent desire by China’s government to satisfy some of its obligations agreed upon under implementation of “phase one” of the U.S.-China Trade Agreement signed during first-quarter 2020.
Looking forward, market signals appear very bullish for continued China purchases although we continue to vigilantly monitor the relationship with booked sales and accumulated exports. We would also point out that during the long-term, there is risk that China will contract for grain from sources other than the United States.
Our bullish opinion about continued grain purchases by China in the near- to intermediate-term stems from three variables.
Core demand – China needs to feed its people and will continue to expand its animal-protein-production capabilities, a positive demand driver for U.S. soybean, soybean meal and corn. Note that the U.S. Department of Agriculture’s recent quarterly outlook for U.S. agricultural trade – which projects that U.S. ag exports will reach $152 billion for fiscal 2021 – factors in an $8.5 billion increase relative to its August 2020 report of ag exports to China, primarily due to strong soybean and corn demand.
Foreign exchange rates – the U.S. dollar is forecasted to weaken further relative to the Chinese yuan during the next two years, as well as relative to the Brazilian real and the Russian ruble. The significance here is two-fold. First, U.S. grain will remain cheap to China in “absolute” terms due to favorable currency translation. Second, U.S. grain becomes increasingly attractive in “relative” terms to Brazil for corn and soybeans and to Russia for wheat.
Economic growth – although China’s reported economic figures are often suspect, the country’s post-COVID-19 economic recovery seems to be gathering momentum based on several anecdotal channel checks. As vaccines become available and widely distributed, an increase in global general economic activity would be positive for China’s economy and incrementally positive for ag exports to the region. We are closely monitoring factors related to logistics, specifically container demand vs. supply. While U.S. railroad, barge and trucking operators have managed the flow of grain exports quite well – with only minor bottlenecks arising nationwide – a shortage of containers in Asian ports due to growing global trading activity could be a risk factor in 2021.
Another positive could come as a result of the change in U.S. political leadership. We expect a more-favorable dialogue between President-elect Joe Biden’s administration and China as well as other key ag-export markets. At present the weaker outlook for the U.S. dollar vs. the Chinese yuan, Brazilian real and the Russian ruble makes U.S. exports quite price-competitive.
Balancing all factors, we envision two likely scenarios unfolding for U.S. grain elevators during the next six months.
- The optimistic scenario is that the backwardation in commodity-future prices reverses, creating opportunities for elevators to buy cheaper basis and capture carry. That could occur in the event of a milder La Niña, which would result in large Latin American crop production, a significant increase in planted U.S. soybean acres, and a temporary or more-permanent reduction in U.S. grain purchases by China. The cumulative impact would exert downward pressure on cash prices.
- The pessimistic scenario and one we see as more likely, is that elevators could be forced to the sidelines amidst an increase in commodity price and a limited ability to buy basis “right” to capture carry. That situation could occur with volatile and/or dry weather and continued robust but unsatisfied soybean demand from both China and domestic processors. That would exacerbate already-tight supplies.
Grain has been flowing with considerable momentum, following an orderly fall harvest and amidst a sharp unexpected price rally. That has allowed elevators to capture exceptionally strong merchandising margins as the current marketing year has been pulled forward amidst backwardation in futures prices. The inversion of futures prices – especially for soybeans and corn, which are more pronounced than wheat for 2021 contracts – will likely continue for the foreseeable future. As such we see limited opportunities to buy cheap basis and capture carry. That being said, grain cooperatives that also have farm-supply retailing operations should see a resurgence in input demand as growers spend money on off-season applications and prepayments for next season’s inputs.
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