By Michael Swanson Ph.D., Chief Agricultural Economist
Food for Thought newsletterSubscribe
The era of cheap gasoline led many U.S. policy makers to assume that growth in consumption would continue, no matter what happened to prices or biofuels policy. This mistaken assumption has put the Environmental Protection Agency (EPA) into the business of trying to balance between Renewable Fuel Standards (RFS) requirements and a new fuel demand reality. How the EPA goes about this politically painful process will be a major price driver for the U.S. grain and oilseeds market.
The USDA continues to use a 2013-2014 corn utilization number of 4.9 billion bushels of corn for ethanol. However, without a major net export surge, there is no way for the ethanol industry to use that much corn to support the domestic gasoline market. Weekly ethanol production and utilization of ethanol is a very seasonal and statistically noisy dataset, and the Energy Information Agency (EIA) has only broken out weekly data since mid-2010. Even so, using a 52-week trailing average helps smooth out seasonal variations. Through the beginning of September 2013, domestic utilization of ethanol is running at 4.53 billion bushels, while domestic production of ethanol is 4.54 billion bushels. There is a 370 million bushel gap between expected use and current demand. With gasoline consumption growth stagnant to slightly negative, there is little likelihood of sufficient gasoline demand growth to close the gap. Likewise, there is little gasoline without ethanol blending (approximately 8% of the total) left for the ethanol market to capture. The EPA effectively admitted the lack of demand opportunity with its reduction in 2014 blending requirements. The RFS calls for approximately 10 billion gallons in cellulosic ethanol production at its peak. The two sources of ethanol combined do not have a realistic outlook given depressed gasoline consumption.
With the largest single source of corn demand stagnant, the markets will have to return to a more fundamental supply and demand pattern. This puts the feed and export markets back in the driver's seat for pricing. This also brings back an old problem of estimating the feed consumption. The USDA has always used a residual method for feed estimation. It basically accounted for exports and FSI usage combined with changes in "reported" stocks with the difference being attributed to feed consumption. The USDA assumes that exports, FSI (feed, seed and industrial usage), and stock numbers are "hard data" given the detailed and timely reporting. Given the large adjustments that reported stocks have seen with more on-farm storage, this residual method for feed usage has some serious problems. This should lead to more "noise" in the supply and demand tables which will create more price volatility every time the markets get caught flatfooted by a report.
The USDA's reported feed numbers have been very volatile over the last five years with a high of 5.9 billion bushels in 2007-2008 and a low of 4.4 billion bushels in 2012-2013. The major decline in feed usage was not accompanied by a similar major reduction in meat production. In part, expanded usage of DDGs (Dried Distiller's Grain) filled some of the gap, but there is still a large gap between what can be explained with DDG growth and the feed/output ratio. With feed usage reclaiming the mantle of "market maker," this gap will be a source of uncertainty. The USDA needs to improve its reporting on stocks and DDG use to keep the market better informed.
Following feed usage in importance for price discovery, exports will also supplant ethanol in the pricing process for grains. The good — and bad — news is that China has supplied 90% of the U.S.'s net gain in agricultural trade surplus. With so much of the gain coming from one trading partner, the Chinese ability to disrupt markets increases significantly. To date, the Chinese Central Bank has remained on its long-term path of strengthening the yuan, but currency policies can be changed overnight when priorities change for decision makers. After accumulating a trillion dollars and more in U.S. Treasuries, the Chinese Central Bank has appeared to reach its limit for that asset position. Like every other holder of Treasuries, it cannot be happy with the losses it is taking on the position. Unlike most other holders of Treasuries, China did not acquire them as an investment but as necessary result from its "cheap" yuan strategy from the 1990s and 2000s. The current strategy of a strengthening yuan and growing Chinese economy support for U.S. agricultural exports to China, but they put too many eggs in one basket for the American grain and oilseed market.
With ethanol stuck in neutral, the return to a feed and export driven grain and oilseed market is a natural trading development. Unlike the previous supply and demand table trading era, this current trading era will be driven by direct exports and "embedded" exports through protein. Twenty percent of domestic poultry and pork production gets exported. Dairy appears to be chasing them to a similar level, and even beef has become neutral in terms of net exports. All of this is a natural development of in terms of population and relative income growth, but exports will always be a much greater source of volatility than domestic markets. In summary, we will exchange the energy price volatility for trade and global economic volatility in the new phase of agricultural trade markets for the U.S.
Michael Swanson is a senior agricultural economist and consultant for Wells Fargo, the largest commercial agricultural lender in the United States. His responsibilities include analyzing the impact of energy on agriculture and forecasting for key agricultural commodities such as wheat, soybeans, corn, and cotton, and livestock sectors, such as cattle, dairy, and hogs. Additionally, he helps develop credit and risk strategies for Wells Fargo's customers and performs macroeconomic and international analysis on agricultural production and agribusiness.
Michael received undergraduate degrees in economics and business administration from the University of St. Thomas in St. Paul, Minn., and both his master's and doctorate degrees in agricultural and applied economics from the University of Minnesota.
Wells Fargo Agricultural Industries presents this analysis as a complimentary service to its employees and customers. It cannot guarantee the accuracy of all the sources of data. And, commodity prices are extremely volatile based on unforeseeable changes. These estimates will change with all new market changes.