Commentary

Rural Voice March 11, 2020

We’ve all heard the old saying in relation to March weather, “March comes in like a lion and goes out like a lamb.” 

As the calendar rolled into March it wasn’t the weather that we needed to be concerned with, it was the markets that have experienced a similar beginning to the weather adage.   March has come in like a lion.  The movement of the market has been very adverse and quite devastating to a wide range of prices and valuations.  Energy markets are devastated, and energy price drops are being called historic.  The contagion of the energy shock spilled over into the broader stock markets, with stock index’s trading lower around the world, forcing US Treasuries to trade to historic lows as investors flee “risk assets” to “safe haven”.  March has come in like a lion and all markets- everywhere, have seen the repercussions - “A lion, which is strongest among beasts, [and] turneth not away for any.”  Very few industries have not been affected by this violent and swift market action.

In times like these, as described above, often fundamentals within an industry do not matter.  It is market momentum that rules, it is forced selling by leveraged players that unwind bad positions, it is short sellers squeezing the market and it is a general fear, that together sway markets forcefully lower.  In such circumstances Agricultural markets can also be pressured downward, from such sweeping value destruction in other sectors – especially energy markets.

This is what has occurred as we entered March.  While many details are still surfacing as to the chain of events and motivations of many market players, it seems to be well understood that this “black swan event” that caused markets to stumble was from the effects of the corona virus.  Here’s a brief summary to the best of my knowledge:  Cornona virus concerns limited the movement of people and goods within and out of China.  This disruption caused market disturbances and many companies were negatively affected.  Due to the continued spread of the virus other countries also saw limited travel and commercial and retail traffic.  Many businesses have been challenged economically from the ramifications of these altered behaviors – especially in (but not limited to) the travel, restaurant and energy industries.  It is estimated that oil consumption fell by 4 million barrels per day from the outset of the efforts to contain the virus.  Due to this demand shock, it is reported that OPEC proposed a production cut to both its member states production and to Russia who has been recently participating in OPEC’s price control efforts.  This production cut Russia refused.  It is reported by some analysts that Russia didn’t want to curtail its production, supporting prices, while US producers reaped the benefit.  From this lack of contained response, the Saudi government declared that rather than cutting likewise, following Russia’s response, that it too would continue to produce, and in fact increased production! 

Consequently, there has been a falling short term oil demand structure and a simultaneous increase of production.  The result has been oil trading to levels not seen since 2016 and oil prices falling 30% in overnight trade the night this news hit the wires.  How long this circus continues is anybody’s guess but both Russia, Saudi Arabia and the US all released news issues that they are well capitalized in their industries and can weather the storm.  We’ll see how well everyone is equipped when the storm is over.

So what does this mean to crop prices?  If the current conditions were to continue for a long duration it is anticipated that crop prices would also be under severe pressure.  1/3 of the US corn supply is used in the production of ethanol.  Prior to the oil market crash, the majority of ethanol producers had been losing money, this energy crash will worsen the losses.  There are concerns about the viability of some ethanol companies in this environment.  This could translate into a loss of corn demand if the situation remains negative for an extended period.  If these producers become insolvent, that corn demand will be lost.  How about soybeans?  Soy oil is used in bio diesel and therefore that price floor could likewise be lost. 

Even wheat has risks from this situation due to currency fluctuations.  Russia, who is amongst the largest oil producers of the world, has what is often labelled a “petro currency”.  In other words, as goes the price of oil, so goes the price of the Russian Ruble.  As oil falls aggressively so does its currency and this currency drop increases domestic prices for Russian farmers.  Russia has become the worlds largest wheat exporter.  This situation does nothing but provide a strong positive tailwind to Russian wheat production and expectations for expansion. 

As with all market crisis moments this situation will also pass.  What the other side of the situation will look like is uncertain.  What will be the duration of the downturn and where will the economy be?  There is a wide range of opinions and this is demonstrated by the big volatility in the markets.   In my mind the key take away is for Ag producers to understand that a large portion of grain demand is highly tied to fossil fuel prices and consumption.