With drought conditions bad and getting worse and agricultural commodities 'stabilizing' at their multi-year highs, tomorrow morning could be the catalyst for the next leg in a global food inflation spike (and its accompanying deflationary impacts on economies). The USDA releases it August World Agricultural Supply and Demand Estimates (WASDE [6]) at 830ET - which is particularly important since it is the first survey-based estimates of the year. It would appear that while pre-positioning has slowed a little, sell-side analysts expect prices (and implied vols) for corn, soybeans, and less-so wheat to rise on the back of not just (dramatically) lower crop yields (in this first of the year survey) but overly optimistic harvested-to-planted estimates and demand limits. Ethanol demand destruction is also emerging as a consensus.
Goldman On WASDE Expectations:
We expect higher corn prices and soybean price outperformance
We forecast a US corn yield of 126 bu/ac and US corn production of 10,750 million bushels. As a result, we believe that ethanol demand destruction is necessary and our corn price forecast is based on the price of corn that pushes the cost of producing ethanol above the price of RBOB gasoline blendstock. Given our forecast for higher oil prices, this puts our 3-mo CBOT corn price forecast at $9.00/bu.
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August weather is key to US soybean yields and recent rains will be beneficial to US soybean production. As we had intentionally left our US yield forecast at a high level of 39.5 bu/ac to allow for such an outcome, our US soybean outlook is unchanged. We expect that 2012/13 US soybean ending stocks will be at critically low levels: with the large shortfall in 2011/12 South American production, the global availability of soybeans will be limited until the next South American harvest, with the US the only supplier until then. As a result, we believe that higher new crop soybean prices will be required to limit demand in the coming months and our 3-mo forecast is $20.00/bu.
We forecast lower global wheat production and lower export surpluses given continued hot and dry weather conditions in key producing regions. However, global wheat inventories remain larger than corn stocks and we forecast that wheat feeding will be required to supplement corn and DDG use in the US and globally. As a result, we continue to forecast that US wheat prices will need to trade back near corn prices by next spring. A further deterioration in weather conditions, potential FSU export restrictions and pent-up import demand create risks that global wheat inventories decline even more than we expect and push wheat prices well above corn prices.
Hedging recommendations
Consumers: We forecast higher corn, soybean and wheat prices over the next 3 months given the severity of the current US drought, with our 6-mo price forecast also above the current forward curve. As a result, we recommend consumers lock in current prices as well as layer in upside calls to hedge against the higher prices that we forecast, especially for corn and soybeans. Although up since early July, implied volatility levels remain well below their previous peaks and still represent value especially if weather conditions deteriorate further.
Producers: Following the recent rally in corn, soybean and wheat prices, we recommend Southern Hemisphere producers lock in producing margins.
Morgan Stanley On WASDE Expectations:
We expect a bullish report for the grains with further downside likely for US corn and soybean yields, and shaky global wheat supplies.
Bullish corn, with entire 12/13 balance sheet in play. Armed with its first survey-based yield estimates of the year, the USDA is likely to reduce (dramatically) yield and production estimates for a second consecutive month. While we expect corn yields could easily come in below 130 bu/acre (our weather-driven models show 127 bu/acre), this will not in and of itself be bullish, with consensus already positioned below that level. Instead, we will be watch how the USDA handles the harvested to planted (H/P) ratio, currently at an above-average 92.2% (vs our recently-lowered 88.7%). Over the past 25 years, the 3 seasons with the worst yield disappointments saw H/P ratios fall at least 3% below average. With news already emerging of farmers cutting corn for silage a month earlier than usual and abandoning fields, we’ll be surprised if the USDA does not cut its optimistic H/P estimate.
To balance a production decline of up to 2 bln bu, the USDA will have to make large cuts to all line items. Ethanol demand will be the hardest line item to ration, in our view; accordingly we expect only a 200-300 mln bu reduction to the USDA’s current estimate of 4.9 bln bu. However, feed and export demand could each see cuts as large as 500-800 mln bu. Providing some offset, the USDA will likely lower 11/12 ethanol and export demand (by 50 and 100 mln bu, respectively) with the latest high-frequency data disappointing. Globally, we see little good news, with as much as 1 mln MT and 2.5 mln MT of downside to Russian and Ukrainian production estimates, respectively, as drought hammers those countries. We see upside to Brazilian 11/12 and 12/13 exports on the need to offset lost US supply, while China may well prove the one bright spot for global production, with as much as 2-3 mln MT of downside possible for 12/13 imports on stronger domestic supply.
Soybean production is likely to fare better than corn, though we still see the need for more demand rationing. With old-crop demand still running inline with last month’s expectations, we expect no changes to the 11/12 balance on Friday, leaving all of the focus on the 12/13 crop. The market has long understood that the soybean crop is more resilient than corn (and recent rains should shore up confidence that conditions can still stabilize). However, with the US soybean crop rated in the worst condition since 1988 (when soybean yields fell 20% YoY to just 27 bu/acre), we see the USDA’s current yield estimate of 40.5 as too high (our models show 38 bu/acre). As with corn, stories of failed soybean fields will likely increase the pressure to reduce the USDA’s elevated h/p ratio — currently pegged at 98.9%, vs our estimate of 98.2%. To offset weakness in US production, we see downside of as much as 200 mln bu to the USD’s 12/13 export forecast, balanced by a combination of higher exports from Brazil and a 1.5 mln MT reduction to Chinese 12/13 soybean imports. We see limited downside to US 12/13 crush, on the need to keep US soy meal and oil stocks above record-tight levels.
Expecting a bullish report for wheat, on faltering international production. Falling production in Russia and China — seen lower by 4 mln MT and 10 mln MT, respectively, from the USDA’s official estimates in the most recent Attaché dispatches — is likely to further support US wheat export demand. We would not be surprised to ultimately see US 12/13 exports lifted by 25 mln bu. However, the slow pace of US export sales MYTD, may keep the USDA on the sidelines this month. While we have raised our 12/13 all wheat yield estimate to nearly flat with the USDA, we continue to view its higher than average h/p ratio assumption of 87% as overdone, particularly given the decelerating pace of the winter wheat harvest.
Citi On WASDE Expectations
Given that large regions of the Midwest are now categorized as being in “Extreme” or “Exceptional” drought, we expect the USDA to significantly lower their July yield estimates of 146 bu/acre and 40.5 bu/acre for corn and soybeans, respectively. Citi’s commodity futures strategist currently estimates yields of 133 and 38, respectively, while on their 2Q conference call, AGU management indicated that they believe corn yields may be in the 120s. As a comparison, following the severest drought in recent history (1988), nationwide yields were ~25% below the trend yield at that time. A similar decline from the current trend would point to a corn yield in the low 120 bu/acre range. At this yield corn demand destruction is necessary, with ethanol and feed usage at risk.