Uncertainty and volatility have characterized major food and beverage commodity markets over the past three years. The COVID-19 pandemic has severely disrupted the global supply chain, and today businesses are facing inflationary pressures not seen in the past 40 years. Commodity risk management has always been a key part of business, but in these difficult times, understanding and controlling commodity costs is extremely important.
In order to effectively control commodity costs, one must assume that futures market prices are usually based on supply and demand fundamentals. From there one can estimate a range of realistic prices.
For grain and oilseed markets, this is expressed in carryout/usage ratios and delivery day calculations. Some markets are more sensitive to tightening stock prices than others. For example, wheat is much more sensitive to low carry-over/consumption levels compared to corn and soybeans. Once you understand the realistic possibilities of execution/utilization ratios for a given market and their historical price ranges, you will have greater confidence and success in staying within budget and managing commodity price risk.
Let’s start with historical price ranges. Below is a table of corn prices since 1960. You can see that corn traded in a range of $1.00 to $2.00 per bushel in the 1960’s and early 1970’s. As inventories/utilization fell, corn tested the $2 level. When the US had too much corn, the price traded at $1.00. This price dynamic changed in the 1970s and the Great Inflation period. Corn generally traded between $2.00 and $4.00. The price range lasted until 2006-2007.
So what happened between 2006 and 2007? The Renewable Fuel Standards Act was introduced in 2005 and expanded in 2007. The U.S. has had to shift its production from a total of 11-12 billion bushels of corn a year to 15 billion to meet the increased demand caused by the RFS. At the same time, China bought significant amounts of soybeans from the US, resulting in corn (ethanol) and soybeans (China) competing for acreage.
After the last two years of inflation, you can rest assured that the markets are in a new price era. The days of $3 corn, $4.50 wheat, and $7 soybeans may be long gone. While not as bad as it was in the 1970s, we have seen a 15% cumulative increase in inflation since 2021 due to the COVID shutdowns and subsequent stimulus measures. Soybean and canola oil will soon become a more important part of US green energy policies and could drive up oilseed prices the way ethanol did corn.
The next thing to understand is the carryout/usage ratios (a similar concept to days of supply). What is considered abundant, sufficient, and scarce for each market? Here are some equations that can be helpful in determining the specific market situation.
Carryout/Usage = end of carryout inventory / total usage
Days of Deployment = End of Stock / (Total Usage/365 Days)
Let’s say corn has a projected 1.5 billion ending supplies and a total annual consumption of 15 billion bushels.
Disposal/Use = 1.5 billion / 15.0 billion = 10%
Delivery days = 1.5 billion BU / (15.0 billion BU / 365 days) = 36.5 delivery days
Carryout/Usage tells us how much remaining inventory we have at the end of the marketing year as a percentage of total demand. Days of Supply tells us how many days of average use we have left at the end of the marketing year, just before harvest begins.
Now that we know the historical price ranges and how carryout/utilization is calculated, we can look at the past few years and see how prices are trending. In the table below you will see that if the yield/utilization is 10% or less, average farm prices for the year can be over $5 per bushel. When the yield/utilization is above 12%, the average farm price is typically under $4 per bushel.
These two charts and the carryout/utilization calculation show that corn is scarce at 10% or less and distressing at 12% or more. If you did the same analysis for soybeans, you would see that 10% or less carryout/usage is scarce, 10-15% is adequate, and over 15% is very stressful/bearish.
For wheat, on the other hand, the shortage starts when the transport/consumption value is between 30% and 35% and the delivery days are around 120, which is almost 4 months.
Why is wheat so much more sensitive to stock shortages compared to corn and soybeans?
Most of the wheat stocks are used for human consumption, while most of the corn and soybeans are used for feed and energy. As corn and soybeans become scarce, you can reduce animal feed and ethanol/renewable biofuel consumption. 85% of domestic wheat consumption is used for human consumption.
Wheat is also one of the lowest calorie options for humans. If we have a shortage of wheat, we have a major food crisis ahead of us. Because of this, the market is much more sensitive to shortages in wheat than corn and soybeans, and 30% carryout/usage is considered tight for US wheat stocks, while 10% is considered tight for corn and soybeans.
The key piece of the puzzle is developing a model for supply (acreage and yield) and demand (exports and domestic uses). The sums of supply and demand rarely vary more than 5% year-on-year, so you can develop some pretty reliable parameters for possible prices, assuming there’s no historical drought reducing supply and no pandemic squeezing demand .
From there, you can use a combination of value targets and time triggers to get coverage for goods during the budget year. Food and beverage companies can use financial protection such as option collars, where the maximum possible is the long call and the minimum possible is the short put. You can also use structured over-the-counter (OTC) products to set price caps for budgeting purposes and set hedges to accumulate price coverage in value ranges weekly ahead of your budget year. We find that sourcing teams are more likely to use financial tools to control their commodity costs when our clients understand the potential price ranges for the year based on bullish and bearish carryout/utilization scenarios.
Choose the right partner
You want a company that knows your industry – and knows your markets. With over 100 years of experience in the commodity markets, StoneX (NASDAQ: SNEX) ticks both the boxes. We work with your business to maximize purchasing opportunities while managing the associated pricing risks. By controlling your raw material costs at the highest level, StoneX is more than just a financial services company – we are your partner. Together we can drive the future growth of your business.
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