Handling the risk of commodity prices in unstable marketplaces
For the past three years, the main commodities markets for food and beverages have been characterized by uncertainty and volatility. Significant global supply chain disruptions were caused by the COVID-19 pandemic, and businesses are currently dealing with inflationary pressures that haven’t been witnessed in the previous 40 years. Although managing commodity risk has always been crucial to business, it is now more crucial than ever to comprehend and keep commodity costs under control.
Starting with the premise that futures markets are often based on the fundamentals of supply and demand is necessary to regulate commodity pricing efficiently. From there, a range of reasonable pricing can be estimated.
This is indicated in Carryout/Usage ratios and Days of Supply calculations for the grain and oilseed markets. Different markets react differently to tightening stock levels. Compared to maize and soybeans, wheat, for instance, is far more sensitive to low Carryout/Usage levels. You’ll be more confident and successful in staying under budget and controlling commodity price risk if you know the historical pricing ranges and realistic carry out/usage ratios for each market.
First, let’s talk about past pricing ranges. A chart of corn prices dating back to 1960 may be found below. As you can see, corn traded between $1.00 and $2.00 per bushel during the 1960s and the first part of the 1970s. Corn tested $2 when stock/usage tightened. The US exchanged for $1.00 when grain supply became excess. During the Great Inflation of the 1970s, this price dynamic shifted. Generally speaking, corn traded between $2.00 and $4.00. The price range was in effect from 2006 to 2007.
What then transpired between 2006 and 2007? 2005 saw the introduction of the Renewable Fuel Standards Act, which was later amended in 2007. Due to the RFS, the US had to boost its annual maize production from 11–12 billion bushels to 15 billion in order to fulfill the increasing demand. Concurrently, China was purchasing substantial quantities of soybeans from the United States, which resulted in a competition for acres between corn (for ethanol) and soybeans (China).
One could argue that, given the inflation over the last two years, the markets are entering a new era of prices. It may be a long way off from the days of $3 corn, $4.50 wheat, and $7 soybeans. Due to COVID shutdowns and the ensuing stimulus, inflation has increased by 15% overall since 2021—not as much as it did in the 1970s, but still not as much. About to play a bigger role in US green energy strategy, soybean and canola oil could drive up oilseed prices similarly to how ethanol drove up maize prices.
The concept of carryout/usage ratios, which is related to days of supply, is the next thing to grasp. For every market, what is ample, adequate, and tight? The following formulas could be useful in figuring out each market scenario.
Carryout/Usage = Total Usage / Ending Carryout Stocks
Days of Supply is equal to (Total Usage / 365 days) / Ending Carryout Stocks.
Assume that there are 1.5 billion anticipated ending stockpiles of corn and 15 billion bushels are used annually.
1.5 bil bu / 15.0 bil bu = 10% is the carryout/use ratio.
Days of Supply = 1.5 billion British dollars / 15.0 billion dollars / 365 days, or 36.5 days.
The percentage of overall demand that remains at the conclusion of the marketing year is shown by carryout/usage. Days of Supply indicates how many days we typically have available for utilization at the conclusion of the marketing year, just before harvest.
We can now look back at previous years and observe how prices have typically traded because we know the historical price ranges and how to compute Carryout/Usage. The chart below illustrates how average farm prices for the year might exceed $5 per bushel when Carryout/Usage is 10% or less. In most cases, the average farm price is less than $4 per bushel when carryout/usage exceeds 12%.The Carryout/Usage computation and these two plots demonstrate that corn
However, when Carryout/Usage is between thirty and thirty-five percent and Days of Supply reach approximately 120, or almost four months, wheat begins to tighten.
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Why is wheat, as opposed to corn and soybeans, so much more susceptible to low stock levels?While most corn and soybean stocks are used for feed and energy, the majority of wheat stocks are used for human consumption. You can use less animal feed and ethanol/renewable biofuels if corn and soybean supply tightens. In the country, 85% of the wheat produced is consumed by people.
Among the least expensive foods in terms of calories for humans is wheat. We face a serious food crisis if there is a wheat scarcity. Due to this, the market is far more sensitive to shortages of wheat than it is of maize and soybeans. For this reason, US wheat stocks are thought to be 30% tight, whilst corn and soybean stocks are thought to be 10% tight.
Creating a model for supply (acres and yield) and demand (exports and domestic usage) is a crucial component of the puzzle. Since the totals of supply and demand seldom fluctuate by more than 5% year, you may establish some reasonably accurate guidelines for potential pricing as long as there isn’t a catastrophic epidemic or record drought that would drastically reduce supply or crush demand.
Among the least expensive foods in terms of calories for humans is wheat. We face a serious food crisis if there is a wheat scarcity. Due to this, the market is far more sensitive to shortages of wheat than it is of maize and soybeans. For this reason, US wheat stocks are thought to be 30% tight, whilst corn and soybean stocks are thought to be 10% tight.
From there, you can obtain coverage for commodities throughout the budgetary year by combining value goals and timing triggers. Financial hedges, like option collars, which have a potential high as the long call and a potential low as the short put, are available to food and beverage companies. Additionally, you can set price restrictions for budgetary purposes and set hedges to build up weekly price coverage at value regions before your budget year by using Over-the-Counter (OTC) structured products. Procurement teams are more inclined to employ financial instruments to assist control their commodity prices when our clients are aware of the potential price ranges for the year based on bullish and bearish Carryout/Usage scenarios.
Selecting the Appropriate Spouse
You want a company that understands both your markets and your industry. StoneX (NASDAQ: SNEX), which has more than a century of experience in the commodity markets, fulfills both requirements. Together with maximizing purchase opportunities, we also help your business manage the inherent price risks. At StoneX, we go beyond providing financial services to become your partner by maintaining the highest level of control over your commodity costs. We can propel your business’s future expansion together.