Long-Term Drivers of Grain Prices
With the strong rally in grains during July, we need to take a step back and look at what the drivers of commodity prices are. Grain prices are volatile due to immediate supply and demand concerns, primarily driven by weather.
The long-term investors need to look at the macro forces that will be driving prices over a three to five year period. It is very difficult to estimate weather conditions and short-term use, but the intelligent investor indentifies the long-term trends.
The three trends that we believe are the most important, and will drive grain prices over the long-term are: exports to emerging markets, the declining U.S. dollar, and the evolving link between energy and agricultural markets (biofuels).
Exports
Rapid population and economic growth, primarily in India and China, will increase food demand and U.S. exports. China is one of the largest importers of grain, as the country has roughly 20% of the world’s population although only 7% of global arable land.
China was a major exporter of grain, but increasing incomes and the development of a middle class have changed consumers’ diets, moving away from carbohydrates and towards proteins. The continued transfer to proteins will significantly increase the demand for grains as one pound of meat requires roughly 10 to 15 pounds of grain.
The increasing global demand for grains needed to feed the growing world population. and its changing dietary habits. will continue to increase U.S. agricultural exports. Looking forward, the USDA baseline projections show a continuing upward trend with total U.S. agricultural exports reaching $119 billion in 2019, from $82 billion in 2007.
U.S. Dollar
The U.S. dollar has been on a significant rally since mid-2008, due to a flight to quality and demand for U.S. treasuries. The long-term outlook for the U.S. dollar is a different story. Large U.S. deficits and the Federal Reserve running printing presses 24/7 will leave the dollar with only one direction to go: down.
A lower dollar is positive for the grain market, as it makes the price of U.S. corn cheaper to foreign buyers. Holding all else equal, a lower price will expect to result in larger imports. There would be a movement down the demand curve to a new, larger equilibrium of quantity supplied and quantity demanded.
The relationship between the U.S. dollar and grain prices does not have a high correlation over the short-term due to other factors. Over the long-term though, as demand for grain imports grow from emerging markets, a cheaper U.S. dollar will make U.S. grain exports more attractive than other markets.
Energy and Agriculture
Agriculture and energy markets have become inextricably intertwined since 2005, as biofuel production and demand surged. Use of corn stocks for these alternative fuels became so prevalent that a biofuel premium had been built into global pricing.
According to the USDA, ethanol production in the U.S. has increased from less than 3 billion gallons in 2003 to over 6 billion gallons in 2007, and is estimated to exceed 12 billion gallons in 2020. The Renewable Fuel Standard from the 2007 Energy Act calls for total renewable fuel to reach 36 billion gallons by 2022. The USDA estimates that more than 33% of the U.S. corn production will have be used to produce ethanol by 2010.
The EPA is also reviewing a proposal to approve the use of 15% ethanol blend gasoline from 10% to help achieve the Renewable Fuel Standards requirements. The increase to E15 will have substantial impact on the agriculture industry as the demand for grains used for ethanol production will increase for the higher ethanol production.
Conclusion
Although there are many factors that will drive grain prices over the long-term, we believe that investors who follow these three trends will be well rewarded.
Grain markets are starting to wake up to the limited amount of supplies available and the difficulty the world will have feeding itself in the future. As the three factors discussed above continue to limit the amount of grains available, the world will be closely watching the grain markets.
- Colvin
The long-term investors need to look at the macro forces that will be driving prices over a three to five year period. It is very difficult to estimate weather conditions and short-term use, but the intelligent investor indentifies the long-term trends.
The three trends that we believe are the most important, and will drive grain prices over the long-term are: exports to emerging markets, the declining U.S. dollar, and the evolving link between energy and agricultural markets (biofuels).
Exports
Rapid population and economic growth, primarily in India and China, will increase food demand and U.S. exports. China is one of the largest importers of grain, as the country has roughly 20% of the world’s population although only 7% of global arable land.
China was a major exporter of grain, but increasing incomes and the development of a middle class have changed consumers’ diets, moving away from carbohydrates and towards proteins. The continued transfer to proteins will significantly increase the demand for grains as one pound of meat requires roughly 10 to 15 pounds of grain.
The increasing global demand for grains needed to feed the growing world population. and its changing dietary habits. will continue to increase U.S. agricultural exports. Looking forward, the USDA baseline projections show a continuing upward trend with total U.S. agricultural exports reaching $119 billion in 2019, from $82 billion in 2007.
U.S. Dollar
The U.S. dollar has been on a significant rally since mid-2008, due to a flight to quality and demand for U.S. treasuries. The long-term outlook for the U.S. dollar is a different story. Large U.S. deficits and the Federal Reserve running printing presses 24/7 will leave the dollar with only one direction to go: down.
A lower dollar is positive for the grain market, as it makes the price of U.S. corn cheaper to foreign buyers. Holding all else equal, a lower price will expect to result in larger imports. There would be a movement down the demand curve to a new, larger equilibrium of quantity supplied and quantity demanded.
The relationship between the U.S. dollar and grain prices does not have a high correlation over the short-term due to other factors. Over the long-term though, as demand for grain imports grow from emerging markets, a cheaper U.S. dollar will make U.S. grain exports more attractive than other markets.
Energy and Agriculture
Agriculture and energy markets have become inextricably intertwined since 2005, as biofuel production and demand surged. Use of corn stocks for these alternative fuels became so prevalent that a biofuel premium had been built into global pricing.
According to the USDA, ethanol production in the U.S. has increased from less than 3 billion gallons in 2003 to over 6 billion gallons in 2007, and is estimated to exceed 12 billion gallons in 2020. The Renewable Fuel Standard from the 2007 Energy Act calls for total renewable fuel to reach 36 billion gallons by 2022. The USDA estimates that more than 33% of the U.S. corn production will have be used to produce ethanol by 2010.
The EPA is also reviewing a proposal to approve the use of 15% ethanol blend gasoline from 10% to help achieve the Renewable Fuel Standards requirements. The increase to E15 will have substantial impact on the agriculture industry as the demand for grains used for ethanol production will increase for the higher ethanol production.
Conclusion
Although there are many factors that will drive grain prices over the long-term, we believe that investors who follow these three trends will be well rewarded.
Grain markets are starting to wake up to the limited amount of supplies available and the difficulty the world will have feeding itself in the future. As the three factors discussed above continue to limit the amount of grains available, the world will be closely watching the grain markets.
- Colvin
Posted by Colvin & Co. at 8/4/2010 5:12 AM 
Categories: Food Security
Tags: ethanol corn exports dollar china
Categories: Food Security
Tags: ethanol corn exports dollar china
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