Could the reduction in road users impact wheat pricing?

By Andrew Whitelaw - Agricultural Commodity Analyst

The agricultural industry continues largely unabated providing the feed and fibre for the rest of the population. However large tracts of the global economy have come to an effective standstill. The closure of factories and huge armies of workers now resigned to working at home has meant fuel demand has declined markedly. What does fuel have to do with grain prices?

The story all starts with corn in the US. During the start of the century there was a monumental change to the demand for corn. Previously most corn was consumed by animals, however there was a switch to increased ethanol production.

This was to achieve mandates which defined the minimal levels of fuel which had to originate from renewable sources. The first five years of the 2000’s saw an average of 10% of corn being converted to ethanol, during the past five years this had expanded to 38%.

The demand for fuel in the past three months has dropped dramatically as cars are parked and planes are grounded. The result being crude oil prices falling to decade lows, and May crude oil futures expiring at negative levels.

The result is a corresponding drop in ethanol requirements, a drop in demand (or increase in supply) tends to equate to a drop in pricing. The result being that ethanol futures have fallen to their lowest level since trading commenced.

This has meant that ethanol plants throughout the US have curtailed their production, with a 56% decline in output since the start of the year. This has lead to plants cancelling contracts, as production margins dropped to unprofitable levels.

As a large proportion of corn is used for the manufacture of ethanol, it comes as no surprise that corn pricing has followed ethanol downwards (figure 1). If you remove one of the largest ‘customers’ of a commodity then the market will have additional supply ergo prices drop.

The correlation between the two futures contracts has been 0.88 since 2010. A result of 1 is a perfect correlation, and 0 signifies no correlation. 0.88 would be considered strong, therefore in theory they follow one another both up and down.

We may not grow much corn in Australia, but that does not mean that price movements in corn will not impact upon the commodities we grow. There is a degree of interchangeability between corn and wheat, as they can be used for similar applications.

In figure 2, the weekly change in price of wheat and corn futures is displayed. The weekly movement in prices tends to track one another over time, with a correlation of 0.81.

In recent years Australian grain pricing has been focused on domestic factors (especially on the East coast), however the majority of pricing in Australia can be explained by the movement in overseas futures.

If we see continued lack of demand for corn for ethanol production, this corn will find alternative markets. This has lead to Europe reintroducing tariffs on US corn, as fears of large volumes hitting the global market.

If corn futures remain depressed, then this would likely pressure wheat futures. This in turn would flow through to prices received within Australia.

To conclude, oil influences ethanol, which flows to corn and then through to wheat. An enduring period of low growth and demand for oil could impact upon the pricing levels for the whole grain complex.

We live in unprecedented times and the market has never seen a dramatic destruction of demand in such a short period of time. We are likely to see a very uncertain market over the coming years as the impact of COVID-19 continues to play out.

(Written in a personal capacity for study purpose)