Economic Analysis & Publications

Supply Chain Woes

Why is it such an anxiety-laced struggle to buy a jug of glyphosate this fall? The short answer: I don’t know. No one knows the full interwoven shuffle of influences that are driving up prices for some products and cutting off availability for others. A longer answer involves looking at several of those influences:

During global pandemic lockdowns, consumers spent less money on going out and more buying gadgets for their homes. This runaway trend slowed in July 2021.

A CONGESTED SUPPLY CHAIN
To plant wheat this fall or to get everything set up for row crop planting in spring 2022, U.S. grain producers must have seeds, fertilizers, herbicides, seed treatments, machinery parts and all the other crucial little things that need to be shipped from the distant places where they’re manufactured to the rural storage sheds and fields where they’ll be used. At the same time, South American farmers are urgently scouring the global marketplace for planting inputs, and farmers from every other region of the globe need those herbicides too. Unfortunately, just as all this demand is hitting, the shipping capacity of the world’s ocean vessels and shipping containers and trains and trucks is already overfilled by all the other stuff that people have ordered over the past 16 months since the initial shock of the global COVID-19 pandemic.
In numbers released last month, the U.S. Bureau of Economic Analysis showed monthly spending on durable goods (things that last three years or more: furniture, appliances, tools, electronic gadgets, etc.) in July 2021 remained above $2 trillion, although the figure represented a pullback from May’s record-high $2.065 trillion. Durable goods spending accelerated sharply after the COVID-19 shock in March and April 2020, when global pandemic lockdowns prevented consumers from going out and spending money. Instead, consumers directed their money toward gizmos and widgets for their homes, which typically arrive in the U.S. packed in the same shipping containers needed for everything else (including tractor parts). Congestion at the Port of Los Angeles has persistently kept about 60 container ships waiting in line in recent weeks. All those gadgets and all that stuff — even if it’s manufactured domestically and doesn’t need to be shipped thousands of miles across an ocean — still needs to be shipped somehow between manufacturing plants and consumers, competing against intermediate bulk containers (a common method for shipping fertilizer) for truck driver availability, if nothing else.

A SHORTAGE OF SUPPLY CHAIN WORKERS
This one is tricky. It may be that there is legitimately a shortage of qualified workers (for instance, commercial truck drivers who already have their CDLs) compared to the sheer volume of stuff that needs to get unloaded at the ports, handled in warehouses and trucked where it needs to go. Or it may be that there is a shortage of people willing to take those jobs at the wage levels being offered. This seems like a problem that could be solvable, eventually, but it’s anyone’s guess about how or when.

HIGHER PRICES FOR INPUTS’ INPUTS
If you’re alarmed by the sudden price increase for natural gas, with Henry Hub prices recently above $5 per metric million British thermal unit (MMBtu) after drifting mostly under $3 since 2014, at least be thankful we’re not in a region at the mercy of Russian natural gas shipments: European natural gas prices skyrocketed past $20 per MMBtu last week. Global arbitrage is limited for natural gas unless it’s liquified, but we should still expect prices to remain elevated as winter approaches. That’s alongside RBOB gasoline futures above $2 per gallon and heating oil futures above $2.15 per gallon. Diesel prices in the Midwest, currently ranging about $3.10 to $3.25, are $1 per gallon higher than they were a year ago. Basically, any sort of fuel is currently priced at a multiyear high, and that only adds to the price tag for any crop input that’s being shipped.

WEATHER
The manufacturing plants where certain crop inputs are made — notably glyphosate and glufosinate — have suffered unfortunate weather disruptions at just the wrong time when producers are relying on new supplies to somehow make it through the supply-chain quagmire. Bayer’s glyphosate plant in Luling, Louisiana — the largest producer in the United States — had to temporarily go offline while Hurricane Ida hit that region late last month. Meanwhile, global production of glyphosate has perhaps never fully recovered since floods in China’s Sichuan province in 2020 damaged production capacity of not only glyphosate but also of the industrial chemical (an iminodiacetic acid called PMIDA) that’s necessary to make it. Clear information isn’t available about how much global glyphosate production capacity is operational right now or how quickly the industry could meet global demands, even if it didn’t face shipping challenges between the manufacturing plants and the crop fields.

FEAR AND SELF-FULFILLING PROPHECIES
Every coffee shop conversation about the scarcity of glyphosate (and every online article, such as this one) increases the level of panic in the market, making it more likely that people will run to their suppliers with a desperate willingness to pay any price for the product. It makes me think of lumber prices, which peaked last May at $1,670 per 1 thousand board feet amid a flurry of breathless headlines, but which have since collapsed to a level as cheap as $448 — nearly what they were before the pandemic. However, this herbicide market seems different than last spring’s lumber market because only a few products with legitimate manufacturing constraints are experiencing the disruption. Other herbicide products remain reasonably priced, so perhaps there is neither industry-wide profiteering nor consumer panic elevating the prices, and perhaps the legitimately constrained products won’t be resupplied so easily or have prices snap back so quickly.
I don’t know if buying spring crop inputs at today’s prices will turn out to be irrational or not; calmer prices may or may not resume next year. There is temptation to wait it out, but it’s a decision that could leave a producer scrambling. I will disclose that I signed a contract this week to lock in my crop inputs for next spring, paying 2.5 times as much for Roundup and 75% more for fertilizer than I did when booking inputs last October. And you know what? I don’t feel particularly bad about it. I consider it an opportunity to manage risk and to put a known quantity on paper for 2022’s production among all the other ultimately unknowable things that can happen when farming.

Elaine Kub is the author of “Mastering the Grain Markets: How Profits Are Really Made” and can be reached at masteringthegrainmarkets@gmail.com or on Twitter @elainekub.

(c) Copyright 2021 DTN, LLC. All rights reserved.

Hog Market Needed Clearer, Faster Prop 12 Signals

Lean hog futures prices have hit another patch of volatility — mostly downward volatility, like last Thursday’s (Aug. 19) $2 drop — and although it’s impossible to point the finger at any singular, certain bearish influence, it does make you wonder, as 2022 inches closer, if the markets themselves are finally starting to reflect the uncertainty and industry-wide angst that results from California’s Prop 12 measure.

So far, most of the worry for the pork market has been centered on California itself, which voted in 2018 to pass the Farm Animal Confinement Proposition (Prop 12), making it illegal, starting in 2022, to sell pork inside the state unless it can be documented that the pork comes from an animal that was farrowed by a breeding sow that had at least 24 square feet of pen space (and other requirements). Not much of the pork currently available in the United States meets those requirements, so the state of California is expected to experience a dramatic shortage in some of its favorite meats, driving the prices of bacon in the grocery stores and carnitas tacos on the streets of Los Angeles sky high. (https://apnews.com/…)

There are still legal efforts that may prevent California’s Prop 12 from disrupting the nationwide pork supply chain (see https://www.dtnpf.com/…), but if it can’t be stopped, those of us in the rest of the country need to get ready for a sudden collapse in demand for pork from conventionally-raised hogs. Data from the National Pork Board’s Pork Checkoff shows California represented 8% to 9% of fresh pork retail sales and total pork retail sales in 2018, 2019 and 2020, both by dollars spent and volume purchased. Other estimates have suggested California accounts for as much as 15% of the nation’s pork consumption. However we slice the ham, if the traditional U.S. pork market suddenly loses 9% to 15% of its customer base because those customers won’t be able to legally purchase pork from conventionally raised animals, then prices will fall. There will effectively be two separate pork supply chains — a high-priced, scarce supply of Prop 12-compliant pork destined to be sold inside California and a glut of oversupplied conventional pork flooding cold storage everywhere else.

Lean hog prices typically trail the pork cutout by about $5 per hundredweight. So, if wholesale pork averages about $75 per cwt, then nearby lean hog futures would be expected to trade around $70 per cwt. This week, October pork cutout futures are around $101 per cwt and October lean hog futures are around $88 per cwt. That’s a $13 spread, but even that is well within the range of what is sometimes seen in this market, especially in comparison to mid-2020 when packers were struggling to stay open during the COVID-19 pandemic. The average spread through 2020 was $16 per cwt and the worst was $56 in mid-May when pork ($114 per cwt) was hotly demanded at grocery stores but overweight hogs ($58) had to be turned away from some packing plants and destroyed because there simply wasn’t enough capacity to process all the animals that reached their market weight on a biological schedule that had been set in motion months before.

Not to get too apocalyptic about this California Prop 12 scenario, but one wonders just how much damage could occur to the lean hog market in January 2022 when the law is scheduled to go into effect. As long as the packing plants stay open and continue to process their usual volume of hogs (approximately 470,000 head per day lately), things should be fine. But without California’s 9% to 15% of U.S. demand, what happens to all that pork? Some of it can be exported, sure; some of it can be stashed away in cold storage. But at some point, any market that is oversupplied with a commodity — in this case, market-weight lean hogs — will eventually push back with lower prices. Looking at history when the hog market was oversupplied, like 2016-18 when swine herd expansion outpaced slaughter capacity growth, we might expect prices to drop 10% to 20% compared with the pork cutout.

The problem with all of this is the uncertainty. If the industry had known all the details of Prop 12 compliance several years in advance, or even now, if we knew for sure what was going to happen in January 2022, then we would expect the market to work in an orderly way to motivate an appropriate-sized shift from conventional hog production to Prop 12-compliant hog production, and a subsequent reduction in conventional hog production, forestalling any concerns about a sudden glut of oversupply in early 2022. Unfortunately, those market signals haven’t happened, or haven’t happened clearly enough or fast enough. In fact, Iowa State University’s latest estimated returns for a conventional farrow-to-finish operation remain above $50 per head — highly motivating to expand production, not reduce it. Their estimated returns for hogs sold in June 2021 were $63 per head — the most profitable this industry has been since August 2014.

Pork that will be on sale in U.S. grocery stores in January 2022 will come from hogs that are slaughtered and processed in December 2021. It takes approximately 17 weeks to finish a hog on calibrated feed rations to reach its target market weight, so those hogs are just now being moved to finishing barns. Prior to that, the animals spent approximately six weeks in a nursery, and before that, approximately three weeks in a farrowing barn from birth to weaning. Therefore, the hogs in question were already born in mid-June. Their sows — the animals whose production practices determine whether the ultimate product will be Prop 12 compliant or not — were already bred back in February. Whatever market signals hog farmers needed to receive to adjust their production quantities in a non-chaotic way, they would have been needed months ago. It’s too late now to avert the coming crush of conventionally raised pork that will have to be absorbed by the non-California rest of the world. Pork cutout futures have some open interest for the October ($100 per cwt) and December 2021 ($95 per cwt) contracts, but nothing past that yet to indicate the market’s price expectations.

Pork packing companies have been communicating with the hog producers who supply their animals to determine what proportion of their market will be Prop-12 compliant by early 2022 and to offer premium bids for such animals, which will be tracked and processed through a separate supply chain destined for the California market. Individual producers have been making decisions about whether those premium prices will be enough to offset the expenses of retrofitting farrowing barns with the necessary group housing arrangements. Packer-owned hog production facilities themselves are perhaps best placed to take advantage of the premiums, having more certainty about what will be required to reach the California market and what the financial rewards might be. In March, Rabobank analysts estimated less than 4% of U.S. sow housing was able to meet the Prop-12 standards. By now, it’s likely that portion is somewhat higher after months of frantic installation of new sow feeding and handling equipment across the country. But will it be enough to meet the sudden shift into a two-path U.S. pork supply chain? So far, the futures markets have been only tentative at signaling what might happen.

Elaine Kub is the author of “Mastering the Grain Markets: How Profits Are Really Made” and can be reached at masteringthegrainmarkets@gmail.com or on Twitter @elainekub.

(c) Copyright 2021 DTN, LLC. All rights reserved.

Note: This column drew on original research by Elaine Kub originally published in July 2021 (see pdf: “Elaine Kub analysis Prop 12 _07062021):

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Beef Market: When High Prices Aren’t Enough

In the commodity markets, we often say “the cure for high prices is high prices.” Either the tantalizing profits will motivate a huge surge in production of that high-priced commodity (and then the fresh oversupply will bring prices back down) or the forbiddingly expensive price tag will discourage end users from buying so much of the stuff (and then the drop in demand will bring prices back down). Either way, hot commodity prices never stay flat for very long.

The exception in 2021 seems to be beef, with wholesale prices still 36% higher than they were a year ago, and yet the country’s herd of beef cattle actually shrunk 2% between July 1, 2020, and July 1, 2021. In this market, there may be no easy “cure” for high prices, and the condition could persist for a few years due to two structural reasons.

The first very obvious reason why the cattle industry hasn’t been expanding its production of beef animals is drought. No matter how much the nation’s ranchers may want to increase their herd sizes and deliver more animals to market, it’s simply impossible when 65% of the West is suffering extreme or exceptional drought. In the state of Washington, only 4% of pasture and range is rated in good condition and exactly 0% is rated excellent. In the High Plains (North Dakota, South Dakota, Wyoming, Colorado, Nebraska and Kansas), only 28% of cattle country isn’t in some sort of abnormally dry or drought condition. The land simply cannot sustain its usual abundance of grazing animals this summer. Miserable ranchers are forced to make the anguishing decision to liquidate portions of their herds, and total U.S. beef cow slaughter has been running 12% above its usual pace, although it’s much heavier in specific drought-stricken regions.

So, that’s one disconnect between the market signal and the response — it wouldn’t matter what price the beef market was signaling, the industry right now simply is not able to respond with overall numbers when drought is this widespread.
There is another disconnect between the beef market’s prices and beef animal production — the market may be giving a signal (consumers buying hamburger for $5.00 per pound and wholesalers selling choice boxed beef for roughly $2.70 per pound), but that signal isn’t getting passed to the right people. Packers are pocketing those high beef prices, profiting hundreds of dollars for each fed steer or heifer they process, but the profit doesn’t make it farther down the supply chain.

Fed cattle prices are $20 per hundredweight better now than they were during the COVID-19-challenged meatpacking environment of a year ago, but they’re not what they could be, according to historical price relationships. During the 10 years leading up to 2020, live cattle futures prices tended to average about 60% of the price of choice boxed beef per hundredweight. In April and May of 2021, when choice boxed beef was $300 per cwt (or more) and fed cattle were only bringing $115 per cwt, this relationship dipped below 40%. At today’s boxed beef prices ($267 per cwt), we might expect to see live cattle prices at $160, but they are instead stuck below $125 per cwt (46%).

Things have changed in the meatpacking industry and no doubt there are legitimate reasons why the profit margins throughout the industry shouldn’t be expected to exactly match those of 10 years ago, but some of these changes could, nevertheless, be addressed. According to the White House’s Fact Sheet that accompanied the July 9 Executive Order on Promoting Competition in the American Economy, “Consolidation … limits farmers’ and ranchers’ options for selling their products. That means they get less when they sell their produce and meat — even as prices rise at the grocery store. For example, four large meat-packing companies dominate over 80% of the beef market, and over the last five years, farmers’ share of the price of beef has dropped by more than a quarter — from 51.5% to 37.3% — while the price of beef has risen.”

For traders, of course, the question is not about which price level would be fair or what prices should be, but rather what prices will be. Reductions in the beef animal breeding herd have already cast the die for production quantities through the next few years. Mama cows who are culled this summer won’t have a calf next spring, and expectations for the 2022 calf crop should be correspondingly lowered. This, in turn, means fewer market-weight steers and heifers should be expected in mid-2023, keeping supply tight.

The dairy herd has been expanding by 2% at the same time the beef herd has been contracting, but calves from the nation’s 9.5 million head of milk cows cannot fully fill the long-term void that will be left after this drought.
There may be implications for the feed markets too — specifically corn futures — but when it comes to demand for U.S. feed grains, a slightly lower number of domestic cattle on feed in 2022 and 2023 could be outweighed by the continued expansion of poultry feeding in this country, not to mention the chances of strong feed grains exports to other countries that are feeding their own expanding herds of animals.

Meanwhile, the highest heat in the beef market may have peaked back in early June, when choice boxed beef (wholesale) hit $340 per cwt (well short of the May 2020 record high of $475, but impressive nevertheless). It has since softened to $267 per cwt in late July. However, the benchmark wholesale prices for 90% lean ground beef remain as strong as they were in June but may now be plateauing beneath $280 per cwt. Perhaps there is only so much a grocery shopper is willing to pay for beef, no matter how delicious it is and no matter how much of that price ever gets passed back to the producers of the animals. It may not be possible for cattle producers to cure high prices with higher production this year, but as always in a commodity market, it could be consumers who moderate the prices with more hesitant demand.

Elaine Kub is the author of “Mastering the Grain Markets: How Profits Are Really Made” and can be reached on that Contact Page or on Twitter @elainekub.

(c) Copyright 2021 DTN, LLC. All rights reserved.

Plague Year Price Patterns

Human behavior appears to be as predictably unpredictable in the 21st century as it was in the 17th century. There are astonishing parallels between our own concerns, obsessions and actions during the time of COVID-19 and the concerns, obsessions and actions of Londoners during the last outbreak of bubonic plague in 1665. Presumably, if there were any first-hand written accounts of the Plague of Justinian in 541 AD or even Pharoah’s plagues in 1800 BC, they would demonstrate the same human concerns — how many are dying, how to treat the sick and dying, how to keep the living fed and how to keep the sickness from surging back more destructively than ever.

For evidence of what behavior patterns the commodity markets might expect during a pandemic, I’ve turned to “A Journal of the Plague Year,” written by Daniel Defoe (better known for writing Robinson Crusoe and Moll Flanders) about London’s Black Death in 1665 when 20% of the population died. My jaw dropped as I turned each page and found descriptions — in Defoe’s wry chatty voice — of market behavior nearly exactly matching our lives and decisions today.

First of all, let me note that Defoe was the son of a butcher before becoming a trader and an economic journalist, so it’s no wonder I appreciated his “journal” with its tables of numbers and attention to the logistics of getting commodities into the hands of consumers. Here’s a small list of the ways his 1665 narrative seems to match our own:

— When the plague started spreading in London, the first thing the rich did was to pack up and leave for their second homes in more remote locations.

— Those who didn’t leave amassed great hoards of food and supplies, if they were economically able, and shut themselves up in their homes.

— “At the first breaking out of the infection there was, as it is easy to suppose, a very great fright among the people, and consequently a general stop of trade, except in provisions and necessaries of life, and even in those things, as there was a vast number of people fled and a very great number always sick, besides the number which died, so there could not be above two-thirds, if above one-half, of the consumption of provisions in the city as it used to be.”

— When people did venture out to buy goods, the shopkeepers made sure not to touch any coins unless they were first dropped into a pot of vinegar.

— All public entertainment was banned.

— Sick people were quarantined in their homes, along with every other resident of the household, for 40 days at a time.

— “The common people, who, ignorant and stupid in their reflections as they were brutishly wicked and thoughtless before, were now led by their fright to extremes of folly: running after quacks and every practicing old woman for medicines and remedies, storing themselves with such multitudes of pills, potions, and preservatives, as they were called, that they not only spent their money, but even poisoned themselves beforehand for fear of the poison of the infection and prepared their bodies for the plague instead of preserving them against it.”

— There was knowledge of asymptomatic carriers: “One man, who may have really received the infection, and knows it not, but goes abroad and about as a sound person, may give the plague to a thousand people, and neither the person giving the infection nor the persons receiving it know anything of it.”

— The poor and the working-class population were acknowledged by Defoe to be the most likely to suffer, because they had fewer resources to begin with, and most of all because they still had to go to work in dangerous occupations (like hauling out dead bodies). As Defoe said, they “went about their employment with a sort of brutal courage.”

— Trading for agricultural goods (grain, butter, and cheese) “carried on all the while of the infection, and that with little or no interruption.”

The temptation, of course, is to skip ahead to the end of the book and ask, “How did it all end?” If market behavior matches up between the beginnings and middles of the two pandemics, shouldn’t we prepare for our own pandemic story to match the end of Defoe’s? Here again I admire the old trader’s attention to prices. He reports that there were no shortages of food: “Provisions were always to be had in full plenty, and the price not much raised neither, hardly worth speaking.”

Specifically, the value of a “wheaten loaf” of bread went from the equivalent of $0.82 (converted into today’s U.S. dollars) before the plague, to $0.91 “in the height of the contagion … and never dearer, no, not all that season,” then back down again within eight months as the plague waned. That may sound cheap to us, when a 16-ounce loaf of bread today costs more than $3.00, but bear in mind that the annual wages for a skilled tradesman in 1660s were only $3,270 (converted into today’s U.S. dollars).

The great value of Defoe’s “Journal of the Plague Year” is its reminder to us that there is nothing new under the sun. It also reminds us that sometimes, patterns do occur in markets. Robert Shiller, winner of the 2013 Nobel Prize in economics for his work describing the “speculative bubble” pattern that occurs in asset prices fueled by herd instinct, has now turned his attention to the opposite pattern perhaps occurring in markets today. Rather than irrationally exuberant buying that creates overheated prices, perhaps we’re seeing irrationally, fearful selling driving unfairly depressed prices. He writes that “a contagion of financial anxiety works differently than a contagion of disease. It is fueled in part by people noticing others’ lack of confidence, reflected in price declines and others’ emotional reaction to the declines. A negative bubble in the stock market occurs when people see prices falling, and, trying to discover why, start amplifying stories that explain the decline. Then, prices fall on subsequent days, and again and again.”

Time will tell whether the current bearishness in the fuel markets, for instance (which include ethanol and corn), or the bearishness in feed markets (including soybean meal), is an irrational overreaction that will correct itself back upward as fear subsides or whether it’s truly an efficient response to observations of suddenly lower demand.

Unfortunately, my own understanding of germs (which, admittedly, comes from nothing more than high school science classes and years of vaccinating calves) is enough to know that our pandemic likely won’t peter out as easily as the Black Death of 1665. Their plague was caused by a flea-hosted bacterium that presumably died over the cold winter when the fleas on the rats died. Our pandemic today is caused by a virus — a trickier, undead non-lifeform with no known cure.

Yet again Defoe has been there before us, noting a resurgence of death counts in the two weeks after a premature rumor circulated that the disease wasn’t really so bad. He lamented “the people’s running so rashly into danger, giving up all their former cautions and care, and all the shyness, which they used to practice, depending that the sickness would not reach them, or that if it did, they should not die.”

Elaine Kub is the author of “Mastering the Grain Markets: How Profits Are Really Made” and can be reached at masteringthegrainmarkets@gmail.com or on Twitter @elainekub.

© (c) Copyright 2020 DTN, LLC. All rights reserved.

Yes, Commodities (or at least their futures) can be worth less than nothing

At some point on the morning of Monday, April 20, I noticed that front-month crude oil futures were worth about $4 per barrel. “Shockingly low,” I thought. “Crude oil will surely be worth more than that eventually.”

Then I shrugged and went back to a different project, because I didn’t really care. It’s been a long time since I’ve had the stomach to dabble in crude oil speculation and the $7,500 margin calls that go along with it. I felt entirely confident that commodities — the physical stuff we use to make the world go ’round — are always worth something and can never be worth nothing. A barrel of crude oil or a bushel of corn contains usable energy, and even if the supply and demand is currently unfavorable, these commodities can be stored away until somebody does demand that energy.

Stored away. Now, there’s the sticking point.

When retail investors get started trading commodity futures, they’re usually spooked by the physical delivery mechanism of the contracts. “If I speculatively buy a 5,000-bushel corn contract,” a rich dentist in Florida might wonder, “and I don’t get out of the contract in time, is someone going to dump five truckloads of farm product here on my beautifully manicured lawn?” No, they’re always assured. Physical deliveries at the expiration of a futures contract must take place at a warehouse facility licensed by the futures exchange. For corn, these facilities are commercial elevators near Chicago, Illinois.

For the U.S. NYMEX light sweet crude oil futures, here’s the delivery procedure (in part) from the CME Group’s website: “Delivery shall be made free-on-board (FOB) at any pipeline or storage facility in Cushing, Oklahoma, with pipeline access to Enterprise, Cushing storage or Enbridge, Cushing storage … At buyer’s option, delivery shall be made by any of the following methods: (1) by interfacility transfer (“pumpover”) into a designated pipeline or storage facility with access to seller’s incoming pipeline or storage facility; (2) by in-line or (in-system) transfer, or book-out of title to the buyer; or (3) if the seller agrees to such transfer and if the facility used by the seller allows for such transfer, without physical movement of product, by in-tank transfer of title to the buyer.”

For the futures traders who found themselves still long in May crude oil futures on Monday (the day before the contract expired, and while there were no daily limits on how far the price could move), we can see that the worry wasn’t about receiving tanker trucks full of light sweet crude delivered to their home address in May. The worry was about how on earth they could be called upon to find oil storage and pay for oil storage, in Cushing, Oklahoma.

Here’s the trouble: the oil storage capacity in Cushing, Oklahoma, was already 72% full as of April 10 EIA data, with inventory rising about 10% each week for the past three weeks. The remaining 21 million barrels’ worth of Cushing storage capacity is likely already spoken for. Oil traders who found themselves facing delivery on expiring May futures contracts could maybe try to buy storage capacity from some existing industry lease-holder, but at what cost?

That’s why the price of the futures contracts was suddenly negative, a condition this world has never seen before, and which most commodity traders probably never considered could happen.

Maybe crude oil would eventually be worth $10 per barrel in June, but if the desperate physical owners had to pay $50 per barrel in storage fees to carry it through the next couple of months, that meant the value — at least during the peak panic of that futures squeeze — was equivalent to negative $40 per barrel.
In the first 30 minutes after the May crude oil contract turned negative, 6,750 contracts were traded at prices between -$1.43 and -$40.32. There’s no way to know the price levels where those traders entered those contracts, but it’s safe to say that a lot of speculative money was lost on Monday. Commercial oil industry participants presumably rolled out of their May contracts before this timeframe and already have their storage needs lined up for the month.

Storage problems will continue amid the profoundly bearish supply and simultaneously profoundly bearish demand scenario for oil. In the grain markets, the prices in later months tend to be higher than the prices for nearby months (called carry spreads or “contango” in energy lingo) to account for the cost of storing the grain. Oil markets typically display the opposite structure (backwardation), with July 2020 crude oil $0.25 per barrel cheaper than June 2020 crude oil, for instance. Since the sudden COVID-19 lockdown, recession occurred and the world’s pumped oil had to scramble to find long-term storage, and these oil spreads have exploded in the “wrong” direction to unprecedented levels. There is now a contango spread of more than $9 per barrel between the June and July futures contracts. The last time drastic contango was seen in the crude oil futures spreads was in January 2009, at a scale of only $2 to $4 per barrel.

What lessons should grain traders, and grain producers, take from this sudden wake-up call? First of all, don’t get caught with open futures hedges in the last days before a contract’s expiration, unless you’re a commercial operation that’s fully prepared to accept or deliver physical grain via warehouse receipt.

The second lesson, we might think, is to worry that maybe grain prices could go below $0 now, too. However, I’m not sure the real physical grain producers and grain traders should worry much about that. Physical spot crude oil prices haven’t turned negative — it was just (temporarily) the futures contracts that were in danger of receiving delivery at the Cushing-specific location. Physical spot grain prices would likely not turn negative in our world, no matter how bearish short-term supply and demand may get, because again — grains contain inherent value, as energy or as animal feed, and dry grain can be stored until such a time as it is eventually demanded. Even if all the grain storage facilities in America were plugged full, and monthly storage costs were unusually high, farmers can (and sometimes do) just pile grain on the ground. You can’t do that with oil. It wouldn’t be ideal for the grain industry to run out of storage and it would result in some losses, but thankfully it shouldn’t zero out the value of the commodity.

Elaine Kub is the author of “Mastering the Grain Markets: How Profits Are Really Made” and can be reached at masteringthegrainmarkets@gmail.com or on Twitter @elainekub.

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