Ongoing concern about the state of the global economy, some of it overdone in our opinion, frequently returns to the state of the oil industry and the downward direction of energy prices. For the man on the street, it seems odd that a declining oil price is provoking such pessimism. After all, if oil was up at $140 / bbl, perhaps then we would have something to worry about.
For commodities traders, however, oil has also been doing some damage to other markets as well, in particular grain and wheat. For starters, when oil was trading at historic highs, grains were being converted into ethanol. A large proportion of America’s corn crop went into biofuel production. That source of demand has now gone.
Energy is needed to produce grain
But consider also that 20% of the cost of producing grains is down to energy. As oil has fallen, so has the cost of farming. This has not been reflected in some countries, where the price of electricity remains steadfastly high (the UK, for example), but in the grain baskets of Canada and the USA, grain production has been getting cheaper in 2015
During the period 2001-2007, according to the International Food Policy Research Institute, oil prices contributed 30-40% to the upside of wheat and soybean prices.
At time of writing, Brent Crude was at $27.19 / bbl, WTI was slightly higher (see above). The critical question for traders will be when oil bounces, and what will cause it to do so. For those following softs, will these markets see more volatility and perhaps a rally in 2016?
The El Nino effect
Grain traders should look to the effects of El Nino in 2016: we have been experiencing extreme weather in both hemispheres, and more than a few harvests could fail. The UK saw its warmest autumn in living memory, and many African countries may find themselves in trouble in 2016. During the last El Nino period in 1997-98, India and China were far less dependent on global food supplies than they are today – for example, their combined vegetable oil consumption in 1998 was approximately 18m tons, according to the Hightower Report, an influential commodities think tank.
Last year combined Indian and Chinese vegetable oil consumption was over 50m tons. It won’t take much to push grain prices up, regardless of where oil goes in 2016.
The general consensus from agricultural analysts is that grains and soybeans will remain under pressure in 2016. It seems convenient to lump all commodities together into one basket, and paint them with bearish sentiment. But if the El Nino weather pattern asserts itself, which it well might in 2016, then expect grain prices to take off. Canny traders should keep an eye on those medium term weather forecasts and news relating to grain supplies in Asia.