Increasing Soybean Price Risk?

USDA’s May supply/demand reports continued to show large domestic and world soybean carryovers. U.S. 2004-05 soybean ending stocks are estimated at 355 million bushels, the largest in 19 years. World soybean carryover is expected to be a record 51.08 million metric tons (mmt). Large supplies usually mean lower prices. However, six months ago these soybean carryovers were expected to be considerably higher. The current U.S. soybean ending stocks estimate is down almost 23% from last November’s 460 million bushels projection. Disappointing Brazilian production also contributed to a nearly 17% reduction from the November estimate of 61.40 mmt world soybean ending stocks projection. Regardless of how large supplies are, declining ending stocks estimates usually result in higher prices and this has occurred. In November, USDA’s 2004-05 marketing year midpoint average price projection was $4.95. Soybean prices have remained above $6.00 since late February and the May USDA estimate for 2004-05 market year average price is $5.65. Soybean supplies remain historically large, but strong demand and production risks, along with other economic factors, have supported prices at higher levels than most analysts expected following 2004’s record soybean crop.

New crop soybean projections add to risk and uncertainty for soybean prices. USDA’s first supply/demand projections for 2005 soybean production uses trendline yields (39.9 bpa) to project the second largest crop ever with an estimated production of 2.895 billion bushels. A large crop suggests lower prices and USDA’s projection is a price range of $4.70 to $5.70, which is well below current prices. However, expected 2005-06 soybean use is projected to be a record 2.964 billion bushels, exceeding production and lowering estimated ending stocks to 290 million bushels. Although this estimate represents more than adequate supplies, it projects a reduction in ending stocks. Does this suggest the possibility of higher prices?

Assuming intended soybean planted acreage, anything less than trendline soybean yields has the potential to tighten supplies dramatically and there is no shortage of production worries. Depending upon location, the weather has been too cold, too wet, or too dry early in the production season. No one is sure what the impact of soybean rust will be or how fast it might spread. Adding to rust concerns this past week, since hurricanes were credited with spreading rust over southeastern states last year, was a NOAA forecast for an active hurricane season. The potential for soybean aphid damage also appears greater this year. The potential for one or more of these factors to reduce soybean yields creates significant production and market risk. However, much of this is "old news" and already in the market, which helps explain why November 2005 futures prices are well above USDA’s projected 2005-06 price range. With large old crop carryovers, $6.00 plus soybean prices represent a "risk premium" in current prices that could evaporate if conditions suggest production projections will be achieved.

USDA did not make 2005-06 world soybean supply/demand projections in the May reports. Although world ending stocks are less than earlier projections, world 2004-05 carryover will be large. While some predict that low returns and economic conditions could limit Brazilian production, it should still be assumed that their yields and production will rebound in 2006. World demand is strong, but old crop supplies appear more than adequate to meet demand in the months ahead.

The bottom line? Expect a volatile soybean market with considerable price risk, creating a challenging situation for new crop soybean marketing decisions. There are a variety of production risks that, should they occur, could send prices higher. But there also is significant downside price risk. Current new crop prices are $1.40 or more per bushel higher than the lower end of USDA’s projected soybean price range.

In view of the production and market risks, producers should use caution in adding to new crop soybean sales. However, the risk premium built into current prices should not be ignored either. While it seldom captures the highest price, it is usually good risk management to spread sales and add to those sales when prices are well above expected price ranges. Although option premiums appear expensive, last year’s volatile markets demonstrated that purchasing put options can produce favorable results in volatile markets that have $1.00 per bushel or more downside price risk. For those who understand them, more complex option spread strategies may provide opportunities to reduce price risk with the possibility of capturing higher prices and reducing the net cost of using options.

Burdensome Corn Supplies

Assuming benefits from early planting progress, USDA used a somewhat above trend yield of 148 bpa on 81.4 million intended planted acres to arrive at a 2005 corn production estimate of 10.985 billion bushels. Although record use of 10.670 billion bushels is expected, it is less than expected production. This means that the already large U.S. 2004-05 corn ending stocks of 2.215 billion bushels are projected to grow to 2.540 billion bushels at the end of the 2005-06 marketing year. This represents the largest ending stocks since the huge carryovers of the mid1980s! These burdensome supplies would be expected to be negative to prices and USDA’s projected 2005-06 corn price range is for lower prices at $1.55 to $1.95. Perhaps the only positive supply/demand news in USDA’s estimates is a small decline in 2005-06 world corn ending stocks from 128.7 mmt (2004-05) to 122.1 mmt.

Production may not reach USDA’s projections. Although rapid planting of the crop has occurred, poor growing conditions and some replanting may trim yields. Some analysts also believe USDA may have underestimated demand and that corn use will be higher than projected. However, everyone seems to agree that, without serious weather related production problems, domestic corn supplies will remain burdensome and prices will continue to be pressured.

Current new crop (December ’05) futures prices result in cash prices near or slightly above the top of USDA’s projected price range. However, these prices are about the same as the price protection the CCC loan programs offers, so there is little incentive for new crop sales at these prices other than speculating on lower prices and the LDP.

More Wheat With Lower Yields and Fewer Acres?

USDA’s 2005 planted wheat acreage estimate (58.6 million acres) is 1.1 million acres less than in 2004 (59.7 million acres). Wheat yield projections are also slightly less, 42.7 bpa compared with last year’s 43.2 bpa. Although planted acreage and yields are lower, total wheat production is projected to increase from 2004’s 2.158 billion bushels to 2.185 billion bushels! The increase is due to an expected increase in harvested acres (51.2 million acres compared with last year’s 50.0 million acres). Ending stocks are expected to increase to 678 million acres and 2005-06 wheat prices are projected to range $2.55 to $3.05.

Winter wheat crop condition ratings, while better than last year, have slipped in recent weeks due to freezing temperatures in the western plains and dry weather conditions in the southern plains. This has helped support July Chicago soft wheat futures prices above $3.02. However, unless wheat conditions continue to deteriorate, the seasonal trend for wheat prices is lower into harvest time.