PRUDENTIAL SECURITIES, INC.
One New York Plaza, New York, New York
212-778-1000
(March 27, 2000) CORN: Coming off a week that brought long-term drought forecasts and higher prices, the corn market eased last week as short-term weather forecasts indicated rain moving into the driest regions of the central United States, with additional systems following. These forecasts dampened concerns generated by the drought reports and pushed prices to levels established before the drought concerns took hold. The market will continue to be sensitive to changes in the weather forecasts or data that supports the increased chance of drought this summer. This attitude is no different from any other year, it just is starting earlier than normal.
The warm winter has heightened weather concerns this year as topsoil and subsoil moisture levels are at severe deficits. Recent rains have alleviated some of these deficits because the warm weather has allowed the soil to thaw earlier than normal and let moisture seep into the lower soil levels. Normally, rainfall or snow melt at this time of year does little to benefit soil moisture levels because the ground is frozen and most of the available moisture runs off into nearby waterways. Despite the improvement in soil moisture levels, most regions of the Corn Belt will need additional rainfall over the next several months to maintain the improved conditions.
Planting has begun in the far southern states despite dry conditions. Shortly after planting, these regions received heavy rainfall that aided early emergence. Texas reported 45% of the corn crop planted as of March 19 (versus the five-year average of 28%), with 29% of the crop emerged. Louisiana reported similar progress, with 42% of the corn crop planted compared with the five-year average of 22%; emergence was reported at 30% versus the five-year average of 6%. These are not large-producing corn states, but is an indication of farmers' desire to enter the fields as soon as possible.
Planting in the major corn states normally would be a month away, but we believe Midwest farmers will show the same desire to enter their fields as soon as possible this spring. Soil temperatures have reached 50 degrees as far north as southern Illinois and southern Indiana. This temperature is considered the benchmark for planting, as corn will germinate at this temperature. Planting when soil temperatures are below that level can cause delayed germination, increasing the chance of seed rot and poor emergence. If warm Midwest weather persists as forecast into mid-April, we would expect farmers in the central Corn Belt to be aggressive in planting, resulting in a quick completion if weather does not cause lengthy delays.
The prospect for drought this summer is encouraging farmers to enter fields early this year because an early planting may mean the crop will pollinate before mid-summer heat sets in. High temperatures during pollination can cause a variety of problems, all resulting in reduced production. By planting early, farmers might be able to capture any premiums that exist prior to the main glut of harvest. This has occurred in the past, but is unlikely without severe production problems, which would reduce available supplies.
Another result of early planting without major delays could be increased corn acreage this year. At this point, we are looking for a modest 200,000-acre reduction in planted corn acres to 77.2 million. If early planting is viable, farmers likely would choose to stay in the field and plant corn instead of waiting to plant other crops and risk a change in the weather. An early planting environment could increase planted acreage to last year's level of 77.4 million acres or slightly higher.
We believe the only chance of breaking out of the pattern of low commodity prices is the threat of production losses. Domestic and export demand remain on target, meaning that carryout this year will be at least 1,700 million bushels. Exports continues to outpace last year's comparable levels, with total commitments equaling 70% of the year's export projection compared with 65% last year at this time. While encouraging, achieving the export projection could be threatened this summer if China remains in the export market. It has been less aggressive in the last month, but has continued to sell into South Korea, which has been the second largest consumer of U.S. corn. During January and February, China exported 434,477 tonnes of corn to South Korea, or 54% of all corn shipped. China likely has exceeded the USDA's export figure of 8 million tonnes and is closer to 9-10 million tonnes. We believe China is comfortable with its current level of sales and that any additional export increases will require better world prices to justify selling additional volume. China's ability to increase exports will not only threaten the U.S. export projection but also will temper prices, as its potential sales hang over the market. To counter this effect, the United States would need production problems this year, which would then change the U.S. and world balance sheets as well as price projections.
Domestic demand remains strong, and the largest sector, feed and residual, is on track to approach the USDA's projection 5,650 million bushels. We continue to trail the USDA projection by 100 million bushels because believe the warm winter did not stress livestock and likely reduced feeding rates. Also, if weather conditions remain favorable in the hard winter wheat growing regions, we would expect increased wheat feeding in those regions at the expense of corn. Even if the board spreads do not encourage wheat feeding, depressed basis levels in wheat should keep the cash spreads at a point that encourages increased wheat feeding this spring.
The remaining demand category, Food/Seed/Industrial (FSI) is the smallest of the sectors this year, but has the potential to exceed exports in the years to come. High crude oil prices have reignited interest in finding a renewable energy alternative. For years, corn-based ethanol has replaced millions of barrels of oil, but its high cost of production relative to the price of gasoline made it necessary for the government to subsidize the industry in order for it to survive. With gasoline prices now at 10-year highs, ethanol is a viable alternative. Any significant increase in corn use for ethanol production will not be immediate, however, as the industry must expand to meet even a modest increase in projected usage. As we pointed out in last week's report, 60% of ethanol production occurs in wet milling plants, which also produce other products, such as cornstarch and corn syrup. These milling plants might produce ethanol later into the season due to increased demand, but it would be at the expense of other products. The net result is an increase in ethanol production, but no increase in the number of bushels of corn processed. Our balance sheet reflects a 53-million-bushel rise in FSI use for 1999/2000, but still trails the USDA's 78-million-bushel increase.
Figure 1
Monthly Corn LDP Entries
(million bushels)
Source-USDA
Enrollment of the remaining bushels into the government programs remain routine. Illinois led the pack in LDP entries last week with 6.4 million bushels, followed by Iowa with 2.4 million. Total U.S. entries were 24.3 million bushels as farmers took advantage of the previous week's rally to take their LDP and sell into the cash markets. Monthly enrollment totals this year exceeded those of last year early in the season (Figure 1), and have fallen behind last year's monthly pace only because there are fewer bushels available. Total enrollment has exceeded last year's level by a wide margin (Figure 2) as farmers have learned to use these government programs to maximize return on their crop.
Figure 2
Total Corn LDP Entries
(million bushels)
Source-USDA
Increased use of the corn LDP has had a depressing effect on prices as farmers still own a large portion of the crop. While some have sold part of their position into the cash market, many have not. This becomes apparent when prices move higher only to be stalled by increased hedge pressure as farmers sell into the rally. With the risk of drought hitting the media, farmers now have their sights set on even higher prices. Thus, a normal growing season could result in a scenario similar to the last two years when the market hit its lows just prior to harvest. That could occur because farmers who wait for a rally that never comes probably would be forced to liquidate into a market that does not want additional supplies.
July corn should range from $2.30-$2.65 per bushel through planting and the early growth cycle. The extremes of this range could be tested in the middle of the growth cycle, depending on the pollination situation. With normal pollination and production, nearby corn has downside potential of $2.10 shortly after pollination. If all systems remain "go" into late summer, we would expect farmer liquidation to press prices below $2.00 and possibly approach last July's low of $1.77 prior to harvest. With production problems, the old-crop July contract will have to keep pace with the new-crop December contract to encourage carrying as much old-crop corn into the new-crop year as possible. Moderate new-crop damage (resulting in production of 8,500-9,000 million bushels) could support a rally to $2.90 through the summer. A crop outlook closer to 8,000 million bushels should mean old-crop prices could surpass $3.00 and head to the $3.25 area in an attempt to ration supplies.
The December contract should have similar volatility. Without production problems into the early growth stage, we would look for December corn to stay in a $2.40-$2.75 trading range. If the crop gets through pollination under normal conditions and production appears to be in the 9,300- to 9,500-million-bushel range, we would extend the low side of the trading range to $2.05, a level that could drop another dime if the market is assured of ample supplies through adequate new-crop production. If the crop appears to be reduced to 8,500-9,000 million bushels, we would extend the upside of the range to $3.00. With a crop near 8,000 million bushels, we would expect December prices to rise to $3.30-$3.50 area to ration supplies as the new-crop carryout may drop to critical levels.
Shawn McCambridge