December 05, 2020
The unprecedented global monetary and fiscal responses to the pandemic have reinvigorated long-simmering concerns over potential inflation. One area where we see the potential for inflation – and a form of inflation that would be felt acutely given current unemployment trends – is in agricultural markets.
FAO Food Price Index over 20 years, January 2000-July 2020
Source: Food and Agriculture Organization (FAO) of the United Nations.
Context on agricultural prices
The FAO Food Price Index shows muted prices relative to recent history. For example, orange juice, eggs, cocoa, and sugar prices are relatively benign. Pork prices moderated in China, and strong chicken and beef pricing in the second quarter of 2020 has recently abated. Despite this seeming calm, fundamental drivers are showing cause for concern in several underlying markets. Wheat prices in the United States are at their highest levels since 2014. Similarly, soybeans and corn are close to their highest levels since 2014. These grain and bean markets are being driven by two primary factors: weather and demand.
Drought conditions in much of the US
Source: US Drought Monitor, used by permission. The US Drought Monitor is jointly produced by the National Drought Mitigation Center at the University of Nebraska-Lincoln, the US Department of Agriculture, and the National Oceanic and Atmospheric Administration. Map courtesy of NDMC.
Deteriorating crop conditions
The US drought monitor, which indicates abnormally dry to extreme drought conditions in much of the western half of the US (source: National Drought Mitigation Center, November 2020), underscores why US crop conditions deteriorated this fall. Globally, the picture also remains bleak, with notable negative weather impacts in Russia, the Ukraine, and Australia. The US Department of Agriculture (USDA) soybean yield estimates are 47.3 bushels per acre, which would be the lowest reading since 2014. (For reference, the drought of 2012 saw yields around 40.0 bushels per acre.) Corn is in a similar position, with an estimated yield of 167.5 bushels per acre, the lowest since 2013. (Source: USDA.) Importantly, recent drought conditions can rob spring soil of the moisture needed to withstand variable weather. La Niña is also potentially affecting future agricultural output with drier conditions in Latin America.
Stockpiling of agricultural products
Demand for agricultural products is relatively stable, historically, but with the recent supply and shortage concerns, we have seen a marked increase globally in governments stockpiling inventories. Furthermore, as China seeks to rebuild its pork supply following significant culling on the back of last year’s African swine flu outbreak, it has markedly increased its soy imports.
Chinese soy imports increasing: Imports over rolling 12 months
Sources: China Customs General Administration, Bloomberg, Macquarie.
Given historically robust soybean crop yields, the US exports a large percentage of its soybean production. We believe the status of the US as a net exporter could be at risk due to increasing demand for low carbon fuels fed by state mandates and incentives.
Increasing demand for low carbon fuels is leading to a significant increase in the number of proposed renewable diesel plants and refinery conversions. Security of feedstock supply will likely be of the utmost priority for these plants. While some incumbents like Valero Energy (through its joint venture with Darling Industries) use animal fats, recycled cooking grease, and so on, the majority of the new facilities will likely need to rely on vegetable oil (soybean, corn, and canola). Should most of these planned new plants and conversions come online, we estimate 10% or more of the soybean crop could head toward fuel markets. This could be similar to ethanol’s effect on corn markets starting in 2006.
A storm on the horizon?
A significant storm is brewing beneath the apparent calm in agricultural markets. Adverse weather conditions have the potential to damage short-term supply; this is currently leading to an additional demand boost from stockpiling. Longer-term rising demand for renewable diesel could cause a significant and disruptive demand boost for soybeans. Both trends should lead to a supportive agricultural environment, but more expensive food costs for the consumer.