By Jon Scheve, Superior Feed Ingredients, LLC
Corn and bean prices will continue to be extremely volatile as the market determines how much grain will ultimately be exported out of the U.S. South America is beginning their harvest and currently their corn and beans are worth less than the U.S. right now. This could slow down U.S. export demand.
While a large percentage of the beans purchased for export have been shipped, a lot of corn purchased for export has not. Both crops still face the potential for cancellations, which could lead to larger carryouts and impact prices long-term.
How do cancellations work? To answer this, it helps to understand how grain trading works after farmers sell and deliver their grain.
What happens to grain after it is delivered to elevators?
Some farmers may be surprised how many times a bushel of grain changes hands before it’s consumed or processed in another country. As a farmer and grain trader, I’ve watched grain sold from our farm and delivered to an elevator be sold and shipped by rail 500 miles away to be used for some type of animal feed several months after we deliver it to my local elevator. That company however might have turned around and sold those bushels to another company before the train was loaded and this new buyer may take the grain to another destination possibly for export.
If that second company sells it to an export facility the new third buyer in the chain may either arrange vessel freight and export paperwork themselves or sell it yet to a fourth company to handle export transport logistics across the ocean.
Once the grain arrives in another country, it can be sold again to another company who off-loads it and puts it in storage. This foreign company might sell it directly to an end user or it could be sold several more times before reaching the final-end user.
While there are countless possible trade scenarios, most exported grain is transported by at least three modes of transportation (i.e., truck, train or barge and bulk ship or container vessels) and can be traded between six to eight different companies before it reaches the final end user in another country.
This seems inefficient
It can seem that way but it’s important to remember that the original seller of the grain, the farmer, may not want to sell the grain when an end user wants to buy it or vice versa. This means there needs to be risk takers and risk managers all trading grain between one another to make sure there is liquidity in the market every day for the farmer to sell when they are ready and for the buyer to be able to get product when they need it. This is why there are so many market participants involved with getting grain from here to there.
Some larger companies have tried to integrate several of these steps to increase efficiencies and improve profit margins, but it can still lead to inter-office trading or other outside integrated companies still trading with each other. The steps don’t change, but the number of players involved might.
The system still works because trading grain between multiple companies helps reduce risk, because no company wants all their trades with one country or one customer because of everything that can potentially go wrong. Credit issues or quality demands with customers can always develop. Freight spreads constantly change, while trains and trucks don’t always run on-time and vessels can get backed up at ports. Plus, demand changes over time too. This type of trading done once the grain has been sold off the farm is known as “arbitrage” and it’s the key to profitability and efficiency in the grain trading world.
The market is always looking for a profit
If a trade could be done more profitably with fewer “middlemen” then it would. Every trader knows someone else is trying to cut them out of a trade to earn a little more, just like they are trying to cut someone else out. Farmers do this too by selling direct whenever they can. All this competition is what keeps the market as efficient as possible.
Since all grain goes through this complex trading system, it helps prevent someone from easily walking away from trades without causing financial strain. Similar to how difficult it is for farmers to walk away from trades without a penalty, each company in the trading chain usually can’t cancel without a cost. However, cancellations can occur when there is economic gain for all parties involved throughout the trading chain.
Futures prices aren’t a factor in cancellations. It may surprise some farmers, but once farmers sell their grain, futures are not really a factor for those in the trading chain. Instead, companies determine profitability of trades based on the basis and spreads off the futures market. As companies trade grain, they exchange futures positions with one another all the way through the system to minimize price risk beyond basis, spreads and transportation costs.
Traders are monitoring global freight spreads and basis constantly to maximize profitability. Right now, South American corn delivered to different ports throughout Asia is nearly 50 cents cheaper than U.S. corn. While this lower price might mean that less corn will be bought from the U.S. going forward, it doesn’t automatically mean there will be cancellations.
Purchases and sales are never final
Back and forth trading can continue until the grain is shipped. A trader who has already purchased corn from a U.S. port to be delivered to Asia may see they can now buy South American corn much cheaper. So, that trader may ask that U.S. corn seller what they would be willing to buy back their corn sale for. If this happens, and the price is right, it can create a domino effect throughout the entire chain of traders. Each then going back to see who is willing to buy the grain back and at what price.
As the trade works backward through the trading chain, each trader will look for the best-selling opportunities available. After all, it doesn’t matter where the grain is coming from (i.e., elevator, export facility, etc.), every trader is always looking to make a profit. Maybe another exporter has a strong bid or maybe a train scheduled from Nebraska to Washington could instead be rerouted and sold to Mexico.
First rule of business: Buy low and sell high
Despite all the middlemen involved in these trades, the market stays efficient because everyone is looking to “buy low and sell high,” even through its a cancellation process trade. This may mean traders will sell the grain all the way back to the company that originated the grain in the first place. For example, that elevator who originally sold the grain on a train may now see that a local ethanol plant is willing to buy for a higher price than what the export chain wants to sell it back to them at. The origin elevator could then buy back the train and move it to the local ethanol plant for a profit.
The cancellation process has a price. No company in the chain will likely do this work for free though. Each company will probably want to make a profit on every trade transaction. And the more work it is, the more profit that is likely required. For example, changing the destination of one train to a different location is a lot quicker and easier than having to cancel that train and find 400 trucks to move the grain of that one train to an ethanol plant.
While traders will demand a profit to make a change, they can’t charge whatever they want. Instead, market competition for everyone involved determines the price and profitability at each step in the cancellation process. After all, it takes a lot of trucks to fill a train and a lot of trains to fill a vessel. Therefore, not all of a vessel’s grain will necessarily originate from the same Midwest elevator. It’s usually spread across many elevators in multiple states, which creates lots of competition.
In theory, farmers could be a part of the cancellation process too. A farmer could potentially make a little profit, if they were willing to tell their elevator that for the right price, they would haul their already sold grain to another location for a premium when the contracted shipment time comes around.
Cancellations can be very complex and expensive
There can be up to 10 transactions involved with cancelling an export order if all transportation companies are considered in the trade. Which gets us back to the cost difference between South American and U.S. grain at 50 cents right now. For some trading chains, it might cost more than 50 cents per bushel to cancel a contract, but for others it might be less. This uncertainty can contribute to market price swings as no two trades are going to cancel out the same way.
If a large cancellation does happen, first there will be local basis pressure as traders try to find a home for sizable amounts of grain. Then the spreads between futures contracts will widen, because the market suddenly doesn’t need grain as badly or quickly. Both scenarios can then put pressure on the futures market.
While public reporting of cancellations is always a little bit after the fact, the market usually has already seen them through sudden domestic basis drops or transportation adjustments. That’s why there are often cancellation rumors when the futures market falls substantially, but then the market will quickly rebound if there aren’t any export confirmations within a few days.
Cancellations in reverse
While the example above showed how a foreign buyer could cancel U.S. grain purchases, the opposite can happen too. If ethanol plants or the feed sector can’t procure enough corn, they can raise their basis bids high enough so elevators with grain sold for export can ask their buyers if they want to cancel their trades. If this happens, the request will then be sent through the export chain for consideration. This sometimes happens after a basis rally causes spreads between futures contracts to narrow and often leads to futures rallies.
The grain trading process after it leaves the farm is complex with many moving parts and players. And while cancellations can occur, they are more likely to happen when there are large imbalances in world prices. Supply and demand will always win out to make sure grain is moved to the area with the highest need and those willing to pay for it. It may seem inefficient; however, having so many different market participants creates a lot of competition, which in the end mitigates risk for everyone.
Please email firstname.lastname@example.org with any questions or to learn more. Jon grew up raising corn and soybeans on a farm near Beatrice, NE. Upon graduation from The University of Nebraska in Lincoln, he became a grain merchandiser and has been trading corn, soybeans and other grains for the last 18 years, building relationships with end-users in the process. After successfully marketing his father’s grain and getting his MBA, 10 years ago he started helping farmer clients market their grain based upon his principals of farmer education, reducing risk, understanding storage potential and using basis strategy to maximize individual farm operation profits. A big believer in farmer education of futures trading, Jon writes a weekly commentary to farmers interested in learning more and growing their farm operations.
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