The Impending Geopolitical G&O Bull/Bear Cycle

The outcome of the current US-China trade negotiations will be drastic and enduring. G&O commodity markets are not reflecting the high risk of an extreme impact of either ‘no-deal’ or ‘super-deal.’ The G&O value chain needs to prepare for the next geopolitical bull/bear cycle.

Prepare for risks from US-China trade talks

Geopolitical decisions, more than global fundamental supply-and-demand dynamics, threaten to make or break the next G&O bull market. The trade war between the world’s largest producer (the US) and importer (China) of G&O upended global trade fundamentals and precipitated a bearish CBOT tailspin last year, hurting unsuspecting US soybean farmers while boosting South American producers. The trade war impact has highlighted an untenable dynamic, namely the US’s reliance on Chinese demand for its grains & oilseeds, and China’s years-long quest to diversify and secure its supply chain of critical goods.

The radical near-term responses reflect the difficult decisions involved: China’s new lower-protein feed standards will accelerate its difficult transition from small to industrial feeding/farms, while US cash payments to soybean farmers threaten to incentivise an even greater supply glut in 2019. These trends have been exacerbated recently by ‘trade deal hopes’ that have priced a 13% rise in CBOT Soybeans from the 11-year lows of USD 8.14/bu in September 2018. With the end of the trade war truce approaching, it is timely to consider the potential outcomes for G&O markets and the supply chain. Price action currently reflects guarded optimism, but certainly does not reflect likely extreme outcomes for trade, whereas Rabobank considers the likelihood of extreme scenarios high.

Scenario 1: no deal won’t mean a return to status-quo

A US decision to escalate the trade tariffs and exert further pressure on China, especially if it follows spring planting, would move CBOT prices back to their September 2018 lows. US G&O farmers and exporters would suffer financial losses, while US & EU crushers would continue to benefit from elevated margins.

Some perspective: from 2013/14 to 2017/18, the US consistently shipped 60% of its soybeans – between 27m and 36m tonnes per year – to China. Importantly, China’s total purchase volumes of US G&O over that period fell by 6m tonnes, as it diversified sources and increased opportunistic purchases of soy from South America, and wheat and corn from the former Soviet Union. Since trade trouble began brewing last summer, Chinese purchases of US soy finally dropped as well, and, in the absence of a trade deal, not even 15m tonnes of shipments will happen in 2018/19. With world demand unable to compensate, US carry-out will double to a record +900m bu, weighing on CBOT prices.

Scenario 2: China elects the US as its primary supplier of G&O, commits to massive US soy imports

As part of any trade deal, President Trump and Premier Xi have committed to significantly reducing the trade deficit. The US’s largest exports to China by value – USD 20bn out of a total of USD 140bn ¬– are G&O products; any efforts to reduce the deficit would necessarily begin with Chinese purchase commitments of G&O far above the volumes that were done in the past. Such an extreme deal would fuel CBOT prices into a bull market that would extend from the soy complex to other critical G&O products for China – namely corn/ethanol, wheat, and sorghum.

Figure 1: US exports of soy, corn, wheat, and sorghum with 2018/19 deal/no-deal scenarios, 2007/08-2018/19

GO_US-China-trade-war-banknotes_fig1

Source: USDA, Rabobank 2019

What, then, would be the impact if China committed in a trade deal to purchase considerably more US soybeans than the previous record? The US soybean complex would face a bullish move, US crush margins would come under pressure, and the rest of the world would almost exclusively turn to cheap South American supplies. US soy acreage would rise, but not at corn’s expense; a deal would encourage a total US farmland expansion.

Turning the corn(er)

To meet its renewable fuel targets, China is expected to commit to importing ethanol, and a trade deal would likely entail purchase commitments of US ethanol. In addition, corn, sorghum, and DDGS are likely to move to China again as China depletes its corn balance sheet over the next three years, and the US would be an obvious supplier. China doesn’t dominate feed grains or ethanol markets as they do soy, so it could achieve higher US purchases without upending global market price dynamics. US ethanol margins would benefit, rising from recent depressed levels, once sizeable volumes of ethanol and DDGS flow to China, and – together with sizeable volumes of corn and sorghum per year – would drive a US agricultural boom benefiting US farmers, exporters, and ethanol producers over several years.

Figure 2: US ethanol, corn, and DDG export fortunes to the world and China have diverged, 2013/14-2017/18

GO_US-China-trade-war-banknotes_fig2

Source: USDA 2019

How to prepare for changes in the G&O value chain?

Geopolitics have kept this market guessing. However, current market complacency undervalues the volatility risk from a US-China trade deal or escalation. These scenarios might seem extreme, but they are not unlikely. The G&O supply chain needs to prepare for the risk that prices and margins could swing widely either way in 2019. Besides outright futures and OTC hedging, options could be a valuable hedging tool in these highly uncertain times.

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  • Stefan Vogel

    Global Strategist - Grains & Oilseeds; Head of Agri Commodity Markets
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  • Michael Magdovitz

    Commodity Analyst
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