China cancelled another 272,000 metric tons of corn from the US this week, taking the total amount cancelled to just over 1 million metric tons or around 40 million bushels. To many in the industry this was not a surprise for a whole host of reasons, while to others the string of cancellations after so much excitement over China’s big March purchases feels suspect.
I feel it is important to clarify how a cancellation or an amendment to a physical grain contract works. At the same time though, I feel this is a great opportunity to discuss why these cancellations were not surprising, with some expecting more to come and why the lack of storage space in Brazil and elsewhere is behind much of the pressure we are currently seeing in the futures market.
When starting to discuss how a cancellation or an amendment works to a contract, I feel it’s important to start with how physical grain pricing and contracting works. Traders in the physical realm focus on basis, spreads and freight when it comes to determining the real value of a product, with shifts in futures values far down on the list of things of importance when making a trading decision.
Basis is the difference between the cash price paid for a bushel of grain and futures value. It is the true indicator of local supply and demand and can act as a brake or an accelerator when it comes to physical grain movement—more on this later.
When physical grain is traded the buyer and seller both agree on basis versus a set futures month, who pays freight and a whole host of other aspects from terms of payment to quality requirements on the bushels shipped. Many times, the trade is transacted as agreed upon and life is good, however occasionally things happen, and trades no longer work or like we are seeing now, the economics point in a different direction.
Many cash grain traders have commented recently that cancellation is a misnomer, that what we are seeing here today is a perfect example of arbitrage, and they are right. Sometimes it is easy to forget, many of the companies exporting grain from the US are also exporting grain from Brazil. In an instance like we are seeing now, China is most likely changing the origin of their corn purchased from the US to Brazil, with the far cheaper values in Brazil more than covering any costs associated with washing out of or changing the origin to a contract.
The primary objective of the cash market is to balance supply. Grain needs to be cheap enough where it is plentiful it can be shipped out of the area. While in regions where supply is tight, values need to be high enough to discourage outbound movement, while also encouraging that cheap grain to travel further.
Back to the nuts and bolts of the recent Chinese cancellations, both parties have agreed on the difference in market values since the initial agreement was entered into, that means the selling party has taken into consideration what they can resell those bushels back into the market for, charging any losses incurred there, in freight or spreads booked, as well as charging a cancellation fee. They then presented the cost to the buyer, who took into consideration what they could re-own those same bushels elsewhere for, or in the case of an outright cancellation, how extreme their loss may be if their home market has gone against them, as well as any freight or spread differences that may or may not work in their favor. If both parties find it economically feasible to do so, an agreement on an amendment or cancellation is reached and the contract is changed accordingly.
Which leads me back to why many cash traders were not surprised by the run of cancellations and why they worry there are more to come. It is not because they hate high prices, or anything bullish in the market structure, as in most cases that couldn’t be further from the truth. When looking at the cancellations from a purely economic standpoint, the arbitrage makes sense and is likely to only make more sense as Safrinha harvest ramps up and the Brazilian farmers and cooperatives find themselves running out of storage space.
Brazil is expected to produce around 155 mmt of soybeans and 130 mmt of corn this year according to the USDA. According to Agrinvest, a Brazilian cash grain brokerage and market analytical group, the country has approximately 192 million metric tons of storage capacity. While some of the space shortage is aided by the country’s offset harvests, the lack of available space became glaringly evident as soybean harvest wrapped up towards the end of April.
As mentioned, the function of basis is to make grain cheap enough where it is overabundant it can move to where it is needed, or it is cheap enough it encourages sellers to find alternatives to selling.
What I mean when I say cash grain oozes, is imagine a slow flow of grain, moving from where it is cheap to the next place down the line that pays enough to cover freight, each time end users in line cover their needs the flow of grain must move further down the line to find another home.
Eventually enough grain is moved out or enough storage space is found, supplies and values stabilize, and the outbound flow is no longer economical. In the case of this year’s harvest in Brazil it took taking soybean values to near record lows, nearly $2.00 below futures and nearly $3.00 below US values in soybeans before the market encouraged enough movement or found enough storage to slow the outbound flow.
Why this matters for the corn market is because Brazilian farmers and cooperatives were able to stop the bleeding in bean basis by finding homes in every nook and cranny, meaning every nook and cranny is now painfully full. Now of course, not every state has the same amount of space shortage, with Southern states able to hold more bushels as they tend to feed domestic demand throughout the year. Much of the concern at first glance is seen in Mato Grosso, where Agrinvest estimates there is around 15 mmt (551 mbu) of soybeans left in bins to be sold, with around 50 mmt (1.97 billion bushels) of corn set to be harvested. According to Agrinvest there was approximately 45 mmt of storage space in the state in 2021. Much of Mato Grosso’s corn production goes to export, with cash prices already reportedly in the low $4.00 range as we find ourselves weeks from harvest ramping up.
If space truly is as short as indicated, basis values paid for corn will remain under pressure, pushing it out of where it isn’t needed by making it cheap enough it can be transported to where it is. As we learned in wheat this week, with reports of Polish wheat being shipped into Tampa mills and possibly elsewhere along the east coast, that can mean into US markets as well.
While of course the Brazilian crop is still a handful of weeks away from truly being made, the bulk of production has been confirmed, with farmer selling remaining painfully slow. The pressure on the market is only further exacerbated by cheap wheat working into the pipeline and poor industry margins for both feed and industrial use in China.
In the end, though it is a painful exercise in economics, there is nothing nefarious happening in the world export market. Purchasers of goods will forever be looking for ways to cheapen wholesale costs and improve margins, and with many end users barely having survived the painful pinch experienced in the cash market the last couple of years, it is likely they will take advantage of any oversupply.
One caveat, I will continue to watch the weather closely, with dryness expected across much of Brazil throughout the next week to ten days. Forecasters say June is trending wetter, but with the risk of frost also on the table, the crop is not yet in the bin, meaning many things can yet change. However, much of Mato Grosso’s crop is working into grain fill, and with Bird Flu having recently been discovered, there are many other factors that will continue to change or become more known as well.
As always, let me know if you have any questions. Have a great week!
On the date of publication, Angie Setzer did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.
