Jon Scheve with weekly market commentary made on February, 17, 2023
Export sales have been very good for beans up to this point in the marketing year, but there are still a high percentage of beans left that have not shipped out of the country yet. As March approaches this might become a concern because Brazil’s beans are valued 80 cents less for shipment a month from now. This may lead to cancellations soon, which could mean a bigger carryout and price pull back. What Are Cancellations? The term “cancellation” in grain trading does not mean foreign buyers can just walk away from contracts without penalties. It instead means there are offsetting trades between two parties that effectively cancels the original contract. This often involves a money exchange between two parties as the original sales need to be shifted to other buyers. How Do Cancellations Work? To answer this, it helps to first understand how grain trading works after farmers sell and deliver their grain. What Happens to Grain After Its Delivered to Elevators? Some farmers may be surprised how many times one 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 and delivered from our farm to an elevator be sold again several months later, and then shipped by rail 500 miles away to a second company (e.g., a domestic processing plant or used for animal feed). Sometimes the second company may even sell those bushels to a third company before the train gets loaded. This third buyer may then take the grain or move it to another destination, possibly for export. If the third buyer is an export facility, they may either arrange vessel freight and export paperwork themselves or sell it to a fourth company that handles export transport logistics across the ocean. Once grain arrives in another country, it can be sold again to another company who off-loads it and puts it in storage. This foreign buyer 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 3 modes of transportation (i.e., truck, train or barge and bulk ship or container vessels) and can be traded between 6 to 8 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 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 moving grain. 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, since no company wants all their trades with one country or one customer with everything that can potentially go wrong. Credit issues or quality demands with customers can always develop. Freight spreads constantly change, trains and trucks do not 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 is 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. All grain going through this complex trading system 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 cannot cancel without a cost. However, cancellations can occur when there is economic gain for all parties involved throughout the trading chain. Futures Prices Are Not 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 a trade’s profitability based on the basis and spreads off the futures market. Basically, 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 beans delivered to different ports throughout Asia are more than 80 cents cheaper than US beans. While this lower price might mean that less beans will be bought from the US going forward, it does not 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 beans from a US port to be delivered to Asia may see they can now buy South American beans much cheaper. So, that trader may ask the US bean seller they have the contract with for how much they would be willing to “buy back” or cancel their bean sale. If this happens, and the price is right, it can create a domino effect throughout the entire chain of traders. Each trader in the chain then goes back to who they bought the grain from to see who is willing to buy the grain back or cancel a contract 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 does not matter where the grain is coming from (i.e., elevator, export facility, etc.), every trader is always looking to make a profit on another trade. Maybe another exporter has a strong bid or maybe a train scheduled from Nebraska to Washington could instead be rerouted and sold to Mexico or another end user in a different state. 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 though it is 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 processing plant is willing to buy for a higher price than what the export chain now wants to sell the grain back to them for. The origin elevator could then buy back the train and move it to the local processor for a profit. The Catch – 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 a processing plant. While traders will likely demand a profit to make a change, they cannot 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 a lot 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 grain buyer that for the right price, they would haul their already contracted grain to another location for a premium when the contracted shipment time comes. 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. This gets us back to the 80-cent cost difference between South American and US beans right now. For some trading chains it may cost more than 80 cents per bushel to cancel a contract. However, for others it might be a lot less. This uncertainty can contribute to market price swings because no two trades will cancel out the same way. Cancellations Can Quickly Have a Rippling Effect on The Market 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 does not 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, some market participants usually have already seen them through sudden domestic basis drops or transportation adjustments. That is why there are often cancellation rumors when the futures market falls substantially, but then the market will quickly rebound if there are not any export confirmation or cancellations within a few days. Cancellations in Reverse While the example above showed how a foreign buyer could cancel US grain purchases, the opposite can happen too. If ethanol plants or the feed sector cannot 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 or even invert which often leads to a futures rally. This could lead to the potential to buy grain from other countries if prices are lower than what it costs to buy domestically. Grain Trading Is Complex The grain trading process after it leaves the farm is complex with many moving parts and players. While cancellations can occur, they are more likely to happen when there are large imbalances in world prices. The laws of supply and demand always makes sure grain is moved to the area with the highest need and those most willing to pay for it. It may seem inefficient; however, having so many different market participants create a lot of competition, which in the end mitigates risk for everyone.
Jon Scheve Superior Feed Ingredients, LLC
9358 Oak Ave Waconia, MN 55387 jon@superiorfeed.com