Managing commodity price risk in volatile markets

Uncertainty and volatility have been hallmarks of key food and beverage commodity markets for the past three years. The COVID-19 pandemic gave way to severe global supply chain disruptions, and today, companies are facing inflationary pressures not seen in the past 40 years. Commodity risk management has always been a key element of business, but during these challenging times, it’s extremely important to both understand and control commodity costs.To effectively control commodity costs, one must start from the foundation that futures markets are usually priced on the fundamentals of supply and demand. From there, one can estimate a range of realistic prices.  For grain and oilseed markets, this is expressed in Carryout/Usage ratios and Days of Supply calculations.  Some markets are more sensitive to tightening stocks than others.  Wheat, for example, is much more sensitive to low Carryout/Usage levels compared to corn and soybeans.  Once you understand the realistic possibilities of carry out/usage ratios for any given market, and their historical price ranges, you’ll have more confidence and success coming in under budget and managing commodity price risk.Let’s start with historical price ranges.  Below is a chart of corn prices going back to 1960.   You can see in the 1960s and into the early 1970s, corn traded in a range of $1.00 to $2.00 per bushel.  When stock/usage tightened, corn tested $2.   When the US had too much corn, it traded to $1.00.  That price dynamic changed during the 1970s and the Great Inflation period.  Corn generally traded between $2.00 and $4.00.   The price range lasted until 2006-2007.So, what happened around 2006-2007?  The Renewable Fuel Standards Act was introduced in 2005 and expanded in 2007.  The US had to adjust from producing 11 billion to 12 billion bushels of corn a year overall to 15 billion to meet the increased demand caused by the RFS.  At the same time, China was buying significant amounts of soybeans from the US and that led to corn (ethanol) and soybeans (China) competing for acres.After the past two years of inflation, you can make the case the markets are in a new price era.  The days of $3 corn, $4.50 wheat, and $7 soybeans may be long gone.  While not as bad as the 1970s, we have seen a cumulative increase of 15% inflation since 2021, due to COVID shutdowns and subsequent stimulus.   Soybean and canola oil are about to become a more significant part of US green energy policy and may shift prices higher for oilseeds the same way ethanol did for corn. The next thing to understand is Carryout/Usage ratios (a similar concept to Days of Supply). What is considered abundant, adequate, and tight for each market? Here are some equations that may help in determining each market situation.Carryout/Usage = Ending Carryout Stocks / Total UsageDays of Supply = Ending Carryout Stocks / (Total Usage/365 days)Let’s say corn has 1.5 billion projected ending stocks and a total annual usage of 15 billion bushels.Carryout/Usage = 1.5 bil bu / 15.0 bil bu = 10%Days of Supply = 1.5 bil bu / (15.0 bil bu / 365 days) = 36.5 days of supplyCarryout/Usage tells us how much left-over supply we have at the end of the marketing year as a percentage of total demand.  Days of Supply tells us how many days of average use we have left over at the end of the marketing year, right before harvest begins.Now that we know the historical price ranges and how to calculate Carryout/Usage, we can look at past years and see how prices tend to trade.  You will notice in the chart below when Carryout/Usage is 10% or lower, average farm prices for the year may be over $5 per bushel.  When Carryout/Usage is above 12% the average farm price is usually below $4 per bushel.  What these two charts and the Carryout/Usage calculation shows is corn is tight at 10% or lower and burdensome at 12% or higher.  If you did the same analysis for soybeans, you would see 10% or lower Carryout/Usage is tight, 10-15% is adequate, and over 15% is very burdensome/bearish.Wheat, on the other hand, starts tightening when Carryout/Usage is between 30% and 35% and Days of Supply are about 120, which is nearly 4 months.  Why is wheat so much more sensitive to tight stocks when compared to corn and soybeans? The majority of wheat stocks is used for human consumption while the majority of corn and soybeans are used for feed and energy.  If corn and soybeans tighten, you can reduce on animal feed and ethanol/renewable biofuels.   85% percent of domestic wheat usage is used for human consumption. Wheat is also one of the cheapest caloric options for humans.  If we have a shortage in wheat, we have a major food crisis on our hands.   That is why the market is much more sensitive to wheat shortages over corn and soybeans, and why 30% Carryout/Usage is considered tight for US wheat stocks while 10% is considered tight for corn and soybeans.The key piece of the puzzle is developing a model for supply (acres and yield) and demand (exports and domestic use).  Supply and demand totals rarely vary more than 5% year over year, so you can develop some fairly reliable parameters for possible prices given we don’t have a historic drought to slash supply or a pandemic to crush demand.  From there you can use a combination of value targets and time triggers to get coverage for commodities during the budget year.  Food and beverage companies can use financial hedges such as option collars, with the possible high as the long call and the possible low as the short put.  You may also use Over the Counter  (OTC) structured products to set caps on prices for budget purposes and set hedges to accumulate price coverage at value areas on a weekly basis prior to your budget year.  We find that when our clients understand the possible price ranges for the year based on bullish and bearish Carryout/Usage scenarios, procurement teams are more likely to use financial tools to help control their commodity costs.Choosing the Right PartnerYou want a firm that knows your industry – and knows your markets. With over 100 years of experience in the commodity markets, StoneX (NASDAQ: SNEX) checks both boxes. We work with your company to maximize purchasing opportunities and manage the inherent price risks as well. By controlling your commodity costs to the highest standard, StoneX is more than just a financial services company—we are your partner. Together, we can drive your company’s future growth.



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