Supply, Demand and Assumptions

Heather Moffatt, Grain Risk Management Advisor, Agricultural Marketing First

The supply and demand theory seems relatively simple. When supplies are abundant, prices trend lower and when supplies are tight, prices rise. When demand increases for a product that is scarce, prices rise, when demand diminishes for a product, prices drop.

Although this theory seems rational to most of us, I have found that it is vastly misunderstood in agricultural circles. The three major grains that we market - corn, soybeans and wheat, are sensitive to a world and local supply and demand matrix. Commodity prices are arrived at through interactions of buyers and sellers facilitated by the Chicago Board of Trade. An exchange of grain occurs whenever buyers and sellers can agree on a price.

Basis, or the difference between cash and futures values, is also directly influenced by supply and demand. This relationship is accurately illustrated when tracking U.S. basis levels. Often, basis widens (weakens) at harvest as an abundance of grain floods onto the market. Grain elevators take possession of a large percentage of the grain crop as producers sell for cash flow. As time moves forward, basis will strengthen (narrow) as grain is needed. True basis values are clouded in Ontario. U.S. values must be converted to Canadian currency and a constantly fluctuating dollar can hide true basis levels.

Agricultural grain prices often move before actual supply disruptions or increased demand is actually realized. World and domestic supply and demand statistics are readily available. One must remember, that because we market in a global market place, these statistics are constantly changing. The final outcome from planting to harvest is largely due to weather. We know from experience this is largely unpredictable. If you know you are marketing half of your grain at harvest, protect price if opportunities present themselves before that time. Spring often presents pricing opportunities for producers. Planting weather or uncertainties over acres planted can create rallies. Actual production won't be known until well into harvest. The 2004 corn crop year was a perfect example of this. In the January 2004 World Agricultural Supply and Demand Estimates (WASDE) reported a 2003 ending stocks reduction from 1.296 to 978 million bushels. This 318 million bushel reduction was much larger than anticipated and brought ending stocks below the psychological 1 billion bushel mark, hence opening the door to potential price volatility. As spring planting ensued, December corn rallied up to $3.30 per bushel in April over production concerns. By the time fall arrived, the November WASDE report had ending stocks pegged at 1.819 billion bushels for the 04/05 crop year. December corn futures dropped below $2.00 per bushel.

Supply and demand reports are projections for the future. In 2004, supply concerns drove the market higher. Today, anticipated strong demand for corn is driving prices higher. Countless final crop scenarios could be factored at this time. Protecting price before harvest makes sense knowing a portion of your grain must be marketed in that time frame. Those of you, who are able to hold corn off of the market with on farm storage, should also be looking at deferred bids or basis opportunities. Use concerns over supply shortages or perceived strong demand scenarios to lock in profitable prices. Know how to manage price. Just because the trade is concerned with crop production, and builds a premium into the market, doesn't necessarily mean high prices will be present at harvest. Look back at December corn futures historically to remind you of what could happen during harvest. Use price spikes caused by supply and demand uncertainties to lock in strong prices. Look ahead, pick your price and lock it in.