NBB In Sight

• 

Growing up in mid-Missouri farm country, one of my father's favorite sayings went something like this: "Most everything in our economy starts in the soil and ends up as money." Naively, I took that information and pursued an agricultural economics degree with a minor in agronomy. What he forgot to tell me was that economists are plagued with the reputation of being individuals who will know tomorrow why the things they predicted yesterday didn't happen today.

In the spirit of having multiple answers to an issue, I would like to tackle a subject that is on everyone's mind in our industry-raw materials supply and pricing-and attempt to shed some light on it. All are aware of the current strain on margins due to raw material values, and there is no shortage of contributing factors.

Let's begin with U.S. commodity acreage. In 2006, U.S. farmers harvested 74.6 million acres of soybeans. One year later, harvest is estimated at 63.2 million acres, down 11.4 million acres. Corn prices, spurred in part by developments on the ethanol policy front and tremendous growth in dry-grind capacity, rose significantly, and farmers made the economic decision to plant more acres of corn in their rotation.

It's easy to get lost in numbers. Without getting into supply and demand balance sheets, let's take a look at this impact. The expected yield in 2007 has been projected at 41.4 bushels per acre. Thus, the loss of soybean acres will result in 472 million fewer bushels in the vegetable oil supply chain. This is almost 5.4 billion pounds of oil, or the equivalent of more than 700 million gallons of potential biodiesel, that was not grown this year in the United States. Analysts and traders feel the market is trying to anticipate potential vegetable oil shortages in the future and that biodiesel has extended the market's horizon.

Many point to the tremendous stocks of U.S. soybean oil and contemplate how prices have reached such high levels. However, the United States is only one part of the global fats and oils equation. In the Sept. 21 issue of Oil World, it was noted that, "the prospective decline in world production of 10 oilseeds by around 13 million metric tons is unprecedented." The authors also projected that, "within only one year all the surplus stocks in soybeans and other oilseeds will have disappeared."

Other factors that have impacted the bull market for fats and oils and should not be discounted include the current value of the U.S. dollar, global biodiesel capacity, crude oil petroleum prices and global demand for edible oils. A unique aspect of the U.S. food industry's demand for vegetable oils is that it tends to grow from year-to-year, despite high prices. When trying to understand this inelastic vegetable oil demand, I often think about my daughter's seemingly insatiable appetite for french fries and the food industry's uncanny ability to pass higher prices on to the consumer.

The future for vegetable oil supplies and pricing is also not clear. Historically, farmers have made planting decisions based on a price spread between corn and soybeans. Current pricing would suggest more soybean acres may be anticipated in 2008. However, this prediction may be tempered due to competition from other crops such as wheat, which are in short global supply. Also, some think that the optimism in corn yield potential will continue to excite producers and keep the pendulum swinging toward corn acreage.

A silver lining, if there is one, is that the current situation is sending plenty of signals to the market to invest in new technologies and methods to increase raw material supplies. New oilseed acreage is anticipated from crops such as canola and camelina. Investment in algae is significant and filled with potential, and investors continue to evaluate the opportunity to generate corn oil from dry-grind facilities. The list for potential avenues to generate raw materials is not short. However, we must remain realistic relative to the amount of time required to fully benefit from these investments.

In a February 2006 article for Biodiesel Magazine, I penned, "… modest growth in biodiesel demand will cause upward pressure on vegetable oil prices. Reality is that raw material availability could become a natural brake for significant future growth." The article resulted in an inbox full of e-mails from parties that thought I was pessimistic regarding the industry's future growth. I also received feedback suggesting I was too optimistic on the potential for additional near-term gains from soybean breeding. Interestingly enough, no one thought I was on target.

While many global and domestic factors are playing into the current pricing scenario for biodiesel raw materials supplies, the result is the same-tight margins. Since biodiesel demand is just one factor in the overall supply and demand structure for fats and oils, successful biodiesel companies will need to incorporate all of these facets into their procurement strategies.

Alan Weber
Vice President of Marc-IV Consulting
NBB Economic Advisor