Itaú BBA - Weaker Grain Demand

Commodities Monthly Report

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Weaker Grain Demand

April 4, 2013

Exports from Brazil and Argentina May Also Affect Prices in the Short Term

Commodity prices fell 2.1% in March, as grain prices were negatively affected by the latest inventory data from the U.S. Department of Agriculture (USDA) and the persistent downtrend in metal prices since mid-February. The agriculture and base metals sub-indexes slid 2.1% and 2.3%, respectively, during the month, while the energy sub-index rose 1.0%. In average-price terms, the Itaú Commodity Index (ICI) fell 1.5% in March (our call: -2.4%). Reservoir levels in Brazilian hydroelectric dams climbed from a 45.9% capacity at the end of February to 54.4% in March, in a rise that outpaced the monthly average. However, given the strong utilization of thermal power plants and above-average rainfall in the period, the water-accumulation rate in the reservoirs remains unsatisfactory.

We revised our year-end price forecasts for soybeans (to 1350 cents/bushel from 1400), wheat (to 750 cents/bushel from 780) and some base metals. We now expect the ICI to drop 0.9% from the end of 2012, versus our previous estimate of a 0.4% increase. When compared with the annual changes between 2007 and 2012, it is roughly a flat-price scenario.

The USDA’s latest inventory data showed higher-than-expected inventories in the U.S. as of March 1, indicating a weaker-than-expected grain demand (particularly for corn) that is reacting to prices above those in 2012. The reaction was a steep drop in prices on the date of the report (March 28), particularly corn. On the supply side, exports from Brazil and Argentina may contribute to a sustained downtrend in prices in the short term, once the exaggerated changes are corrected. For the next crop year, the expected weather trends remain compatible with a moderate recovery in yields in the Northern Hemisphere.  However, the critical period for plant development is still some time away and the risk of crop losses cannot be ruled out if weather conditions deteriorate.

In the sugar market, fundamentals continue to indicate global surpluses despite the falling prices throughout 2012. In Brazil, the outlook is of a much greater sugarcane crop than last year. Given the recent adjustments in the Brazilian ethanol market, we expect mills to reduce the share of sugarcane used to produce sugar, thereby halting the slide in international prices.

For base metals, the decline in prices throughout March took place without material changes in fundamentals. In our view, the move reflects ongoing concerns regarding the global demand impact of the measures to cool down the property market in China as well as renewed concerns about the economic growth in the euro zone. Iron ore prices have started to retreat. Average spot prices slipped to $139.90/ton in March, from $154.60 in February. We believe prices will continue to drop throughout the year, reaching $125.00 by December.

Finally, energy prices remained close to those registered at the end of February. Prices for Brent crude remained close to $110.00/bbl, a level that is consistent with our supply-and-demand scenario in 2013.

Weather: Improved Soil Conditions in the U.S. 

Weather conditions in Brazil in March were compatible with the unchanged expectations for the summer crop. The largest areas of the states of Paraná, São Paulo and Mato Grosso do Sul recorded above-average rainfall. Rio Grande do Sul, Goiás and Mato Grosso showed a mixed picture, with above-average rainfall in some areas and below-average in others. In the in producing regions of the Northeast, rainfall was once again below average. Looking ahead, neutral conditions in the Pacific Ocean (i.e., no El Niño or La Niña) suggest that precipitation levels will be in line with historical patterns.

In the Northern Hemisphere, the outlook is of a still-moderate recovery in soil conditions in the U.S. and Eastern Europe. In the U.S., drought areas diminished in March and above-average rainfall is expected throughout the spring season in the corn- and soybean-producing regions, in line with a higher-yield scenario than the last crop. Winter-wheat producing regions were favored by the snow storms in February, but the planting and harvesting cycle offers no time for full soil recovery.

Reservoirs in Brazil: Better Weather, Unsatisfactory Advance

Rainfall in the main electricity-generating regions of Brazil (reservoirs and rivers with hydroelectric dams) exceeded the historical seasonal average in March (110%). Year to date, rainfall is at 93% of the seasonal average. Water levels in the reservoirs climbed to 54.4% capacity, from 45.9% at the end of February. The 8.5-p.p. increase surpassed the average increase for the month between 2000 and 2012 (6.4 p.p.).

Still, the situation is worrisome for 2014. The rainy season is coming to an end and the rise in reservoir levels between early December and late March totaled 21.4 p.p., which is below the average registered between 2000 and 2012 (30.2 p.p.). Even the high usage of thermal power plants has not been enough to reduce the gap between current reservoir levels and the historical average.

Grains: Weaker Demand

After a period of prices above those registered in late February, contracts (first due date) for corn, soybeans and wheat declined sharply on the last business day of the month. The movement was driven by the higher-than-expected inventories reported by the USDA for all three commodities, which indicate a weak demand. The biggest surprise was corn inventories, which prompted the sharpest slide in prices among the three commodities. The decline will likely be sustained, leading to lower average prices for the rest of the first half of the year. In the second half of the year, prices will be more influenced by the evolution of conditions for the next crop in the Northern Hemisphere. So far, the weather is compatible with larger crops (particularly in the U.S.), enabling inventory replenishment during the next crop year. We cut our year-end 2013 price estimates for soybeans (to 1350 cents/bushel from 1400) and wheat (to 750 cents/bushel from 780).

The gaps between the inventory data (on March 1) and median expectations for corn (10.1 million tons), soybeans (1.6) and wheat (1.4) suggest a more intense demand reaction to the high prices. On average, prices for the three commodities in 1Q13 rose 13.7% yoy. It is noteworthy that the materialization of the expected inventories for soybeans and corn would cause a sharp downward revision in ending stocks in the next WASDE report (World Agricultural Supply Demand Estimate). Based on the reported inventory data, one can expect an upward revision in ending stocks for corn and wheat in the U.S. Regarding soybeans, the implied demand in inventories, though below consensus, suggests a downward revision in U.S. stocks.

In Brazil, we expect crop volumes of 81 million tons for soybeans (CONAB estimate: 82, USDA: 83.5) and 71 million tons for corn (CONAB: 76, USDA: 72.5). In Argentina, our soybean and corn volume estimates are slightly below the USDA’s (soybeans: 51.5 and corn: 26.5). The risk of shipping delays receded in Brazil, but is still relevant in Argentina.

Bottlenecks in road transportation, low ending stocks and dock-worker strike threats probably led to a lower volume of soybean exports from Brazil. Exports year to date are 2.3 million tons lower than one year earlier, despite the sharp losses in the last crop.

In Argentina, it is not yet clear how the possible threat of export delays by producers for better exchange-rate conditions will be solved.

As for the next U.S. crop, prospects indicate a strong increase in production relative to the 2012/2013 crop. The first USDA estimates suggest a stagnation in the planted area for corn and soybeans. However, the current weather conditions are consistent with higher yields for both crops. A recovery in productivity, to the levels seen in the 2011/2012 crop, would be enough to enable the replenishment of global inventories starting in October. The outlook for wheat is not as favorable, even when considering the expected 1.6% increase in planted area; the quality estimates for the winter wheat crop remain way below the historical average, with little improvement during the dormancy period.

Sugar & Ethanol: More Ethanol, Less Sugar

Raw sugar prices (first due date) ranged between $0.18 and $0.19/lb. throughout the better part of March. During the last days of the month, the price fell to below $0.18, in a move that may be partly attributable to quarter-end adjustments by investment funds and the drop in grain prices following the USDA report (see more details in the section on grains). For the year as a whole, we expect sugar prices to remain around $0.18/lb. The ethanol market in Brazil may provide a higher bottom for sugar prices, generating a relevant increase in the share of sugarcane used to produce ethanol.

Global sugar-balance estimates continue to indicate surpluses throughout the next few quarters. The current prices are not yet low enough to convince countries that produce sugar from sugarcane to allocate the area to other crops.

In the Center-South region of Brazil, the sugarcane harvest has already started for the 2013/2014 crop. The harvest could reach 580 million tons under favorable weather conditions. With investments to renew sugarcane plantations last year and better weather conditions than in 2012, the expectation is that the total recoverable sugar (ATR) per metric ton of sugarcane will be higher than for the previous crop (138 kg/ton of sugarcane vs. 135.5 for the 2012/2013 crop).

From a producer’s standpoint, unlike 2012, the prices (raw-sugar equivalent) for anhydrous and hydrated ethanol are already above those of sugar. In 2013, the increase in the ethanol content in gasoline is expected to help sustain the relatively high anhydrous-ethanol prices. Hydrated-ethanol prices may be influenced by another increase in gasoline prices during the second half of the year and the inclusion of the sector in a new round of tax breaks. These factors should lead to less sugarcane being used to produce sugar. Our scenario for the Center-South region in Brazil assumes that 43% of the sugarcane output will be used to produce sugar, marking a sharp decline from the 2011/2012 and 2012/2013 crops (~49%).

Considering the above mentioned forecasts for the Center-South and a conservative scenario for the North-Northeast region, we estimate an output of 41.7 million tons of raw sugar in the country (vs. 41.4 for the previous crop) and a strong hike in ethanol production, to 28 billion liters from 21 billion.

Crude Oil: Lower Geopolitical Risk in Producing Regions 

Brent crude prices (first due date) remained close to $110.00/bbl throughout March. The drop in relation to the mid-February levels may be attributed to a looser short-term balance and a possible decline in the perception of geopolitical risk. We believe that $110.00/bbl is consistent with the sector’s fundamentals in 2013. A slide to below $105.00 would lead OPEC nations to reduce output. On the other hand, the still-low global growth that we forecast for the year, particularly in developed countries, limits the possibility of sustained prices above $115.00.

The global balance in February and March was looser than in the two previous months, with higher production by OPEC countries (particularly Iraq, according to International Energy Agency data) and above-average maintenance work in refineries, which affected the short-term demand for crude oil.

The lower perception of geopolitical risk in producing regions (ignoring relevant issues in other regions, such as the recent developments in the Korean peninsula) has been driven by no particular news in recent weeks. As for Iran, the expectation of progress in the negotiations in April remains unchanged. In Africa, there was no significant news flow in producing countries or bordering regions, as opposed to the terrorist attack in Algeria in January.

Artur Manoel Passos




** The Itaú Commodity Index is a proprietary index composed of those commodity prices, measured in U.S. dollars and traded in international exchanges, that are relevant to Brazilian consumer inflation. Its sub-indexes are Metals, Energy and Agricultural.

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