Agricultural Commodities Part 1: Grains, Oilseeds, and Crop Markets
Book: Commodities: Markets, Performance, and Strategies
Editors: H. Kent Baker, Greg Filbeck, Jeffrey H. Harris
Publisher: Oxford University Press, 2018
ISBN: 9780190656010
Chapter 8, by Nicole Moran and Kelsey Syvrud, covers agricultural commodities in serious detail. There is a lot of ground to cover, so I am splitting this into two posts. This first part focuses on grains, oilseeds, dairy, and the basic market structure. Part 2 will cover soft commodities and trading dynamics.
Agriculture Is a Bigger Deal Than You Think
Agriculture contributed roughly $2.9 trillion to worldwide GDP in 2014. For frontier markets like Sierra Leone and Chad, agriculture makes up 40 to 50 percent of GDP. For the United States, it is only 1.3 percent, but that still translates to over $179 billion. The U.S. consistently runs a trade surplus in agricultural goods, exporting more than $11 billion and importing over $9 billion per month in late 2015.
The key point: many developing nations depend on agricultural exports as a major income source. Price swings in corn or wheat are not just abstract market movements. They affect entire national economies.
How to Invest in Agricultural Commodities
You have several options. The most common are futures and options traded on exchanges like the CME and the Intercontinental Exchange (ICE). Between 2007 and 2015, average daily volume of agricultural contracts on the CME increased 74 percent. You can also invest through ETFs, buy stocks in agricultural companies like Cargill or ADM, or use over-the-counter contracts.
One important concept here is the basis, which is the difference between a futures price and a specific cash price. Many OTC contracts are priced based on this spread. For example, a flour mill might enter a basis contract pegged to the difference between CME wheat futures and the cash wheat price in Toledo, Ohio.
The chapter also covers the convergence problem. At expiration, futures prices should equal spot prices. When they do not, it signals a problem with contract design. This happened with wheat and corn contracts on the CME, and the exchange had to make fixes, including adding delivery points and changing from warehouse receipts to shipping certificates.
What Moves Agricultural Prices
Four main factors drive agricultural commodity prices:
Weather and natural disasters. An early frost or local drought can destroy supply and spike prices not just domestically but worldwide. Agricultural products have a finite supply each year, so weather events have outsized effects.
Seasonality and storability. Corn demand stays fairly steady year-round, but supply spikes at harvest. Corn can be stored for six months to a year, allowing the market to ration supply. Storage works only if future prices compensate sellers for storage costs and opportunity costs.
Stocks-to-use ratios. This is the key metric everyone watches. It measures existing and carryover stock as a percentage of total use. Low stocks relative to use mean higher volatility and higher prices. High stocks mean the opposite.
Government policy. Subsidies, tariffs, trade quotas, and price controls all affect agricultural prices. The U.S. subsidizes crop insurance. Tariff-rate quotas limit imports. Price floors and ceilings can lead to overproduction or underproduction.
Corn: The King of U.S. Agriculture
Corn is the primary grain produced in the United States. Over 90 million acres go to corn each year, and it accounts for more than 95 percent of total U.S. feed grain production. In the 2015-2016 trade year, the U.S. produced 345,486 thousand metric tons.
What changed the corn market was biofuels. In 1980, only 5 percent of corn went to biofuel production. By 2015, it was over 40 percent. This shift directly affected prices. Corn averaged $2.00 per bushel in 2005, spiked to $6.89 in 2012, then settled back to $3.61 in 2015. The chapter shows a clear positive correlation between ethanol usage and corn prices.
Most U.S. corn comes from Illinois and Iowa, which together produce about 33 percent of the national total. Planting happens between March and June, with harvesting from August to December. The big trading venue is CME, where one standard corn futures contract covers 5,000 bushels with physical delivery settlement.
Soybeans: The Versatile Oilseed
Soybeans are the second most planted U.S. crop, accounting for roughly 90 percent of all domestic oilseed production. They are rarely used raw. Instead, they get crushed into meal (for livestock feed and food) and oil (for cooking, paint, lubricants, and biodiesel).
The biodiesel connection matters. About 30 percent of U.S. soybean oil went to biodiesel by 2013, and the chapter shows a strong positive correlation between soybean prices and biodiesel production. Average soybean prices went from $5.66 per bushel in 2005 to $14.40 in 2012.
Interesting fact: soybeans and corn are usually grown in rotation. This is not just tradition. Rotating corn and soybeans reduces nitrogen expenses, lowers insecticide use, and controls corn rootworms. It is a practical risk management strategy for farmers.
The CME lists separate futures contracts for raw soybeans, crushed soybeans, soybean meal, and soybean oil. Standard contract size is 5,000 bushels, settled by physical delivery.
Wheat: Declining Acreage, Steady Demand
Wheat is the third most planted U.S. crop, but its acreage has declined about 33 percent since peaking in 1981. Part of the reason is that legislation gave farmers more choice in what to plant, and wheat became less profitable relative to corn and soybeans. Unlike those crops, wheat has not found a meaningful role in renewable fuels.
The EU, China, and India are the top wheat producers. The U.S. ranked fifth and produced 55,840 thousand metric tons in the 2015-2016 trade year. About half was consumed domestically.
Wheat comes in five classifications: hard red winter, hard red spring, soft red winter, white, and durum. Hard wheat has higher protein and gluten, costs more, and goes into bread. Soft wheat goes into cakes and pastries. The most liquid wheat futures contract on the CME is tied to soft red winter wheat, which acts as a pricing benchmark for other wheat grades.
Rough Rice: A Global Staple with Local Quirks
Rice is one of the most important food commodities worldwide. Asia produces roughly 90 percent of global rice, with China and India combined producing about 250,000 thousand metric tons of milled rice. But most of it stays domestic. The U.S. is only the fifth largest exporter.
About half of U.S. rice is exported, making American rice farmers more exposed to global market changes than corn or wheat farmers. Rice is also a high-cost commodity to grow, so fuel and fertilizer prices directly affect what farmers charge.
The rice futures market on the CME is less developed and less liquid than corn, wheat, or soybean markets. One contract covers 2,000 hundredweights of rough rice.
Dairy: A Different Animal
Dairy products round out the first half of this chapter. Unlike grains, dairy is highly perishable and cannot be stored the same way. The U.S. is the world’s second largest milk producer behind the EU. From 1992 to 2012, the number of licensed U.S. dairy farms dropped from 131,509 to 51,481, but average herd size grew 142 percent. Small farms gave way to large operations.
The U.S. has a complex milk pricing system based on four classes. Class I is fluid milk for beverages. Class II goes to soft products like ice cream. Class III makes hard cheeses. Class IV makes butter and dry products. Each class is priced based on weekly wholesale market data from the USDA.
Milk futures on the CME are cash-settled rather than physically delivered, which makes sense. Nobody wants 200,000 pounds of milk showing up at their office.
My Take
The sheer volume of data in this chapter is impressive. What stands out most is how the biofuel revolution changed everything for corn and soybeans. A policy decision to promote ethanol reshaped demand, spiked prices, and redirected millions of acres of farmland. That is a powerful reminder that agricultural commodity prices are not just about weather and harvests. Government policy can be the single biggest price driver.
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Next: Agricultural Commodities Part 2: Softs, Livestock Feed, and Trading