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Preliminary Renewable Fuels Mandate Adds to Uncertainty
Sunday, January 1, 2023
filed under: Marketing/Risk Management
By Mike Krueger*
The markets headed toward 2023 on a weak note. There are three major reasons for the downturn in soybean and soybean oil futures.
• The potential for a record soybean crop in Brazil has been a headline story since planting got underway in Brazil. The planting season is complete, and it appears that Brazil’s farmers again increased acres by 5 to 6% from last year. The market assumes a record yield is possible and a crop in excess of 150 million metric tons is likely. Most of Brazil is in good shape, though it has been dry across the southern region.
• China’s domestic Covid behavior is also still a problem. Their ongoing lockdowns to contain Covid have created uncertainty about how strong their demand for soybean imports will be. China was a solid buyer of U.S. soybeans during December.
• The last problem was created by the EPA’s announcement of its preliminary renewable fuels mandate, including renewable diesel. The lack of any push to increase the renewable diesel mandates was the most bearish of the EPA’s numbers.
The ethanol market is mature, and we are up against the blend wall. The renewable diesel market is just starting to roll. The EPA (which is proposing the new targets) used old renewable diesel production capacity in its assessment. The U.S. produced 280 million gallons of renewable diesel in 2017 and had the capacity to produce 2.0 billion gallons in August. The EPA used the capacity of 1.5 billion gallons from last February, and that’s the number EPA used.
The final decision on these mandates will be made in June 2023. There will be a public comment period over the next several months, and the oilseeds groups will be mounting an all-out effort to get these mandates changed.
Unlike the early days of ethanol, several major oil companies have partnered with oilseed processing companies to build or expand processing plants across the U.S. and Canada to provide vegetable oil for renewable diesel. Remember that renewable diesel requires zero petroleum; it is 100% vegetable oil.
Some of these companies have stated they will push forward with renewable diesel production regardless of EPA mandates. Again, the EPA will not finalize the mandates until June of 2023.
The accompanying chart clearly shows the impact of the EPA’s proposed renewable fuels mandates on soybean oil futures. Soy oil futures collapsed following the EPA announcement as the speculative trade opted to exit long soybean oil positions and buy soybean meal, pushing soybean meal futures to new highs.
This EPA stuff just added more uncertainty to an already uncertain market.
Brazil’s soybean crop is in the ground and in good shape. Another 5-6% increase in their soybean acres, coupled with record yield estimates, has the trade looking for a record 2023 soybean crop in Brazil.
Argentina still hasn’t broken the grip of a major drought that cut its wheat production in half and is now threatening soybean and corn production. Most analysts have started to trim the corn and soybean production estimates for Argentina because of the drought.
Keep in mind that Argentina is typically the world’s third largest exporter of corn — and the world corn situation is very tight. If this drought isn’t broken by the end of December or early January, significant yield cuts will occur. The USDA made no changes in its December estimates.
December’s USDA WASDE (supply and demand) report was a non-event. That is typically the case in December. They made no changes to the U.S. wheat outlook, leaving ending supplies unchanged from the November report at 571 million bushels — the smallest ending supply number since the 2007/08 marketing year.
USDA reduced its corn export forecast, as expected, and increased ending supplies accordingly. The pace of corn export sales is well behind last year. Brazil has been a heavy exporter of corn; but Brazil can’t supply all the demand, especially with EU corn imports projected to set a new record because of their drought-reduced 2022 crop.
U.S. corn ending supplies are now forecast to be 1.257 billion bushels, the second smallest in a decade.
The U.S. soybean numbers were also left unchanged from November. Analysts were looking for a reduction in the export forecast, but that didn’t happen. China was a significant buyer of U.S. soybeans the first two weeks in December. The ending supply forecast is 220 million bushels. That is tight.
Market volatility should continue until a big crop in South America is assured.
The other market headwinds are also still in place.
• Inflation hasn’t been tamed.
• Interest rates are expected to move higher.
• China’s demand for everything — but especially soybeans — is still a question mark because of their handling of Covid with lockdowns.
• The dollar is still strong.
The good news is that the Mississippi River seems to be recovering from record low levels, and ocean freight rates have been dropping. The Russia/Ukraine war appears far from over. Disruptions to shipments from Russia or Ukraine will be immediately bullish.
* Mike Krueger founded The Money Farm, and is now a senior analyst with World Perspectives, a Washington, D.C.-based consulting company. While the information in this article is believed to be reliable, marketing involves risk, and the author and The Sunflower assume no responsibility for its use.