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Wednesday, May 20, 2015

El Nino confirmed – what's the likely grain market impact?

By Angus Brown  |  Source: BOM, ABARES, CME, ASX

Key points

  • The BOM has forecast an El Nino this year. El Nino is associated with low rainfall and high temperatures, which can impact crops.
  • In general, El Nino years see east coast crop production fall, with 44% of years seeing very large production declines, and prices moving to import parity.
  • Most of the upside price risk is in local basis to CBOT, and consumers and producers should be thinking about how to manage this.


2015-05-20 El Nino And Grain FIG 1

2015-05-20 El Nino And Grain FIG 2

2015-05-20 El Nino And Grain FIG 3

The Australian Bureau of Meteorology has said that El Nino is on its way. Whether you believe them or not, it’s worth taking a look at what El Nino’s have meant for grain production and prices in the past. This will give us an idea of the probability of a failed crop and very strong basis occurring.

According to the BOM, ‘El Niño is often associated with below-average winter and spring rainfall over eastern Australia, and above-average daytime temperatures over the southern half of the country’. Not every El Nino results in lower crop production, and not every drought is associated with El Nino.

Figure 1 shows east coast wheat production over the past 34 years, with arrows indicating El Nino years.  The average east coast wheat crop over the past 34 years has been 11.7mmt.  Average yields in non El Nino years have been 12.8mmt and in El Nino years they have been 7.5mmt.  So, on average, El Nino wheat yields are 41% lower than non-El Nino years.

Figure 2 paints an even starker picture of what El Nino means for grain production.  In all but two years, El Nino has resulted in a 20% or larger decrease in wheat production, and in four years (44% of El Nino) the decrease has been over 60%.

If we take the current estimate of the 2014 harvest of 16.3mmt, and assume that El Nino is a fait accompli, based on the past nine events, there is a 22% chance that wheat production will be above 16.3mmt, a 44% chance production will be below 6.5mmt and a 34% chance production will be 10-13mmt.

East coast wheat consumption is, on average, around 6mmt, which grows to 7-7.5mmt in dry years.  Economic theory suggests that, if we produce more than 7.5mmt of wheat, prices will remain at ‘export parity’, which is the price at which competing counties can supply importers.  When wheat production falls under 7.5mmt, wheat prices should revert to import parity. This is the cost of bringing wheat into the country to make up the shortfall in domestic production relative to consumption.

Figure 3 somewhat confirms the 6mmt level for prices to hit import parity, with delivered Melbourne prices rising to strong basis to (premium relative to international benchmark) CBOT in 1994, 2002 and 2006. These were all El Nino years with production lower than 7.5mmt.  In 2007, basis was also strong, with wheat production around 7.5mmt, but it was not an El Nino year.

What does this mean?

Taking a straightforward reading of the data, we’d say there was a 44% chance of east coast wheat pricing being at import parity next year. And while that doesn’t tell us the absolute price, as this will always be governed by international prices, it does tell us there is a strong chance of local wheat basis being above $100/t. 

However, the analysis is clouded somewhat by the fact that the BOM is still expecting a wetter than average June to August. This, combined with updated cropping techniques, is likely to see reasonable crops in some areas at least.  There is also the fact that nine years is a small sample, size which can throw out the probabilities.

It is worth thinking about plans in the case of a severe production impact from El Nino, and associated higher prices and basis.  For consumers, the course of action is to take some basis cover. For producers, it’s not so simple. However, many will steer clear of physical and ASX futures on the back of potential basis increases.

Mecardo information is provided to assist in your marketing decisions. It contains a range of data and views on the current market. It is not intended to constitute advice for a specific purpose. Before taking any action in relation to information contained within this report, you should seek advice from a qualified professional. The information is obtained from a variety of sources and neither Mecardo nor Ag Concepts Advisory will be held liable for any loss or damage whatsoever that may arise from the use of information or for any error or mis-statement contained in this report. 

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