Ever since ethanol became a major user of corn, the prices of grain, oilseed and crude oil have been closely linked.
The strength of the linkage is surprising given that while some grain and oilseed is used for biofuel, the majority is consumed as food or livestock feed.
Nevertheless, in the minds of global investors, the biofuel factor meant grain and oil had an unseverable link.
The story for energy and grain was similar: demand from rapidly developing Asian countries was outpacing the ability of producers to supply the global need.
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Investment fund money poured into oil and grain markets, but because oil is the bigger and more widely traded market, it often took the lead. As it rose, it helped to pull along grain prices.
Oil price inflation helped drive grain higher, and now oil deflation is helping drag grain lower.
In the 12 months starting in mid 2007, oil, corn, soybeans and canola all about doubled in price. Since the start of July this year, they have all dropped about 50 percent, giving back all their gains.
You’ve heard all the reasons for the crash: the U.S. housing bubble burst, the banking-credit crisis, investment funds liquidating all their holdings to get cash to pay for losses, the recession in the United States and the slowing world economy.
The question now is, how low can oil go?
Oil demand has fallen quickly, prompting the Organization of Petroleum Exporting Countries on Oct. 24 to agree to cut production by 1.5 million barrels a day to 27.3 million barrels, beginning in November, to try to restore the supply and demand balance.
But recession panic gripped markets on the same day and OPEC’s news was greeted with a further $5 per barrel fall.
All major energy forecasting groups have cut their forecasts for oil consumption in 2009 because of the slowing world economy.
Fuel demand in the U.S. averaged about 18.7 million barrels a day during the four weeks ended Oct. 17, down 8.5 percent from the same period a year earlier, according to the U.S. energy department.
World oil demand is expected to fall to as low as 83.5 million barrels a day in the second quarter of 2009, from 85.7 million barrels a day last quarter, a Morgan Stanley investment bank consultant said.
The weakening demand has some analysts now saying oil could fall to as low at $50 per barrel before rebounding.
If oil and grain remain in lockstep, what does that mean for grain prices? Corn is perhaps most closely entwined with oil prices because of ethanol.
Oil prices last week were in the mid $60s. The last time they were at that level was early 2007 when corn was in the $3.50 to $4 range, similar to where corn traded last week. Oil hit $50 early in 2005 when corn was $2 to $2.25 and Minneapolis wheat was below $4.50.
So if we hit $50 oil again, will corn and wheat fall another $1 per bushel or more?
It is possible, but I continue to be an optimist. World grain stocks are tighter than they were in 2005 and 2006 so you’d think that would support prices. However, the market does not appear to be trading on fundamentals these days.
Another thing to consider is that if oil falls to $50, it is unlikely to stay there. But it won’t necessarily see a strong rebound.
Various bank economists now forecast a 2009 oil price average of $60 to $80 per barrel depending on how they view the severity of the global economic slowdown.
But there are still oil optimists out there. Jeff Rubin, chief economist for CIBC World Markets and a longtime oil price bull, still forecasts oil climbing back above $100 in the coming year.
Such forecasts seem wildly optimistic as the global economy, and perceptions of it, fall deeper into a funk.
But something that Rubin says does seem convincing.
If oil stays down at $70 or less for an extended period, it will stop development of new oil fields and tar sands needed to replace fields that are being exhausted. This has the potential to drive oil even higher once the global economy recovers and oil demand surges again.
If it does, grain and oilseed prices will likely again ride its coattails.
