Crude oil prices and grain prices took different directions last week, breaking what had become a general assumption.
For years, rising oil prices were expected to support grain prices because of the connection between oil and biofuel. If oil rose, there would be more demand for ethanol and biodiesel , which would push feedstocks such as corn, wheat, soybeans, palm and canola higher.
But as oil pushed past $100 per barrel on the New York exchange, up 11 percent from the previous week, grain and oilseeds fell about four percent.
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The reason appeared to be that investors were worried that the violent revolution in Libya, which unlike Egypt and Tunisia is an oil exporter, had the potential to create oil shortages. There were also worries the unrest could spread to larger oil producers such as Iran and Saudi Arabia.
If oil prices remain higher than $100 for a sustained period, then that could set back the international growth forecast for this year.
Some commentators have widened the threat to say a one-two punch of high oil and high food prices will floor the economic recovery.
There is substance to that worry. It wasn’t only the U.S. mortgage crisis and bank collapses that propelled the world into recession in 2008. Oil at $140 and corn at $7.50 also had a role.
And remember, oil price shocks preceded all the recessions since the 1970s.
So what is the prospect for oil remaining above $100?
Libya produces only two percent of the world’s oil and there is surplus production capacity in other countries.
CIBC oil expert Peter Buchanan said the Organization of Petroleum Exporting Countries, particularly Saudi Arabia, has five to six million barrels of spare capacity that it could press into service if it worried that the world economy could fall back into recession.
But oil bulls like Jeff Rubin, a former chief economist with CIBC World Markets and author ofWhy Your World Is About to Get a Whole Lot Smaller,say the ability of Saudi Arabia to increase production is much less than generally believed.
And if the popular uprisings spread to Saudi Arabia, the worry would increase even more. The Saudi government last week tried to head off unrest by announcing billions of dollars in programs to increase jobs for young people and improve pay for government workers.
So oil prices are a wild card as long as people in the Middle East and North Africa keep rising up against their authoritarian governments.
With the uncertainty, some money that was in crop commodities has been withdrawn into safer investments.
That helped pressure crop prices lower, but it also set the stage for increased demand and improved fundamentals for grain prices.
We can’t forget the oil-biofuel link. Higher oil prices make biofuel makers more profitable so they will increase production.
And by the end of last week, that point was again in traders’ minds as corn prices climbed back from the midweek decline.
The U.S. Department of Agriculture’s Outlook Forum drove home the message last week.
The forecast delivered at the forum was for increased seeded acreages for U.S. corn, soybean and wheat crops. However, even with more production than last year, demand is so high that there would be little growth in year end stocks. Indeed, U.S. wheat stocks would decline.
It is not a sure thing that the production levels that were forecast can be achieved. The heavy snow pack is not limited to the eastern half of the Canadian Prairies. North and South Dakota and Minnesota all have heavy snow packs.
If there are seeding delays, USDA predictions of a near record corn yield of 161.7 bushels per acre, up from 152.8 bu. last year, will be a stretch.
