5/19/2004 - Trapped between increased demand and reduced supply, soybeanprices are setting highs for the decade. What sold last year for $5/bushelnow goes for $10 with new crop prices in the Midwest touching $8. Buyerswith sticker shock are looking for substitutes that do not easily existwhile farmers in soy zones are enjoying the boom and thinking that it willtake at least a year to rebalance supply and demand. With soy ingredientsenjoying increasing popularity, these new prices are touching an amazingarray of consumers.

Why the spike? There are several reasons. The 2003 conventional crop inthe United States dropped 30% from anticipated volume, while the organiccrop dropped 40% all due to weather issues. At the same time, the U.S.dollar dropped in value, making U.S. soybeans a better value tointernational buyers and prompting an increase in exports. Chinese demandfor foreign supplies surged along with the growth of Chinese crushingcapacity, much of which is owned by well-recognized western players.Soybean Rust continued its rampage in parts of Brazil while weatherchallenged the crop in Brazil, Argentina and neighboring countries.Finally, domestic U.S. crush has continued to soar.

Surging demand for soy protein and soy health benefits in everything fromsoymilk to cosmetics has added to the clamor for a declining supply. Thoseseeking premium food varieties and organic soybeans are finding the U.S.bins empty. Fortunate buyers who planned ahead are covered but those whoplanned to buy from open market supplies are acutely disappointed. Chineseand South American supplies are trickling into the market but lack theproduction base to really capitalize on this opportunity and satisfyexisting demand.

How long will the spike last? How low will prices fall? Today’s strongprices will reverse the imbalance; the question is when? Prices at thislevel will bring many more resources into soybean production but sincemost of the flexible resources lie outside the U.S., the surge inproduction will likely come from non-U.S. sources. Brazil has as manyundeveloped acres to bring into production as the U.S. currently has inproduction. Since it takes time to make these adjustments, conservativemarket watchers think the market will likely remain high into the newNorth American crop. Should the new crop be good, prices will likely fallto $7-9/bu and not return easily to the low levels seen in recent years.Should North America suffer a weather blip and/or see the Chinese go on abuying spree, future prices could make the current prices look low.

The evolution of competitive market position will depend upontransportation. With increased fuel prices and the greater efficiency ofwater freight over land freight, the coasts of Argentina and Brazil arecoming closer to much of the U.S. coast than is the U.S. Midwest. Savvyinternational players with lower priced land, labor and services combinedwith sophisticated marketing will likely become dominant players in thesemarkets, their competitive costs plus freight determining the price capsfor U.S. soybeans. Since freight declines as a factor in price as themarket value of a soybean increases, this reverse flow seems most likelyto happen with specialty soybeans. Some U.S. farmers are noticing thesituation and are increasingly hedging their bets by buying into SouthAmerican land. The standard thought is that Brazil and Argentina will takethe lead in supplying commodity soybeans to the world while U.S.agriculture switches its focus to specialty soybeans and niche markets.The weakness in that theoryis that foreigners may find it even easier to compete for the specialtymarkets that offer 130% to 200% of commodity soy prices.Dr. Hamish Gow, of the University of Illinois Food and AgribusinessManagement Program, sees three factors supporting a future increase in theSouth American competitive position for supplying specialty soy markets.

The Brazilian government has invested in infrastructure, Gow says, whichleads to lower logistics costs and better freight movement. Large SouthAmerican producers have developed lower cost I.P. (identity preservation)systems, which are required to supply specialty and niche markets.Finally, “because there is limited down-side risk in U.S. commodityagriculture, U.S. farmers have no market incentive to increase theirindividual profitability by pursuing niche markets.

Experience indicates the introduction of consumer-ready soy food productswill require manufacturers to secure stable and reliable supply lines fortheir ingredients. Changes in demand for non-GMO, organic, and varietyspecific soybeans come in large increments relative to the size of thesespecialty markets. The result is that as processors introduce moreproducts, the domestic supplies get even tighter and premiums increase,attracting the attention of large international producers.

The wild cardChina! What will this centralized economy do next? Has itoverstated inventories to improve its bargaining position? Is the domesticgrowth in income and calorie consumption about to overwhelm its productioncapacity? Can it hold off purchases until the 2004 crop comes to market orwill it decide to compete for what is left of the 2003 crop and take oldcrop prices to record levels? The balance may lie in the hands of someunknown central planner with a huge stick.