Nidera Australia, Peter McMeekin on the interplay between agriculatural production of biofuels and world oil prices following OPEC announcement to cut production.

Global oil producers have announced a deal to help the market strike a balance between demand and a surfeit of supplies that has weighed heavily on oil prices since 2014.

Organisation of the Petroleum Exporting Countries’ (OPEC) pledged to curb member production by 1.2 million barrels per day (bpd) from January, to no more than 32.5 million bpd. This move lifted crude prices for three-straight sessions at the back end of last week and on Monday oil extended those gains to be up 16 per cent since the decision was announced.

Eyes have now turned to a meeting this weekend between OPEC and non-OPEC producers to expand the deal. It is expected that non-OPEC producers will agree to cut their output by 600,000 bpd at their meeting in Vienna on December 10.

So what does this mean for the Australian grain grower? Immediate thoughts will turn to increased input costs as bowser prices increase and the bill for the next load of diesel delivered to the farm is higher than the last.

But this may be a little short sighted. Limited supplies of fossil fuel and increasing concerns about global warming have created a growing demand for renewable energy sources. The production of these fuels is highly dependent on the availability of agricultural products with around 20 per cent of the global corn crop now being used in the production of biofuels. We live in a world where the correlation between the prices of crude oil and grain around the world is now quite intimate.

It is therefore no surprise that as oil prices rise, grain prices should follow suit. This change in market momentum will not necessarily happen immediately. The current burdensome global supply of feed grains is likely to weigh on grain prices in the short-term.

However, as the viability and profitability of the global biofuel sector is supported by a more sustainable oil price, and regional governments in the developed world mandate for increased ethanol inclusion rates, the demand side should start to play its role in supporting global grain prices.

The one sector to watch here may be the United States shale-oil industry. One of the major drivers of OPEC’s reluctance to decrease production in the past couple of years has been their desire to curb the expansion of the shale-oil industry in the United States. The survivors in that industry have been forced to drive efficiencies, to the extent that any increase in the oil price will rapidly expand production and decrease the United States’ reliance on imported oil.

Meanwhile, the funds continue to sit on the short side of both the corn and wheat futures markets. The corn short has certainly been wound in considerably, but the wheat short is still sitting at around 80 per cent of its peak earlier in the year. Any change in global demand resulting from the increased oil price (assuming it is sustained) will almost certainly be reflected in a change in these speculative positions.

And that is, this week’s good oil…

Source: Nidera Australia