Oil, Ethanol, Maize, Oilseeds and Gold

Oil, Ethanol, Maize, Oilseeds and Gold

Many assume that the price of crude oil determines the price of bioethanol and thus the price of maize and/or sugar. Similarly the assumption is made that the price of oil determines the price of vegetable oil for biodiesel and thus the price of oilseed rape. After all biofuels are a significant use of both crop types and would be expected to influence price.

 

The relationship initially appears good:

 
Graph 1: Relationship between Brent Crude and UK Oilseed Rape

As the oil price rises, so too does the price of oilseed rape. In fact, the oilseed rape price in £/t is approximately three times the price of Brent crude oil in $/barrel. Thus a $1/barrel rise in crude would raise the oilseed rape price by £3/t. A little more accuracy can be squeezed out of the relationship by converting both components into the same currency but it is only a small improvement and, besides, the two commodities are reported in the units used above.

However, the relationship only considers demand. Supply can also be a significant influence on price. The impact of extra demand for biodiesel, when supply to the food market is tight, is likely to have a greater impact than when there is ample oilseed rape. It is possible to explore this by looking at the crop within a marketing year or by building stock levels into the model (lower stocks suggesting higher demand). In the current year, the fall in oil price accelerated from the beginning of August 2014 while oilseed rape prices increased – as would be expected following the usual price depression at harvest. The relationship between the two commodities on the current marketing year was the opposite of the long-term monthly trend shown above.

The relationship is no better between ethanol and oil. There is a relationship between the two but the spread around the trend is wide. Surprisingly, the relationship between oil and ethanol is weaker than that between oil and maize. A bet on the price spread between ethanol and oil may be more effective when the difference is wide, than to sell quickly in the expectation that low oil prices will reduce the price of oilseed rape, or maize, or wheat.

Not surprisingly in practical terms the price of oil is not a good indicator of short term crop prices.

There are a number of reasons:

1. Many dismiss the importance of the biofuel mandate arguing, correctly, that it is weak both in the US and Europe since it is sometimes cheaper to take the penalty than produce at a large loss. Furthermore, it is possible to defer production if profitability looks likely to be higher at some future point, or to use surplus production in one month to off-set lower production in other months in order to meet the mandate. While these points are correct it does not mean that the obligation has no impact; without the mandate there would be very little biofuel production. Ultimately, demand for biofuels is determined as much by volume of fossil fuel sold as the price of fossil fuel.

2. When oil prices fall, or the economy strengthens, this can at least theoretically mean that consumption of road fuels increases and thus more ethanol or biodiesel is required. The evidence is weak for this but there are occasions when consumption does appear to vary with affordability.

3. The cost of the raw material since 2005 has been as important as the price of oil in determining profitability of biodiesel or bioethanol manufacture and therefore demand.

Finally, just because the two commodities appear to follow the same pattern it does not mean that one causes the other to change price. We suspect that the larger economic factors over a period of years trump the relationship with oil. We are still puzzling over the relationship between gold and oilseed rape.

 
Graph 2: Relationship between Gold and UK Oilseed Rape

It is all too simple to imply crop marketing expertise by suggesting price mechanisms. Many assumptions are either not true or so weak that it is difficult to use to advantage. To market well requires expertise and analysis to test the theories.

 
 

Key contacts

Andrew Wraith

Andrew Wraith

Director
Food & Farming

Savills Lincoln

+44 (0) 1522 508 973

+44 (0) 1522 508 973