Commodity market’s dealings sometimes get too hot to handle. Be it gold, crude oil, vegetable seeds/oils or grains, very volatile price movements have been observed at commodity market during the past few months. Market volatility is even more intensified by electronic trading and involvement of Wall Street funds. Vegetable oils futures and options became investors’ triumph card lately, especially in Asian markets. Palm oil and Soy oil futures have been creating buzz for all good reasons since quite some time. But now it’s about time that those interested in vegetable oil market think twice before entering into any future contract involving these two commodities.

Facts and Figures

Vegetable seed and oil market is generally dominated by soybean seeds and soybean oil. In 2006, soybeans contributed for 57 % of oilseed production in the world. High demand for Soybean products has resulted in making them the hottest commodities traded at Chicago Board of Trade (CBOT) in recent years. United States, Argentina and Brazil are the main players at CBOT in terms of production and exports of soybean products. European Union and China hold the position of largest importers of soy oil and seeds. The US being the world’s largest soybean producer contributed 38% of the total soybean production in 2006. The demand for soybean and soy oil had been phenomenal for the past two years and profit margins rose for the trader as well as the farmers. The average price per bushel of soybean (paid to the farmers) was $6.20 in 2006, whereas it rose to $14 per bushel in 2008. This led the farmers to increase the area under cultivation for the production of soybean. In 2007, the US used 63.6 million acres land for soybean production, which is expected to increase further to 70million acres in the year 2008. The country dominated the soybean trade by exporting 1.1 billion bushels of soybeans, i.e. 42% of the world's soybean trade. China was the largest buyer of U.S. soybeans with exports from the US worth $2.531 billion. The graph below portrays a comprehensive picture of U.S soybean export customers.

Source: www.soystats.com

Latest Buzz: A Chinese buyer defaulted on purchase of soybean cargo

The news that a Chinese soybean buyer in the province of Shandong had failed to pay for U.S soy cargo, has been creating strong commotion in the commodity market. Many traders think that it has put a question mark on the future of many other transactions involving the Chinese counterparts. However, the traders were not willing to provide the details about the Chinese buyer who had defaulted on a purchase deal of expensive variety of U.S soybean. The only information made available was that the default occurred in the northern province of Shandong (China), following the abrupt and negative changes in the price of soy oil futures earlier in March 2008. Moreover more defaults have also been reported on the purchase of one or two cargoes of soybean oil and 150,000 to 200,000 tons of palm oil from Argentina. Many other vegetable oil suppliers in Shanghai, China are also expecting the cancellation requests from the Chinese buyers.

Suppliers are really concerned as they had previously lost a big fortune due to similar kind of issue, back in 2004. The crushers in China had defaulted on the purchase of soybean seeds from South America, following analogous sharp rises in the price of Chicago soy futures. Argentinean soy suppliers were also reluctant to continue sales to China over the same fear of defaults on payments.

Considering the fact that the commodity market had already suffered violent damages caused by wheat trader during the same month, the soy traders are quite apprehensive about the possibility of soybean oil defaults. MF Global, one of the most important players at CBOT and the world’s largest broker dealing in futures and options, incurred a huge loss of $141 million in the first week of March 2008, because of a wheat trade by one of its clearing customers.

Factors Responsible for the Fear of Default

If we analyze the whole scenario, we discover that the prices of vegetable oil futures had been going up since the fall of year 2007 due to its huge demand in Asian countries. Chinese were among the most aggressive buyers of soybeans, soybean oil and palm oil during the heydays. China’s soy imports exceed the substantial figure of 2 million tons in February 2008.  The country imported 2.02 million tons of soy in February and 3.44 million tons in January 2008. As snow storm had already destroyed the Chinese rapeseed crop, the demand for vegetable oils had been very high in the country. Moreover, high inflation in the country also enables the local buyers to sell soy oil at high price in the local markets. So the Chinese soybean and palm oil buyers enjoyed high gains by selling vegetable oil at high prices at home. Chinese buyers bought approximately 300,000 tons of soybean oil per month. Moreover, they also reserved 500,000 tons of palm oil for the months of June/July 2008.

In order to cope with massive price rises in Chinese soy oil futures, the Chinese Government decided to put a cap on the soy price. The Government released 250,000 tons of soybean oil from its soy oil stocks in the market to meet the demand and lower the price. It could also be termed as one of the factors that put an end to the record-breaking price rally of Asian vegetable oil market. As a result the prices of Dalian soy oil futures, Chicago soy oil and Indian soybean oil fell considerably, and observed aggressive sell-offs by the buyers. The price of Malaysian palm oil futures also dropped to its 9-months low value. Similarly, the cash vegetable oils prices in China also fell considerably (approximately 20 %) following the Government’s intervention and a sharp decline in the international vegetable oil prices.

In margin trading, the small buyers and speculators usually get caught in trouble when the market at once starts going down drastically. Same happened to small buyers of vegetable oils at CBOT. The cancellation fees is quite high for the vegetable oil deals ($200 per ton), which made it even more difficult for the buyers to call it off.

News that Brazil has signed a big deal with China to supply soybean to the Asian country also affected the credibility of Chinese buyers in the eyes of Argentinean and US suppliers. Other factors like decrease in crude oil price, downward trends in the price of wheat futures, and pressure from South American soybean crop have immensely shattered the upward price-rally of soy oil futures.

Future outlook

Short Term (Based on Technical Analysis)

CBOT analysts and traders are expecting more volatility in the prices of oilseeds till USDA makes its March 31 planting intentions report public. Traders are of the view that apart from Chinese buyers, the buyers from India may also default on US soy oil and Malaysian/Indonesian palm oil. Since this news of defaults is out, there has been an immense sell-off pressure on soy oil futures at the CBOT.  Limit-down moves have been observed on four consecutive days of trade, which resulted in huge losses on soy oil future contracts. The May soy oil futures price took a nose dive from week’s high of 60.90 US cents and ended up at 54.40 US cents (7-weeks low). If we analyze the daily price movement by using Technical analysis, a week negative trend is depicted by all the daily-technical-indicators. For instance, the daily candlestick chart predicts a bearish trend in the upcoming week as well. The chart support for the soy oil market is recorded at the level of 50-46 US cents. If the price falls below this point, the downward trend will continue further in the next week.  

Long Term Trend

But in the long term, analysts believe that the demand for the vegetable oil will stay unabated in the Asian markets due to the fact that poor soybean and rapeseed crops are expected in India and China. Most of the rapeseed crops already got damaged due to one of the worst freezes in the history of China. Increase in the price of crude oil will support the soy oil futures at CBOT. As soy oil is used to manufacture almost 50% of biodiesel used in the European Union, so the European countries would also be among the top importers for the US during 2008. But the production of biodiesel might suffer due to massive increase in the price of soy oil.

The whole default controversy might help US to meet its target of wheat production. Before the soy oil was taken by the bearish trend, the analysts were of the view that due to lucrative profits offered by the soybean market, the farmers in the US were most likely to prefer soybean cultivation over spring wheat seeding. That would have been a big blow to the U.S. wheat stocks in 2008, which were already expected to be at a 60-year low. USDA urged the farmers to cultivate 17.447 million acres for wheat production in 2008. But private analysts were predicting a different fate for the spring wheat seeding. Now that the bearish trend has taken on the soy oil futures market, many farmers may consider USDA’s appeal to plant spring wheat instead of soybean. But if the bearish trend persists for long, the possibility of more defaults on soy oil futures payments cannot be denied.