Connection Fall 2016 | Page 20

Reforms aimed at tackling stockpiles issue Although, the Chinese government has time and again announced incentives to reduce its corn stocks by disposing of the aged or moldy corn at throw-away prices for the production of domestic ethanol, these measures have also not had much of an effect on reducing stores, say market players, primarily because any sales were offset by the fact that the acreage under corn cultivation kept increasing. compare this to, one could take Chicago Board of Trade (CBOT) futures prices, add the “basis” spread to account for an FOB Gulf cash price, adding freight to the most likely destination (South Korea), and then deducting freight from China. For 2015, this average “export parity” amounted to $186.37/ mt, meaning Chinese corn was $186.37/mt from being competitive internationally. In 2009, in a policy that has been flip flopping, China went as far as removing value added taxes to spur the export of processed corn products. The measure was discontinued again in January 2016 only to be resumed in September 2016 for a limited time period, but has not had much of an effect, because of higher priced yet lower quality Chinese refined corn products, say Asian traders. In its different avatars, the export subsidy on corn-based products has not had much of an effect on the corn stored in Chinese elevators. The gradual liberalization in 2016 led to a further erosion of this export arbitrage, with China’s theoretical FOB values falling to the $250s/mt region in May 2016, while seaborne prices as reflected by CBOT were in the $180s/ mt region, which indicated a spread narrowed to around $70/mt. With increasingly desperate steps being taken, could it reach the final stage where the local oversupply is cured by corn exports? For this to happen, only one condition needs to be met: for domestic prices to be low enough to compete with other seaborne origins such as the US, the Black Sea and South America. The export arbitrage should be made easier to reach because of China’s freight advantage given that huge corn importers are literally on its doorstep, including Japan (world’s largest corn importer), South Korea (number three), Taiwan (number eight) and Vietnam (the largest importer of corn in Southeast Asia). Certainly the latest price trends point to this being possible very soon. Domestic prices are perhaps best represented by Dalian Commodities Exchange (DCE) futures prices, which although they depict derivatives can act as a reasonable representation of physical prices, traders say. While domestic front month prices for corn on the DCE had been as high as Yuan 2,455/mt ($400/mt) or more during early 2015, they had fallen to the low $300s/mt at the end of the year. For ease of comparison with seaborne prices, a “fobbing cost” of $6.50/mt can be added to DCE values, giving a theoretical FOB offer value. The average theoretical FOB China corn prices hit an average of $365.55/mt in 2015. To provide a realistic seaborne price to 20 The latest auction results for domestic Chinese corn conducted in Heilongjiang on September 1, 2016 went as low as RM1,460/mt or $218.62/mt at the domestic elevator, compared to an FOB value of $279.77/mt. Yet as US prices fell in late August, the spread against the US CFR China price widened again to $127.42/ mt making Chinese corn exports look like a faraway dream. For reasons of simplicity, the price comparison above assumes that Chinese corn quality is at par with international corn. However, major Asian and international traders could be forced to apply quality discounts to Chinese corn sold into the Asian market, even for the latest harvest. Besides still being too expensive to tempt buyers, most international consumers are not prepared to take the risk relating to quality variance, and major Asian feed millers at least expect a quality-related discount. Even if Chinese corn was discounted $20-30/ mt from international prices, Asian buyers are suspicious of the quality of the corn, reports a Japanese trader. Buyers would not know about the age of the corn being sold, says a market source, and buyers are not sure whether even the new corn would adhere to international specifications, particularly on parameters like aflatoxins levels, he adds. International traders who have seen spreads between Chinese corn and US corn prices melt during 2016 and have offered Asian buyers the possibility of Chinese corn stocks, have so far seen little interest from buyers, though some international traders have started adding China as an additional permissible origin in their sales to Asia, where possible. Meanwhile, Chinese ethanol and corn starch are not even tempting buyers due to their high prices and lower quality, especially when compared to US refined corn products, says a trader, even in spite of the 13% tax subsidy on refined corn product exports. China used to be a net exporter of corn but exports fell to under 1 million mt in 2008, from a peak of 16 million mt in 2003, as domestic industrial use increased around 2000, to produce feed ingredients, sweeteners, alcohols, food additives, and other products. The Chinese government responded by introducing subsidies to spur domestic corn production. It was a program that was a bit too successful and now, more than a decade later, the country is struggling with an oversupply problem. Chinese agricultural reforms are seriously aimed at tackling China’s decade long corn stockpiles issue, by reducing the production of Chinese domestic corn. However, in the absence of competitive pricing and huge stockpiles whose quality has deteriorated severely, the Chinese government will need to take write-downs on the stored corn, which could amount to billions of dollars, by some estimates. In rationalizing the stockpiles, there will be some pain for China’s planners, on policies that support the domestic farming industry. The central government will try to reduce its losses by trying hard to push its aged corn into ethanol production, at highly discounted prices. China could try to subsidize farmers and sell its new crop, which will start harvesting in September at heavily discounted prices to the Asian market, especially South Korea, but that will involve additional cost to the Chinese government, which is already struggling with impending write-downs of its aged corn. Whatever the outcome, Asian corn market participants will continue to keep a close eye on this potential source of price risk, and will hopefully welcome the emergence of a new tool to track regional corn prices. On August 22, 2016, Platts launched a daily assessment tracking the cash price of corn on a CFR South Korea basis. The decision to measure this market stemmed from the country’s openness to all origins of corn and the frequency and transparency of its purchasing tenders, which have all contributed to the South Korean market being viewed as a benchmark across Asia.