Why soybeans are a proxy for US-China trade war?

By Nelson Low Source:Global Times Published: 2018/9/19 22:18:42

Illustration: Luo Xuan/GT

Soybeans have hit the headlines after being caught up in the China-US trade dispute. The tit-for-tat tariffs imposed by the two economic powerhouses have sent US soybean prices plunging to near 10-year lows, creating issues for producers and importers alike.

In many ways, soybeans are the perfect proxy for the current trade tensions: the US is the world's largest producer, while China is its biggest consumer. Although the end products of soybeans are as diverse as tofu, biofuels and industrial lubricants, their prime commercial use is as soybean meal, which represents two-thirds of their economic value. Soybean meal accounts for 60 percent of world meal production, and it is used mainly as animal feed, the majority of which ends up in China. Another third of soybeans' economic value comes from soybean oil, which is considered to be the second most important vegetable oil.

The US has long been the world's largest soybean producer and a key player in global supply, accounting for around one-third of the global crop, closely followed by Brazil. Brazil is expected to overtake the US as the world's biggest producer of soybeans in 2018-19, with a harvest of 120.5 million tons compared with the US' 117.3 million tons. Even so, the US remains a key player in the global market.

On the demand side, China is the world's largest soybean importer by some distance, buying more than 60 percent of world exports in 2016-17. The net result is a market that is highly concentrated with two dominant suppliers and one dominant consumer.

Over the years, rising demand, driven by a combination of increased applications for soybean products and growing consumption, has provided some support to prices. Globally, soybean meal and oil consumption has been rising at a steady rate for the past 15 years. Much of this increase was driven by China, with the US Department of Agriculture (USDA) previously forecasting China's import volume would hit 110 million tons by 2021. Other Asian countries have also played a role, with economic growth, expanding populations and an increasingly meat-heavy diet all leading to higher consumption of soybean products.

Rising demand is just one factor that contributes to price volatility. Other factors include the high concentration of soybean production in only a few producing countries, weather and the unpredictability of what farmers will choose to sow each year at the start of the planting season. Given these variables, the USDA's World Agricultural Supply and Demand Estimates report typically has a big impact on prices when it is published.

Unsurprisingly, the current political situation has increased soybean price volatility. China first warned it would impose a 25 percent tariff on US soybean imports in April 2018, in response to existing and planned tariffs by the US on Chinese goods, setting soybean prices on a downward trend.

The Chinese tariff was imposed on July 6, hours after the US confirmed 25 percent tariffs on $34 billion of Chinese imports, triggering further price falls. The tariff has already affected export patterns, with China increasing imports from other countries such as Brazil and US soybean producers having to explore new markets.

It is difficult to say if and when the trade tensions will be resolved, with both sides recently announcing plans for further tariffs. It is worth noting, however, that the Peterson Institute for International Economics has warned that many of the US tariffs on Chinese imports are for parts that are used in assembly by US companies, meaning the tariffs adversely affect US businesses and raise prices for domestic consumers. Until there is a resolution, price volatility is likely to persist.

The tariffs have already hit US soybean prices hard, triggering a 20 percent fall since April to the lowest level in nearly a decade. A reversal in the trend looks unlikely, with China warning that higher prices because of the tariff  will curb demand and cause farmers to switch to alternatives for animal feed.

The US government has also forecast purchases by China will drop by 6.8 million tons for the 2018-19 crop year, down from 32.9 million tons last year. As a result, it expects end-of-season stocks will be the highest on record, a situation that is likely to put further downward pressure on US soybean prices.

The low US soybean price is leading to higher US sales to non-traditional markets such as Europe, the Middle East and North Africa. Brazil is also buying US stocks for its domestic market. Furthermore, more soybeans are being sold and crushed in the US than ever before. But these sales are unlikely to take up all of the slack caused by the sharp fall in exports to China.

Investors and hedgers can trade soybean futures on the Chicago Board of Trade to manage their exposure to price risks. At the same time, derivatives on a number of soybean-related contracts, such as soybean oil and soybean meal, can also be traded as a proxy on soybeans, offering various ways of profiting from price movements or hedging risk.

While 12 billion bushels of soybeans were produced in 2017-18, more than 20 times this volume was traded on derivatives exchanges alone, suggesting that the market for soybeans was deep and liquid.

Producers are predicting November 2018 soybean futures could trade below $8 per bushel by the autumn, according to the Purdue University/CME Group Ag Economy Barometer, and with global trade tensions showing no signs of abating, investors and traders of soybean derivatives, as well as other soybean-related products, could look to the derivatives marketplace to manage their price risks or to profit by accepting risks.

The author is the executive director of Commodity Products, Asia Pacific, CME Group. bizopinion@globaltimes.com.cn


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