Undisciplined capital has potential to greatly impact U.S. soybean crush potential

Hi everybody. I'm Paul Yeager This is the MToM Show podcast production of Iowa PBS in the Market to Market TV show. Soybean crush, we talk about it on the TV show quite often. But what exactly does it mean? And what happens if capacity expands, it may be a little too rapid of a rate and what's called undisciplined capital comes into play. What does that mean? For those of you that grow soybeans, Tanner Ehmke, is an economist with CoBank. And the Knowledge Exchange recently had a report about that soybean crush capacity. Tanner's role now is the lead grain and oil seed economist for CoBank. So we visit with him, we talked to him about specialty crops before in sports, we'll get into sports, but at the end of this time, just if you were wondering, but what happens when all of these plants come on? Is there enough demand for soil for renewable diesel for biodiesel ones up, one's down, we'll discuss that. But we'll also talk about the three legged stool that's in place. That's All on this episode of The MTOM Show podcast, New episodes come out each and every Tuesday, you can subscribe wherever you get your podcasts. Or you can watch us on Youtube. We kind of tried to keep it interesting flow back and forth, put us on there in the background as you're doing some work. New episodes every Tuesday, this episode about soybeans now. CoBank still is a bank when it's all said and done. But you certainly are paying attention a lot to agriculture. I mean, that's your job right to enter that hasn't changed.

Tanner Ehmke:  Agriculture is what we do all day, every day, we are a part of the Farm Credit System. So what happens on the farm affects us every day.

[Yeager]  I don't remember. I mean, yes, I remember the 80s, of course, but the time where producers are looking at the interest rates so closely to determine what they do. Right. I mean, we haven't seen this since the 70s and 80s. 

[Ehmke]  Heavily not to mine. I mean, we had back in the financial crisis of await no nine, obviously, interest rates were a big thing back then. And they dropped rates very low for a very long time. And then well, as you know, that environment changed quite radically. And so now here we are at this juncture on interest rates, or are we done, and the Federal Reserve has indicated that we are done with the rate hike cycle, but we'll see. You never know. I mean, the world can throw some odd things at you at any time. And so I think the markets are preparing for what the Federal Reserve is saying, we're just gonna have to take them at their word that we're gonna see three rate cuts at some point this year, we'll see.

[Yeager]  And the whole concept of what it is you do on a regular basis with grain and oil seeds is you're looking at the end, you were a user, not necessarily the end user. And their expansion or contraction is tied to the interest rate, it seems right that hasn't changed either, has it?

 

[Ehmke]  interest rates are going to flow through the economy in ways that sometimes we can't foresee. But right now as it is, with interest rates being the highest they've been in quite some time. That's obviously a tighter monetary environment. And that puts upward pressure on the value of the dollar. And that tends to be a headwind to agriculture. Generally speaking, when you got a strong dollar, that means negative, or that's, that's inversely correlated to commodity prices. And so when the dollar is up, commodity prices tend to go down.

[Yeager]  Which is contrary to some of the old school thinking of a lower dollar is good for agriculture, because it makes your goods more attractive in a global market. 

[Ehmke]  Absolutely, your exports become a lot cheaper. And so when you have a weakening dollar that attracts a stronger export bid and the value of the commodities go up. So as it is right now, we're going to have to continue to see or continue to go with his theory that the Federal Reserve is going to hold where they're at. And until they see sufficient data that they can cut interest rates. And when they start doing that, that in theory is going to put some downward pressure on the value of the dollar and would be helpful to commodity prices.

[Yeager]  But I hear from a couple of farmers that tell me don't get caught up in interest rates as you do its inputs. That is the problem that and but interest rates is part of that big but it's totally different. It's like the economy it's not as simple on or off, yes or no. It's like 15 different switches that have to flow that a producer has to kind of take stock of before they can determine what's the most profitable thing to plant. 

[Ehmke]  Yeah, the dollar is going to have impacts on all aspects of the farm. The positive with a stronger dollar is that your fertilizer becomes a lot cheaper, because our purchasing power allows us to import more fertilizer. So because of that, that's going to cut your fertilizer bill, your fuel bill is down. So there are some positives here with a strong dollar. But it's the other. The other aspect here is that your borrowing costs are still high. And so that's another aspect of higher interest rates. So on the whole, we're looking at a tighter year financially on the farm. I don't think there's any news to anybody, we've been talking about that for quite some time. When you have commodity prices coming down and the cost of production being so resilient. It's gonna be hard to depends on the margin and that kind of environment.

[Yeager]  Resilient, that's a fancy word for it's not going down Stubborn. Stubborn. Yeah, yes, I have to use resilient next week or this week on the show. The common discussion point, when we get to soybeans each week, it seems that comes up at least once a month on the show is talked about this crush capacity this crush. I daresay the tidal wave of new crush opportunities in the United States, how do you characterize what's about to come online for crush capacity in the United States?

[Ehmke]  Great question, we just come out with a report on that. And we just for our reports, a call of the announced expansions, and put all together and try to get it out and we're seeing a 23% increase in soybean crush capacity in the US over the next three years. That's obviously friendly to soybean demand, that's going to put a stronger floor under local bids. And your, in your local basis. If you have a new soybean crushing plant coming online in your area. Typically what that means is a 20 cent increase in your local basis. So if you're in one of those areas, yeah, you're absolutely going to benefit from this new crush capacity. That being said, crush margins are down, we had a couple of record years of soybean crush margins. And that's benefited crushed. Excuse me, little security got a cold that my daughter brought home from her daycare center. A lot of crushed or soybean crushers are doing very well. Financially, their balance sheets are extraordinarily strong. So even though we've seen crush margins drop off their record highs back to historical norms. We don't see any financial stress coming this year or perhaps even next year. The concern is what happens over time. When you have crush margins, persisted low level. And perhaps there might be other additional stressors like higher transportation costs. So if you're a destination plant, as they call it, that means your soybean crush facility that's located outside of the main growing regions. And so therefore, you require that you depend upon transportation, they have access to soybeans, well, that's another risk to that plant. And so there's risk that transportation costs could go up. Or if you're in an area where there's strong competition for soybeans, let's say there's a couple of crushed plants in a short vicinity within each other with a within one location. You could see soybean bases come up by significant amount. And that can erode crush margins as well to levels that you didn't anticipate. And so at that point, then it becomes a concern about what is the breakeven cost of production for that plant. And that's going to depend on each plant and what they spent on getting the plant built and what their borrowing costs were the cost of construction, all of those things, and there could be some financial risk to some players over time. So that's really in the longer term view here. 

[Yeager]  And that's on the Crushers side of things but those providing the goods to the crush plant bringing in the beans, when you talk about even rising over 20 cent basis improvement and it goes higher. Sounds like the farmer might benefit from that. 

[Ehmke]  Absolutely that's how it would play out in the near term as new plants come online in those local areas, that's for sure going to put in a stronger floor under their bases. That being said, I do need to point out we've got a lot of imports coming in canola oil record high used cooking oil imports record high palm oil imports record highs. So as we continue to see this flow of vegetable oils flowing into the US at a record pace that is going to dampen the story here for the crush, excuse me for the crush store because soybean oil is getting more of a becoming a more competitive environment. Not just soybean oil, but vegetable oils at large. And so that's one reason to be cautious but By and large, as you said, Paul, if you have a crush facility coming into your local area, that's for sure going to be a positive on your basis.

[Yeager]  Is this similar at all to the grow out that we saw in the ethanol industry? I mean, is this following the pattern of where plants are built? And are these plants? Kind of in little vacuum spots or little? I guess if you use a football analogy, it's where Travis Kelce runs a route inside the zone.

[Ehmke]  That's the comparison everyone makes is ethanol. We saw this before, where a lot of capacity came online in very short order. The industry was overbuilt. And what happened are margins eroded to negative level. And that caused a lot of your financially risky, risky players to exit the industry. And those plants were sold at pennies on the dollar. And so the people who are experienced that are looking at this expansion now, and making the same comparison, we got to be careful, we have to be disciplined about the build out. And as I mentioned earlier, we feel the same way in the longer view in the near term. We don't see that happening because balances or balance sheets are so strong. But in the longer term that is the concern when undisciplined capital perhaps starts coming into the industry, then you start to see overbilled capacity. And perhaps you might see some of those more risky investments have to be liquidated,

[Yeager]  Undisciplined capital. That's a new one on me.

[Ehmke]  Let's just say as people call it the New York money. Yeah. People didn't know agriculture. They don't know. Yeah, but you don't know about commodity cycles. They're not accustomed to commodity cycles. And then when bad times come, they pull the capital out. Or they exit. And so those things risky. Absolutely. Those are risky bets, of course. But that's what you see in these in commodity markets, is a commodity industry will be overbuilt, and the undisciplined capital that is not accustomed to the cycles that we are accustomed to, in agriculture are then prompted to exit the industry and liquidate rather than pull out more cash and try to allow those investments to make it through a downturn. It's more of a reactionary response, and they pull out and liquidate.

[Yeager]  And if it does build within 100 miles of something else, there's a chance it erodes that other facility to and takes them both down. I mean, that could happen like it did in ethanol.

[Ehmke]  Yeah, what could happen. Usually what's going to happen if one goes down, that makes the corn supplier, in this case, the soybean supply, more readily available, the basis is going to drop and then the margins are going to improve for the other plant in that local area. So not all people would be affected equally, some would actually benefit in that scenario.

[Yeager]  You mentioned all the oils, the soybeans, the vegetables, the canola, the PA all of those things that are coming in. We don't really have a market for vegetable oils where we make our own vegetable oils in this country, do we?

[Ehmke]  Well, soybean oil is the main other than soybean oil, soybean oil, that's the big one. We have a little bit of canola oil. There are some other camelina you know there's a lot of interesting, I'll use the word interesting ideas about some other oil seeds. But really, it's all about soybeans in this country. All the other vegetable oils or imports really for the most part, canola being the big one coming in from Canada, they're expanding their canola crushing capacity up there to meet the needs of rising vegetable demand here for renewable diesel. And then palm oil imports are record high to backfill the food demand that is left vacant by all this soybean oil is going into renewable diesel. And then you have used cooking oil, a lot of controversy there about this record increase of what's being branded or called used cooking oil is not actually used cooking oil. And this is all about coming. The what's happening back of the, US cooking all coming in from China. And it's being accused of being fraudulent sales, that what they're taking is actually palm oil from Indonesia or those Southeast Asian countries Malaysian Indonesian, what have you, and then they heated it up and then call it used cooking oil and send it to the United States. That's not allowed. Palm oil is not supposed to be used in renewable diesel because it contributes to tropical deforestation. But that's what it's being labeled as and perhaps there might be some restrictions they're going down the road. And like you

[Yeager]  said earlier the it's the bad players that are going to maybe cause a big industry. So if I am a producer watching this with soybeans To send somewhere or hope to send it somewhere, what's my watchful eye? Focused on first or second? 

[Ehmke]  About where to send your soybeans? 

[Yeager]  Well, and just what should I be watching with these facilities? What do I like about what this industry provides me near term? But I also want it long term too.

[Ehmke]  I would say first of all, if you have a new soybean crushing plant coming online in your local area, check to see who it is. Who's behind it. Is it discipline to capitalize somebody who knows what they're doing? Is this somebody who's spent their lifetime or builds their entire business model around crushing soybeans, or they know agriculture? Those people are accustomed to the cycles in agriculture. And so they're not going to be surprised when margins erode for a period of time? Those that's going to be the discipline capital, the patient capital, if you will, if those are the people that are building a plant in your area, generally speaking, I'd say you're probably safe. If the people that are coming in to build the plant are outsiders to agriculture, then perhaps you might want to ask a few questions about the longevity of that plant.

[Yeager]  And well, by the time the ground moves, and that things build, that that ship may have gone too far, but but I think we saw with the ethanol build out there were a lot of those locally owned, Farmer Co Op, you know, that farmer owned setups, and some of those are the ones that didn't survive, because they did not have as much deep pockets to keep Exactly. So I mean, there's that concern, right? 

[Ehmke]  Exactly how deep the pockets if they are industry players that have been around for a while, and they've got strong balance sheets, there's really you probably have nothing to be concerned about it again. And again, it goes back to the who is behind it. And if it is undisciplined capital, and or as you point out, Paul, they don't have the deep pockets there to withstand poor margins for a period of time. Yeah, that'd be a reason for concern.

[Yeager]  I'm still writing down undisciplined capital. I really think that's what we should name this episode. I think that would be good. When we talk crush, I should have done this. In the very beginning. It is oil, but there is meal that it gets crushed. Right, and biodiesel. These are all parts of those. I mean, I guess walk me through what is some of these typical new plants coming on? What are their specialties?

[Ehmke]  Well, historically, soybean meal has been the reason why you crushed soybeans. And soybean oil was the byproduct. Very rarely would a rally in soybeans be lifted by soybean oil prices, it was always it was meal was the story in feed demand. And now that story is changed a fair amount and now it's all the soybean oil is the leader in the crush. And so you know, that's, that's really the thing here that is different that is different about this environment. With soybeans, the soybean, it's all about the soybean oil. So what about the soybean meal, we got an issue there. It's about where you're going to send it. Our animal protein, Ellis ecobank. Brian Ernest, he was the co author and one of the co authors on the report. He wrote a lot about this provide a lot of his insights about the future feed demand here in the United States. And it's not going to be a phenomenal increase. A lot of people would think that because of all this very low cost soybean meal that's going to be hanging around that we're going to see phenomenal increase in feed usage. And we just don't see it happening. Based on all the things that Brian writes about. He focuses mostly on the hog in the poultry sectors, and the constraints there to in to increasing those animal numbers and those bird numbers. So the conversation then turns to what can we do or what is the environment look like for soybean meal exports. And that gets a little bit trickier. Southeast Asia is a very important destination. And we've got a lot of competition. Brazil has really come up as a major player in soybean meal exports. They replaced a lot of the exports coming out of Argentina, because Argentina has terrible drought and their availability to crush and export soybean products was greatly reduced. So the United States and Brazil kind of tag teamed if you will to fill that export void. This year, you're going to see Argentina come back with a record crop or what looks to be a record crop. And Brazil, again, they've they're going to be there to export more soybean meal. So the export market on soybean meal is going to be pretty competitive. So if we're not going to be appreciably increasing demand domestically for the meal, then it becomes a price war for the export market. And we'll see where that goes. But it's going to cause some pain somewhere and we write in the report. Our view is that the pain will first probably be felt down in Argentina. They had a bad crush year last year because there crop, a lot of plant capacity was idled. They are hurt financially. And now they have a new government that's proposing higher export taxes on meal and oil, that's not going to bode well again for those crushers. And so in a price war, they would be at a disadvantage.

[Yeager]  Even though they need to push product to get some money back in to recover from a downed crop year because of the weather conditions. And again, Brazil rides into favor with I mean, China has looked to Brazil for a lot of its oil issue, you don't see that changing?

[Ehmke]  Well, excuse me, sorry about that whole, China is leaning more on Brazil for their soybean needs. Remember, China's got a huge amount of cross capacity, and they don't want to idle that they don't want to idle that capacity, they're still probably going to be focused more on bringing in soybeans. In fact, the government here and their latest. What do you call it their food policy is wanting to increase more soybean production? In Country? What does that tell you? They want soybeans to run to push through their soybean crush facilities, they don't want to buy meal, they don't want to buy oil they want to buy the soybeans or and keep those plants active. So what that means then is some of these other markets like Southeast Asia, are going to be quite a bit more competitive. Not everybody is going to be able to meet that demand, someone's gonna have to be pushed to the sidelines. And our view is, that's probably going to be Argentina in the short term.

[Yeager]  But I just, I don't know how to say this. I'm concerned about what they all these new facilities coming on here in the US of how did they do the math to figure the long? Why did it look like that was a good idea to build some of these facilities?

[Ehmke]  The story here is twofold. You got to look at the three legged stool of the crush, and soybean meal, soybean oil and soybeans. The soybean oil side of the story is strong, because renewable diesel although we've got imports competing with soybean oil, the soy with like canola imports, or canola oil imports and palm oil imports and used cooking oil imports, the story there is still strong because demand is still growing. And as long as it's a growing story, we've got growing demand. So that's a positive. The other positive here is on the soybean side, we are going to be reducing exports, making those soybeans available for domestic usage. And so as long as you got a ready supply of soybeans, in as long as you've got a strong story there for the soybean oil side, you're the only concern left here is on the soybean meal side. And so the focus here really is going to depend upon how the other two legs of the soil of this three legged stool perform soybean oil and soybeans. And right now that's very positive going forward. But there are some locations as I mentioned earlier destination plants would be a concern or plants that are in be going to be in competition with each other in a local area. That would also be a concern. Otherwise, the story on soybean crushes a positive one.

[Yeager]  It's popular in politics right now to be talking about who owns these facilities? Are these all these plants themselves coming in as I guess friendly is a is a term that's hard to use. But American owned companies because I had received a message. This was probably 12 months ago, eight months ago about Oh no, this new facility is coming on in North Dakota. Is Chinese owned, and that's been shut down. What's the ownership groups of some of these facilities, too.

[Ehmke]  When you look around the ownership of the plants that have been announced by and large, most of them are us. I wouldn't say that that is a concern. But even then, Paul, even if they weren't us owned? I don't know. I don't know if that would matter. Yeah, I don't think that would matter. They want to make it. They want the plant generally to succeed. If it's patient capital, it's going to make sure that it survives over the long haul. undisciplined capital can come from any any direction us non US doesn't matter. The point is it discipline focused. Is it patient capital or is it undisciplined capital? I think that's the bigger question.

[Yeager]  Let's talk renewable fuels. You mentioned it a little bit on the biodiesel side of the ledger with this do we anticipate in the rest of 2024 that fuel is going to biodiesel specifically is going to be enough of that that stool that you mentioned, to help prop us up?

[Ehmke]  Well, distinction your biodiesel is declining. Renewable diesel is Increasing renewable diesel is replacing biodiesel. Okay. And so when all told though, when you look at biodiesel plus renewable diesel, total capacity when combined is still growing, even though some of this biodiesel capacity is exiting the industry, the increase in renewable diesel is more than making up for it. So when you add those two together, it's still a very positive story longer term.

[Yeager]  As you look at 24, we're, as we record this, we're flirting with that $12 mark, we've kind of been up and down from it on a on a price for the raw commodity itself, again, with our analysts saying when they come on, and they look at the crush numbers, and does that, how much is what your your world? How are your worlds colliding here, in talking about supporting the the overall beam price before we even get into weather issues and oversupply issues, and Brazil and all of those things?

[Ehmke]  Well, like I said, it's going to be a stronger domestic bid in a local area. And so that's going to put a stronger floor under soybean prices, for sure. And you've seen the you can you can see the difference when you compare soybean prices to corn prices, looking at the soybean to corn price ratio, which is so often quoted, and the ratio would clearly tell you that there is a stronger story there for soybeans more than corn, and we're probably going to see that play out in the prospective plantings report. I'm not sure when you're gonna hear this, Paul, but…

[Yeager]  Well, that's the thing. When we get down when this airs, we will know what our acreage number is. But the speculation has been acres really aren't going to change from what was released, you know, kind of last year, but anything that is changing is because corn doesn't seem to be profitable. So is that a good thing for soybeans, when there's more acres on it?

[Ehmke]  That would make corn vulnerable to losing acres? For sure. Yeah. That's my bet. I think soybeans are going to pick up a few acres, maybe not what people had anticipated, but I think it's going to pick up a few. So I think the story is still there, for soybeans. And then of course, we've got a record crop down in South America, that's going to be shortening our shipping season. But some of that negative story goes away, because the domestic story has been so strong.

[Yeager]  What else do you see as the 24 unfolds big things in the soybean market?

[Ehmke]  Well, I think we've covered a lot here, Paul. But I still think that we got to keep an eye on these imports, record large imports, we'll see what happens there. We've got some other renewable diesel programs or biofuel programs around the world, they're going to be coming online over time. And that's going to be drawing on that soybean oil supply around the world. And that's going to be restricting how many tons of palm oil or canola oil, or used cooking oil can flow to the United States. So over time here, I think we're going to see probably stronger Florida, so under soybean oil prices, as that demand kicks in. And that's gonna put a stronger Florida soybean prices.

[Yeager]  I know farmers always they like to hear the word stronger floor.

[Ehmke]  You know, I'm reluctant to say rally because in today's price environment that's it's hard to it's hard to hold on to. But let's just say it's, it's maintaining a value on soybeans relative to corn, you can see that play out in the futures market. 

[Yeager]  Do you see the story playing out longer than 24? 

[Ehmke]  Right now, the capacity is growing over the next three years. And unless some of these plants are called off, and some of the plans are no longer going to be followed through on if a shovel isn't going to be put into the ground anymore for a new facility that's obviously going to be taking capacity or expected capacity offline. But as it is right now, we gotta go with what we know. And right now we are seeing continual expansion of capacity. And that's going to put more demand domestically out there for soybeans.

[Yeager]  What's the scenario that takes the shovel and puts it back in the truck and never moves any dirt?

[Ehmke]  If investors start looking at the crushed margins and get concerned that perhaps they're not going to get their money back over a timeline that makes them comfortable with as we know borrowing costs are still high. You know, construction costs are still high, labor costs are still high. The cost of building a new plant is not coming down. And so as a result, that could scare away some investors perhaps, or at least scare away the undisciplined capital. Got to drop that in again.

[Yeager]  You have to. Tanner as we leave, you’re a big K State guy that Iowa State football game in the snow. Were you wishing you were maybe at that game, you know, or was it just like I'm gonna watch the one on TV.

[Ehmke]  I'm gonna stay home. I'll watch basketball because it's indoors. Yeah, I prefer to stay warm.

[Yeager] And that looked cold. It looked miserable. And that was at that point more snow there in Kansas than we had an Iowa up until January. I mean, it was just a weird fall. early winter in that in that capacity.

[Ehmke]  Yeah, it's did look fun. Reminds me of the Kansas City game.

[Yeager]  Oh, against glad I'm glad I wasn't there.

[Ehmke]  Ah, yes, that was where mahomes broke his helmet. 

[Yeager]  cold and brittle. His helmet I just unbelievable. weather extremes. That's the next episode with us Tanner.

[Yeager]. Thank you so much. Appreciate the time. Appreciate it. Paul. Thanks. Bye, thanks to Tanner Ehmke for his time. Hopefully we're all warm as we discuss commodities, and we appreciate you for logging on and watching this podcast new episodes each and every Tuesday. If you have feedback for me, hit me up in an email Market to Market at Iowa PBS.org. Thank you for watching. We'll see you next time. Bye bye