Kub's Den

"So it's decided. We'll all cut back our production -- all of us! And then we'll announce it to the press, and prices will go up. But it's only going to work if every single producer of this commodity here at this meeting sticks to the plan. Got it?" The other members of the cartel nodded in grim determination. What they lost in business volume, they hoped they would make up in price. Like any cartel, they were meeting in the swankiest place they could book, which in this case was an American Legion dance hall instead of a Vienna boardroom or a Dubai skyscraper. And they all wore seed caps instead of keffiyeh headdresses. They were ... the Corn Cartel.

Would it work? If all American farmers agreed to cut back production of corn, or soybeans, or wheat, would prices jump high enough to offset the lost revenue from fewer bushels being sold? Well, the big crude oil cartel -- OPEC -- has had some success with this strategy in recent months.

OPEC, the Organization of the Petroleum Exporting Countries, perhaps ought to change its name to the Organization of "Some" Petroleum Exporting Countries, or of "countries that represent a diminishing proportion of global production." Its membership includes 14 countries, primarily in the Arabian Peninsula and Africa, although late last year they notably convinced Russia (not technically an OPEC member) to join them in pledging to withhold 1.8 million barrels per day of crude oil production from the global market.

That sort of worked.

Crude oil futures shot up more than 9% in one trading day, then continued to trend upward, above many producers' breakeven costs around $50 per barrel, then topped out above $55 per barrel at the start of 2017. More recently, late last month, the alliance pledged to continue those cuts through March 2018, but the futures market had already started to doubt the effectiveness of all this pledging. Now this week, three OPEC members, including Saudi Arabia, have cut diplomatic ties with a fourth member, Qatar, the world's top seller of liquefied natural gas. The spat is reportedly due to payments that may have ended up in the hands of terror groups, and not related to energy production. But, nevertheless, it makes those former OPEC pledges look precarious ... if they were ever effective to begin with.

That 1.8 million barrels per day of crude oil OPEC members have pledged to withhold will only hobble global production by 2% in 2017, when total world production is forecast at 98.3 million barrels per day. The non-OPEC oil-producing countries, including the U.S. and Canada in their shale oil heyday, are projected to pump over 59 million barrels per day, or 1 1/2 times as much as OPEC itself.

When we look at equivalent cuts to grain production, what would American farmers have to do, or how much would they have to lose, to achieve a similar market effect? Well, if U.S. corn production, for instance, were to only reach 13.3 billion bushels in 2017, instead of the currently projected 14.1 billion bushels, that would be a 5% loss roughly equivalent to OPEC's pledged production cuts. But farmers can't just turn off some pumps to achieve a production cut. What would they have to do? Make everyone vow not to use any fungicides and hope that results in a 5% nationwide yield loss? Or maybe everyone could pledge to set their corn headers slightly wrong at harvest?

A 9-bushel-per-acre drop in the nationwide yield projection, going from 171 bpa in the latest USDA table to 162 bpa by harvest time certainly sounds like something that could spark a rally in corn prices -- similar to the one crude oil experienced after OPEC announced its cuts. It could theoretically take prices above breakeven costs for many producers. And some would argue that perhaps we have already lost those bushels. The late planting and wet conditions in much of the Eastern Corn Belt, now joined by a dry forecast at a critical growth period for the U.S. crop, make a bullish case that the nationwide crop will not have its full agronomic potential this year.

Weather is the only way those corn production cuts will be made, if they're made at all. Cartels only work, OPEC is discovering, if their members represent a significant majority of a commodity's production sources -- that is, if no one else can come into the market and undercut their plan. This was possible in the oil market in the 1960s when a dozen or so men from autocratic countries could all get together in a room and decide to move a market. It's not possible in the grain markets, where thousands and thousands of individual decision makers all over the world would never all agree to the same decision.

In any scenario of global commodity overproduction, or simply of abundant commodity supply, unfortunately there's really not much a single producer -- or even a group of producers -- can do to affect prices. If end users have "enough" of the commodity, however we define "enough," then they won't be obliged to pay higher prices or to ration their demand.

So, in the absence of taking an action to change prices, producers of an ample commodity have only one action they can take. They can aggressively hedge when prices pop above the cost of production.

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Editor's Note: Elaine Kub is the author of "Mastering the Grain Markets: How Profits Are Really Made" and can be reached at elaine@masteringthegrainmarkets.com or on Twitter @elainekub.

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