Crude Oil's Role in the Ag Markets

Most individual markets’ daily price movements are inter-related to at least some degree, and more sessions than not they are influenced by key “outside” markets—including the grain and livestock futures markets.

The major outside markets include crude oil, U.S. stock indexes, U.S. Treasury bond and note futures, and the value of the U.S. dollar on the foreign exchange market.

Crude oil and the other outside markets help determine the “risk-on” and “risk-off” trading days in the market place. These terms have been commonly used for the past few years to describe the general daily mood of the trader/investor. Examining the few aforementioned outside markets daily can provide a quick gauge of the level of risk appetite or risk aversion in the market place. Most market prices react to varying degrees on a daily basis to risk levels in the market place.

Crude oil is arguably the most important outside market for the raw commodity futures sector, including the grain and livestock futures. Most agree crude oil is the major raw commodity futures market traded worldwide. It is a fungible commodity that has strong demand around the world. The daily price movements in NYMEX crude oil futures can significantly impact most other raw commodity futures market prices on that given day, and also have a somewhat lesser influence on the world stock, currency and financial markets.

On a trading day when crude oil market prices are significantly higher, it’s also likely a “risk-on” trading day in the market place—a day when investors are seeking out the so-called risk assets such as raw commodities and stocks. The exception to that notion would be if there was a major geopolitical shock in the Middle East or some other strategic part of the world, in which the daily shipments of crude oil could be impacted. Such a day would be a “risk-off” day in the market place that would also see crude oil prices likely trading sharply higher.

On a trading day when crude oil prices are significantly lower, it could be that it’s more of a risk-averse or risk-off trading day. The lower crude oil prices would at least limit buying interest in other raw commodity futures markets, and possibly the U.S. stock indexes.

Historically, the price of a barrel of crude oil has had some degree of a “war premium” built into it. The past 20 years have seen that so-called war premium vary widely, depending upon the level of risk aversion in the market place—usually caused by geopolitical tensions in the Middle East, whose countries are major exporters of crude oil to the world. During times of high anxiety in the markets, such as military action in the Middle East, the war premium for a barrel of crude arguably could have been as high as $40.00 a barrel, or more. Presently, with the relative stability in the Middle East compared to recent years, the war premium priced into a barrel of crude oil is very low—possibly as low as $5.00 a barrel. Also, the U.S. in recent years significantly ramping up its domestic crude oil production has made the Middle East a bit less of a powder keg of potential military conflict, from a crude oil market perspective.

More specific to grain and livestock markets is the fact the price of a barrel of crude oil can impact production levels of corn-based ethanol. Varying ethanol production levels in the U.S. have become a very important factor which affects corn futures prices. And given that “corn is king” in the grain futures markets, the price of corn futures indirectly affects wheat and soybean futures prices.