As we observed in our past research , soybean oil prices often lead the movement in crude oil prices. The past year has been no exception. Even as WTI crude prices soared from $42 to $66 per barrel between June 22, 2017, and January 25, 2018, soybean oil traders weren’t buying in. Soybean oil prices peaked on November 9, 2017, at 35.38 U.S. cents per pound and began a 10% sell off that started two and a half months before the recent peak in crude oil prices (Figure 1). This is the eleventh such episode of soybean oil prices leading crude oil prices since 2005.
Here is a list of the various episodes:
Soybean oil prices have not to-date staged any sort of sustained recovery and this might suggest lower prices for WTI in the weeks ahead. Once soybean oil does eventually hit bottom, however, it will be interesting to see if WTI once again follows it higher for a 12th episode as outlined in our brief history of the relationship between soybean oil and crude oil – a story that works just as well when one looks at Bursa Malaysia’s palm oil futures when converted from the Malaysian ringgit to U.S. dollars.
On another note, WTI and soybean options traders perceive largely opposite risks. While they agree that there isn’t a huge amount of risk going forward – at-the-money (ATM) volatility is closer to historic lows than to record highs for both products – (Figure 2), the ‘smile’ chart of option volatility suggests that soybean oil traders fear upside risk (Figure 3), whereas the concerns of WTI traders are dominated by the downside (Figure 4).
This is probably because agriculture traders are concerned that prices for the soy complex (beans, oil and meal) might be close to the marginal cost of production of many producers and therefore can’t go too much lower. WTI, by contrast, is trading well above the assumed marginal cost of production of around $40 per barrel for many producers, including many of the key, swing producers of shale oil in the United States.
While the views of options traders are consistent with the idea that soybean oil prices might continue to lead movements in WTI, we would note that the risks for soybean oil might be more evenly balanced than some might think. Just because agricultural goods prices are low and near the cost of production, it does not mean that they cannot fall further. Likewise, WTI traders would be unwise to ignore the upside risks to oil prices stemming from geopolitical risks in places as diverse as the Middle East, Algeria, Angola, Nigeria and Venezuela.
We remain unsure of the exact reason why soybean oil and other vegetable oils prices tend to lead crude oil prices but we suspect that it results from two factors: 1) the existence of biofuel mandates in over 60 countries around the world (including the U.S. nations in the E.U., Brazil and China), and 2) the modest size of the veg oil market in comparison to the vastness of the crude oil market. The latter is roughly 20x larger and via the biofuel mandates small fluctuations in crude oil supply and demand conditions can have an outsized impact on vegetable oil prices – impacts that may be moving vegetable oil prices in advance of crude oil prices on many occasions.
All examples in this report are hypothetical interpretations of situations and are used for explanation purposes only. The views in this report reflect solely those of the author(s) and not necessarily those of CME Group or its affiliated institutions. This report and the information herein should not be considered investment advice or the results of actual market experience.
Erik Norland is Executive Director and Senior Economist of CME Group. He is responsible for generating economic analysis on global financial markets by identifying emerging trends, evaluating economic factors and forecasting their impact on CME Group and the company’s business strategy, and upon those who trade in its various markets. He is also one of CME Group’s spokespeople on global economic, financial and geopolitical conditions.
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WTI crude oil prices have followed in the footsteps of soybean oil, with a slight lag, in nearly every year since 2005, based on our research. Is the vegetable oil currently indicating that crude oil prices could be heading lower in the weeks ahead? Hedge against the uncertainty with CME Group Energy products.