By James Cordier and Michael Gross
19 Aug 2006 at 07:50 AM EDT
TAMPA, Fla. (Liberty Trading Group) -- While major news events can often cause immediate knee-jerk reactions in the markets, the longer term fallout of such events is often not known for months, or even years. The series of devastating hurricanes that struck the U.S. Gulf coast over the last two years are examples of how prices of certain commodities such as oil, natural gas, cotton, soybeans and even sugar can be affected in the immediate aftermath of such an occurrence. With the possible exception of natural gas, these commodities have long since recovered, replaced or repaired any storm related supply losses or damage to production or shipping facilities.
There is, however, one glaring exception. In the hurricanes of 2004 and 2005, there was one market that had its infrastructure damaged so severely that its impact will be felt for years to come. The market to which we are referring is frozen concentrate orange juice (FCOJ).
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When storms with names such as Charlie and Francis roared through Florida’s growing regions in 2004, the FCOJ market, like many other commodities markets, immediately began pricing the damage to the current supply. When a second round of storms battered central Florida the following year, the market again raced to new highs to account for orange production loss to the 2005 crop. What was not immediately known was the longer term damage done to Florida orange trees and its impact on future production.
What was not known then is now becoming clear. Florida groves suffered substantial long term damage, having lost thousands of trees. And the Florida orange industry is in no immediate hurry to replace them. This fact is clearly evident in the production estimates for the upcoming 2006/2007 crop.
But before we discuss current production, one must first understand what type of production occurred before the storms took place. In the five years prior to the summer of 2004, Florida produced an average of 226.2 million boxes of oranges per year (1999-2003). The storm in 2004 damaged crop produced only 149.6 million boxes of oranges; 2005 faired only moderately better, producing 151 million boxes of oranges. This means that for two years running, Florida groves have produced roughly 34% less oranges than their previous 5-year average. This shortfall in supply has resulted in one of the most sustained bull markets in all of commodities over the last two years. On Thursday of this week, FCOJ prices at the New York Board of Trade hit a new 16 year high, topping out at over $1.87 per pound.
Those that thought the bull market was nearing completion and that 2006 would bring more “normal” production back to Florida may want to check again. Largely due to the loss of trees, commercial firm Louis Dreyfus pegged the 2006/2007 crop at only 160 million boxes. This estimate does not, of course, take into account any possible storms that could affect Florida this hurricane season. Another private analyst, Elizabeth Steger, has the crop pegged at a stunning 123 million boxes.
Liberty Trading’s estimate is closer to Dreyfus at 145 million boxes for 2006/2007 production. We believe Florida growers will probably grow close to 160 million boxes of oranges. However, what many in the trade fail to consider is that many groves in the most heavily damaged regions will only yield 30%-50% of their pre-storm production. At these low yields, the cost of harvesting the oranges becomes less than the revenues they would produce. In other words, it is more cost efficient for growers to forego harvesting. We project that this “lost” production will reduce the 2006 crop an additional 10-15 million boxes of oranges.
The fact that growers have been slow to replant trees does not bode well for future orange production. With Florida’s bulging population, land hungry developers are making some attractive offers to Florida growers and many are accepting. With production down and land prices skyrocketing, many growers figure this is a good time to sell. However their gain is the market’s loss and the FCOJ contract will have to rely more heavily than ever on Brazilian oranges to fill the void. However, not only can Brazil not cover the entire shortfall, their oranges are more expensive to ship (they must be imported into the U.S.), and they are harvested at a different time of year.
If October’s USDA estimate is anywhere near Dreyfus’s estimate of 160 million boxes, we think $2.00 OJ is fundamentally justified. Another storm blowing through central Florida before then could probably drive prices near the $2.20 range.
Many traders talk of trading with the trend but few find it easy to do so, instead seeking fast and sizable rewards by trying to pick tops and bottoms. We advise against this. As we state repeatedly in our book and our columns, selling options in favor of the trend is one of the highest probability trades an investor can execute. Though currently a bit overbought, the uptrend in juice is solidly entrenched and has a sound fundamental justification.
At the very least, it is our opinion that it will be difficult for FCOJ to reverse trend and head substantially lower facing the third strait year of anemic production and heading into the heart of hurricane season. For this reason, we think a correction next week will provide opportunities to sell put premium below the market.
Copyright © Liberty Trading Group 2006
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