- DTN Headline News
Getting to the Root of Residual
Monday, July 21, 2014 9:16AM CDT

By Katie Micik
DTN Markets Editor

OMAHA (DTN) -- USDA raised a simple question when it dropped the soybean residual to -69 million bushels in the July 11 supply and demand report: How do you create soybeans out of thin air?

The answer is anything but simple. It's a mixture of mathematics and the relationship between two USDA crop forecasting agencies.

July's phantom soybeans will be found when all is said and done in September. In fact, they've probably been there all along, several analysts said, and they anticipate USDA will increase 2013 production in the September Grain Stocks report.

The soybean market plunged to near-limit losses immediately following the July supply and demand report as old-crop ending stocks came in at 140 million bushels and 2014 production swelled to 3.8 billion bushels, said DTN Analyst Todd Hultman.

"It would have taken most people a few minutes to home in and see that residual demand was reduced from zero to -69­ mb so I suspect that the surprise of that was not realized until after the market's initial sell-off."

The rare sight of the negative residual took the edge off the market's plunge, even though it closed lower for the day.

"I did not find the residual adjustment surprising because there was no room anywhere else to account for a more comfortable level of supplies, so the adjustment had to go somewhere," Hultman said. "To me, the residual account just means that USDA is likely to increase its old-crop production estimate later this year.

"More importantly, we had noticed and discussed price weakness in the August soybean contract in early June that did not match USDA's bullish old-crop estimates, and suggested that commercials were content with the supply situation until harvest."

Keith Menzie, an oilseed analyst with USDA's World Agricultural Outlook Board, walked DTN through USDA's thought process on dropping the residual into negative territory. He explained what residual is, its role on the balance sheet and how the soybean balance sheet reconciles at the end of the marketing year.

UNDERSTANDING RESIDUAL

Residual is a statistical term. In layman's terms, it's a numeric value that represents how far off your original predictions were. USDA uses residual on the demand side of the balance sheet "to account for disappearance or usage that cannot be verified or cross-checked against another objective information source."

That includes uses USDA doesn't measure, such as food use of soybeans, Menzie said. But it also includes something more abstract: discrepancies in measurement.

"If you measure yourself on a scale three times, you might not get the same number each time. Instruments have a measurement error," Menzie said.

When you're trying to measure the volume of a large quantity of something, measurement error is more likely. For example, assume the Commerce Department's Census Bureau measures 1.600 billion bushels of soybean exports, but in reality, 1.605 bb were sent out on ships. Since the initial measurement was off, no one would ever know more beans were actually exported.

"To the degree that we don't correctly measure the true volume, the difference ends up in the residual," Menzie said.

There's also the possibility for error in USDA's soybean crush estimate. The Census Bureau stopped surveying every processor in the country due to budget pressure three years ago. Now, USDA analysts estimate total crush from the National Oilseed Processors Association crush report, which includes fewer processors.

"We're getting into estimating a number from another number, and there's room for that to not be precisely correct," Menzie said. "Again, the difference would become part of the residual."

Earlier this year, NASS received funding to take over the industrial crush surveys, which includes soybean crush. No date has been announced on when the reports will resume.

RESIDUAL'S ROLE IN RECONCILIATION

"For soybeans, unlike any other crop, we have a pretty good way of truing up what the crop size is," said Bill Lapp, president of Advanced Economic Solutions. There's good data for the two main usage categories -- exports and crush -- unlike corn and wheat. There's no reliable survey of feed usage for those grains, so it's lumped with residual in the balance sheets. The National Agricultural Statistics Service's doesn't adjust production for those crops after the January final numbers come out. Recent research from a group of Illinois professors has suggested that the inability to reconcile the corn balance sheet contributed to large surprises in quarterly stocks figures in recent years.

"I like to say the corn crop estimate is more of a Protestant thing, where you pray and you go to church but you don't go to confession," Lapp said. "Soybeans are more like Roman Catholics. You have to confess."

As a result, it's not unusual for NASS to make sometimes large changes to its production estimate in conjunction with the September stocks report, he said.

On soybeans, the NASS's surveys establish beginning stocks, production and ending stocks. Soybean for seed use relates to acreage. Crush, export and import totals are tallied. The residual becomes the only variable in the balance sheet formula (supplies - use - x = ending stocks).

NASS reevaluates its production number in the September Grain Stocks report in light of its stock figure, disappearance data and farm program administrative data. Over the last 10 crop years, NASS left the production number unchanged twice. It revised production up and down over that time. The largest change was to the 2007 soybean crop when NASS increased production by 90.6 mb.

That was also the last time USDA reported a negative residual figure, Menzie said. The crop year started out with 84 mb designated for residual use. It dropped to 2 mb in April and -35 mb in July.

Menzie said the decision to drop to a -35 residual was made using an ending stocks estimate of 125 mb.

"If we had known all the facts, we would have gone a lot farther than" -35 mb on residual, Menzie said. NASS showed ending stocks of 205 mb. With an accurate prediction of the final ending stocks figure, the residual would have plunged to -120 mb.

THE ROAD TO -69 MB

The final ending stocks number comes from NASS' survey. It's something a forecaster like Menzie can't know ahead of time. He can only estimate.

Most analysts use supply and demand data to arrive at their monthly ending stocks forecasts, Menzie said. When the June 1 Grain Stocks figure came in at 405 mb, "analysts were generally surprised at how large the actual stocks were. It seemed like stocks should have been lower. So that says that somewhere, somehow, there's more beans around here than we thought we had."

Menzie said he's confident that based on data through the third quarter, the current estimates for exports and crush (1.620 bb and 1.725 bb, respectively) are unlikely to be lowered significantly.

World Agricultural Outlook Board analysts like Menzie are required to use NASS production numbers once they're available (August to January for corn and soybeans).

He uses the balance sheet and historical reference points to estimate ending stocks. Over the past 10 years, the stocks-to-use ratio hasn't fallen below 4.5% until now, Menzie said. "An ending stocks number of 140 mb isn't out of the question. When combined with the export and crush estimates, more soybeans would be needed for the balance sheet to balance."

The only way a forecaster like Menzie can add soybeans to the balance sheet is to lower the residual number. To meet a 140 mb ending stock number, the residual needed to be lowered to -69 mb.

Menzie said he doesn't know how NASS will resolve the negative residual in the 2013/14 soybean balance sheet. However, if it turned out that production were 1%-2% higher, that would go a long way toward sorting everything out, he said.

Katie Micik can be reached at katie.micik@dtn.com

Follow Katie Micik on Twitter @KatieMDTN

(SK/AG)


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