Effects of growing-season weather on the dynamic price relationships between biofuel feedstocks

Abstract

Our study is the first to examine the effects of growing-season weather conditions on both the mean and variance of futures returns in the multipurpose agricultural commodity markets of U.S. soybean oil, Canadian canola, and Malaysian/Indonesian palm oil, based on their significance as substitutes in the global food and energy sectors. We use the vegetation health index (VHI) from major feedstock-growing regions in North America, Brazil, Malaysia, and Indonesia as an indicator of the anticipations of the future crop supply. We assess the impact of current VHI on price dynamics in these markets, we employ the EGARCH-X-DCC framework, which captures the effect of VHI-related news on both returns and short-term volatility in the food and biofuel markets. We also extend our analysis to explore how a crop's VHI, as a slow-moving determinant, influences volatility not only in its own market but also in substitute markets. For this, we use the GARCH-MIDAS-DCC framework, in which one year's worth of VHI acts as the slow-moving component in the MIDAS filter, allowing us to isolate the impact of slowly changing growing conditions on daily volatilities through the long-run component and the dynamic correlations between commodity returns. We find that information about current and longer-term growing-season weather conditions affects both the primary crop market and its substitutes. Furthermore, the broader set of crop condition information increases variability in the long-run correlation between commodity returns.