Analysis: Canada canola crush strong even as margins plunge

WINNIPEG, Manitoba (Reuters) - Canada's canola crushers look to keep up their record production pace, even though Western Canada's rains this spring have driven up supply costs and watered down profits.

Wet conditions will force farmers to leave up to one-fifth, or 12.5 million swampy acres, of Canada's crop-growing belt fallow this spring, sharply reducing canola crop estimates to around 10 million metric tones. That would be a three-year low and 15 percent less than the government projected in May.

New-crop November canola futures have shot up 11 percent since June 3, the contract month's biggest three-week gain in nearly 18 months.

That spike in canola prices, combined with the Canadian dollar's strength against the U.S. currency, have caused canola crushing margins to plunge 35 percent from a month ago, according to ICE Canada. Margins based on the November-December canola and soy contracts now sit around C$67 ($64) per metric tone, in the lowest range in nearly a year.

Crushing volumes, however, show no sign of easing, even if crushers aren't using all their capacity to produce edible oil and meal for livestock feed from canola.

Canada has crushed 4 million metric tones of canola during the 2009/10 crop year to June 23, up 11 percent from the year-earlier volume. With two new plants and one expanded facility, however, crushers have used only 81 percent of capacity, down from 92 percent a year earlier.

Canada is the world's No. 3 producer and top exporter of canola and rapeseed, which compete against soybeans and palm in the edible oil market.

The reversal of fortune has forced crushers Cargill Inc CARG.UL, Viterra (VT.TO), Bunge Ltd (BG.N), Archer Daniels Midland Co (ADM.N), Richardson International and Louis Dreyfus to weigh the relative risks of slowing production or diving into a fierce bidding war for small supplies.

With big capital investments recently and long-term canola demand bright, crushers aren't about to cede market share to escape what may be short-term pain.

"We think those margins will correct themselves and we'll be running the plant based on what our business plan was," said Pat Van Osch, vice-president and general manager of oilseed processing for Richardson, which officially opened its C$170-million ($163 million) plant this week in flooded eastern Saskatchewan.

"The fundamentals are still very attractive for demand of vegetable oils globally," he said. "We built this plant not for this year but for the next 50 years and beyond."

Canola futures have in the past 10 days slipped into a new trading range, albeit a higher one than earlier this spring, giving crushers more cost predictability if not relief. Historically, canola tracks soybean prices closely but canola's gains have far outpaced its oilseed competitor, suggesting a possible correction ahead.

Limiting any downside are the wet conditions and strong crusher demand.

For the near term, crushers can weather the profit drop because some of their costs and prices are locked in at more-favorable levels, said Ken Ball, commodity futures and options broker at Union Securities.

But all bets are off if canola prices keep rising.

"As far as booking future business down the road four, five, six months, it's going to become less attractive for them to crush," Ball said. "Nobody wants to lose money."

If anyone can ride out the current conditions, it would be crushers, who benefited from margins as high as C$110 per metric tone earlier this year, said analyst Larry Weber of Weber Commodities. But current prospects should give them pause, he said.

"They have made a ton of money the past three years," he said. "But if I was (Richardson), I'd put on the brakes."

Smaller supplies and sustained high crush volumes would add up to smaller canola exports.

Canada's canola seed exports in 2010/11 could fall 18 percent from last year to 5.9 million metric tones, Hamburg-based oilseeds analysts Oil World said on Tuesday. That would be the lowest in three years.

"I just think the canola is going to be rationed between crush and export," said JoAnne Buth, president of the Canola Council of Canada. "The plants are going to do as much as they can."

(Editing by David Gregorio)