Saturday, August 14, 2010

Drought Sparks Wheat Prices Ablaze

The Colorado wheat harvest is officially over and it is starting to wrap up across the country as well. With most of this year’s bumper crop in the bin there is nothing to do but sit back, watch the price of wheat fall to its cyclical lows and wait for this years harvest to be turned into flour, bread and Smack ‘Ums. But wait, hold the phone! Even with reports of bin busting yields and an estimated harvest of 2 billion bushels -1.95bb were expected- the price of wheat is headed through the roof! My home state of Colorado even reported record breaking production of 103.5 million bushels. So what gives?
Let’s look at the crop itself. Wheat accounts for 20% of the world’s caloric intake. One crop makes up 1/5 of what we eat in the form of cakes, bread, flour, pasta, ect. On average the world produces somewhere around 600 million metric tons. According to the FAO, four countries produce the lion’s share for the world: China, India, Russia and the US. In 2009-2010 these counties produce around 318 million tons. That is approximately 10.6 billion bushels for all the Americans out there. On the flipside, there are countries around the world that do not grow enough wheat to meet their consumption needs. Among these are two already mentioned, India and China. Imports are widely distributed throughout the world; the regions that import the most wheat -about 25% of all imports- are North Africa and Middle East markets.

So what happens when the supply of such an inelastic commodity is at the whims of Mother Nature? It seems as though we are about to find out. Even as wheat is readily flowing into bins and elevators of the USA, the wheat crop coming out of the European Union, Kazakhstan and the Ukraine will be lower than expected and Russia and the Black Sea region is burning up in an unprecedented drought. Javier Blas, Jack Farchy and Catherine Belton describe in the Financial Times:
The worst drought in more than a century in the Black Sea region has led to widespread alarm. Forecasts for the Russian grain crop have been falling daily, with the agriculture ministry’s most recent projection at 70m-75m tonnes, down from 85m tonnes a fortnight ago. Last year, the harvest was 100m tonnes. Traders at Glencore, the world’s largest commodity trading company, on Tuesday warned the crop could fall to about 65m tonnes.
Adding more fuel to the fire is a ban from Moscow on any export of wheat from the country starting August 15th. These events have combined to cause the fastest wheat rally in 40 years with prices jumping 80% in 6 weeks! Wheat prices shot up to a two-year high of $8.41 per bushel, not seen since the 2007-2008 food crisis (more on it later), but have since leveled off around $7 on the Chicago Board of Trade. This leaves the American Farmer in a very unique position. Tom Vilsack said, “There is no question this is an opportunity for us and we’re going to take advantage of it.” And that we will. The USDA has already increased its export forecast to 32.6 million tons (1.09 billion bushels). An increase of 20 percent! This would be the highest level of US wheat exports since 1995-96.
Even as the US and her farmers seize this tremendous opportunity other issues are on the horizon. The first and most pressing is the United States ability to physically export such a large amount so quickly. This is evident with the current sugar price. Even though there is ample supply from a stellar crop in Brazil, their infrastructure, or lack there of, is causing a bottleneck as they are unable to ship the product quickly enough! While US infrastructure is superior to Brazil’s, there are other factors that could lead to a snarl-up. The US is also expected to have its largest soybean and corn harvest ever. This in conjunction with on over reliance on one country’s stocks could put pressure on the grain handling systems. Rabobank analyst Doug Whitehead says “The US has amazing elevating capacity, but I think you’ll see it come under pressure through the second half of this year.” Side note- Rabobank’s professional cycling team is always fun to watch in the Tour de France.
The other issue vying for attention is the food crisis that I mentioned beforehand. As the world was watching wheat prices soar like sputnik, the UN was saying don’t panic, we are not in a food crisis. The food crisis in reference was the 2007-2008 global food crisis that sent commodity prices to the moon. This was caused by very poor previous harvest that brought inventories to 30-year lows. Thanks to a strong US crop the world isn’t facing a crisis again, but the picture still isn’t all roses.
The USDA recently lowered the global wheat forecast to 645.7 million tons from 661.07 million tons. The cut in production now only leaves 174.8 million tons in ending stocks. Don’t let this fool you though. This includes ending stocks held by China of 65 million tons and don’t believe for a second that they will ever leave that country. India also has 14 million tons stored as a cushion but up to 10 million of them are at risk of rotting away! Factoring in this information indicates exportable supplies are tighter than they might appear. So while there is current supply to meet demand, not much is left of the safety net leaving the market vulnerable to any supply shocks as Argentina and Australia enter critical growing periods.
So while one of the worlds most relied upon crop hangs in a delicate balance, the American farmer can pat themselves on the back for a job well done and take advantage of this opportunity. Even though things seem stable now and the world has averted another crisis many events loom on the horizon that could upset this delicate balance. While I can’t predict the future, (sure wish I could though) I have a feeling we aren’t done with the ride just yet. Stay tuned!
Nicholas C.

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