Wheat’s on Wheaties

February 12, 2008

Wheat’s not just beating the market, it’s breaking it…

  • Record high wheat prices
  • Exchanges increase daily limit
  • The domino effect? Food inflation?

 

That morning bagel you just had might be getting a bit more expensive in the future. Wheat prices have been hitting all-time highs in the past week, and the power of wheat is much in the news.

Not all wheat is created equal, however, and before we consider the prospects for the amber grain, a refresher is in order.

Wheat is traded in the U.S. on three markets – Chicago Board of Trade (CBOT), Kansas City Board of Trade and Minneapolis Grain Exchange. Forty-five percent of the wheat grown in the U.S. is Hard Red Winter Wheat, and is traded on the Kansas City Board of Trade. Hard Red Spring Wheat makes up another 20% of U.S. crops and is traded on the Minneapolis Grain Exchange. These two wheat varieties are considered the best for bread making because of the high protein content and are in high demand from importers. By contrast, wheat contracts traded on CBOT have a looser specification, and are made up of a variety of types of wheat, including soft wheat. Those contracts are ones quoted in the media as the main benchmark for prices.

Contracts on the three exchanges tend to follow the same general price curve, with CBOT usually showing the highest volume and volatility and Minneapolis the highest price because it trades the premium Hard Red Spring Wheat. Lately, demand for Hard Wheat has served to pull up prices on the CBOT contracts. Prices have risen so much, and so consistently, that the exchanges have increased the daily limits (circuit breakers) from 30 cents a bushel to 60 cents a bushel after a week of the 30 cent limits being reached daily. To put that in perspective, this is like the circuit breakers that exist on the major stock markets, which effectively shut down trading when a stock just moves too far too fast.

In this case, however, the stops are being hit because there is simply so much demand the market can’t keep up. The exchanges are not only going to raise the ceilings, they’re putting into effect policies that will allow them to continue to increase the daily limits if need be. The hope is to give the market more freedom to find the true price of wheat than to have it artificially going up in stepwise fashion.

The charts below show the recent price trends for the three U.S. wheats.

Wheat (W,CBOT)

Kansas Wheat (KW,KCBT)
Hard Red Spring Wheat (MW,MGE)
A Global Trip Back In Time
The run-up in wheat prices is a combination of reduced hanging planted acreage (due to corn’s own price run), extreme weather conditions affecting the harvest and increases in demand.
Domino Effect
The biggest driver in any agricultural commodity is the intricate dance between the expected prices of various crops and the farmer’s decision of what to plant. Higher prices in one grain crop influence what gets planted the next season.
There are winners and losers in the crop wars; it’s simple economics. In October, the Financial Times noted that wheat and cotton were battling it out for acreage. And more recently, there have been reports that vegetable oils may be in shorter supply if more wheat is planted, resulting in a run-up of palm oil prices last week. Palm oil and vegetable oils are also used to make biofuel, reducing the amount available for food. We’ve had a short-term pressure on farmers to plant things other than wheat.
To make matters worse, in early 2007, bad weather damaged crops in Europe and Canada. The market looks to the upcoming Australian crop to help balance out the bad news. But Australia is experiencing drought conditions, and projections that start out promising (22.5 million tonnes) got revised down, and in the end, Australia’s farmers harvested only 12.7 million tonnes for 2007/2008 (with the harvest completed in December). While that is better than the previous year’s low of 9.8 million tonnes, considering the initial projections, 12.7 million tonnes was a paltry number. Blame it all on the continuing drought.
Fast-forward to December. Argentina confirmed that November frosts severely damaged crops, translating into lower expectations there as well. As the sixth-largest wheat exporter, accounting for 7% of the market, that news was enough to spark the December run-up of the March contract.
Another major producer, India, has been sending its own mixed messages. Farmers there have planted 5% more acreage year-over-year, but dry weather may hurt production there too. India is the second-largest consumer of wheat after China and has been importing wheat in order to build up its reserves. If its March harvest is lower than what’s needed, India will be looking to the global market to make up the deficit at a time when world wheat supply is already unbelievably tight.
Super Demand
“Much of the U.S. stockpile of hard spring wheat has already been pre-sold, analysts said.” Bloomberg
“There is a genuine physical shortage of higher-grade wheat,” Tobin Gorey, commodity strategist at Commonwealth Bank of Australia Ltd, said by phone today in Sydney. “We’re in a phase of the market where people just have to buy it and price has stopped being a real consideration.” Bloomberg Feb. 7, 2008
On February 8, the USDA released its latest figures on U.S. wheat stockpiles. As the world’s largest wheat exporter, what we have in our silos is global news and has a huge impact on price. Just like the above quotes, the news isn’t good for buyers: Wheat stockpiles are down 40% from last year at this time, and inventories are at their lowest since World War II.
Holy Cow, What Now?
What we’ve got here is a classic squeeze. We have inexorable demand – people don’t really stop eating bread and pasta. We have a consistent string of supply shocks. It’s difficult to imagine a scenario where wheat prices plummet in the foreseeable future, and so the high prices will have a definite influence on the next round of crop plantings beginning in the spring. (Hard Red Spring Wheat is planted from March through May.) How long these prices last, only time will tell. An exceptionally large spring planting might lower further-out contract prices, but March contracts won’t likely be affected. And given the tightness of supply, even a record planting year may not be enough, especially as it would only take one extreme weather event to knock projected harvest numbers off. And then, of course, more wheat acreage would translate into less corn acreage and …
Ahhh … maybe Rice Krispies for breakfast?
Links

Wheat’s Volatility Spills Over
Wall Street Journal, Feb 7, 2008
Record wheat price ignites food inflation fears Pioneer Press – McClatchy-Tribune Information Services via COMTEX, Feb 8, 2008

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