Crop markets

Full of sound and fury?

Few will have missed the stratospheric rise in the wheat and oilseed prices, just as few will have missed the pictures of burnt-out Russian houses, the suspension of Russian grain exports, threatened suspension of Ukrainian exports or be unaware of the downwards revision of the US wheat area.

The situation can be summarised:

* The price increase (fastest since 1973) is still largely speculative albeit based on a real fall in production.

* The rise in maize price is much smaller than the rise in wheat price. The difference between the two crops is high but not uniquely so. The spread in price between wheat and maize has tended to increase in recent years.

* UK prices have also risen because the wheat shortage has meant that UK wheat now tracks US wheat rather than US maize (as it did for most of this year).

* The sterling exchange rate is now around £1 = $1.5 compared with £1 = $2.0 during the peak price in 2007/8. This alone would make current prices 23% higher than 2007/8 and 14% higher than July last year.

* There is an increase in the number of open positions (sales and purchases) on the CBOT wheat futures market, suggesting that investment by speculators has increased. The number of open positions is now similar to 2007/8.

* The Russian shortfall is not sufficient to maintain the price increase. Traders are looking for drought-induced shortages or locusts in Australia and/or drought or export limits/taxes in Argentina to maintain the price increase.

* At least another 2 months of major speculation remain until the actual supply situation is known with any reasonable accuracy. USDA forecasts are more likely than ever to move prices (up or down).

* World recession does not appear over and could again reduce demand.

* Option contracts have once again helped maintain profits but the dramatic speculative rise might make closing some of the open positions worthwhile.

How important is the Russian crop?

Despite the impact of the Russian crop failure on prices, Russia's contribution to global exports has only recently become significant. Furthermore, Russian stock levels are exceptionally high. To put it crudely into perspective, estimated 2009 harvest stocks plus exports were equal to about 70% of the production. Even if production fell to 30% of the 2009 levels (which no one at present is forecasting) there would still not be any need for imports. Some cutting back is also likely as high grain prices mean less grain will be fed to livestock over the interminable Russian winter.

Russian stocks and exports (m t)

Source: USDA analysed Inside Track

Our Russian contributor, as ever on the ball, has supplied us with his estimates:

Russian estimates of total grain production

	Contribution to 2010	Estimated 2011 pro-
Region	harvest (%)	duction as % of 2010
South	28	100
Volga	26	50-25
Central	15	75-50
Urals	8	75-50
Siberia	22	100
North/other	1	100
Overall	100	81-69

Source: Inside Track

Malting barley has been particularly badly hit and the little production that there is, is likely to be downgraded
to feed, requiring the import of 2-3m t of barley (or malt). Our correspondent estimates that exports of total grain are still likely to be 4-14m t (official estimate 8m t), allowing for a reduction in stocks of about 10m t.

A 10m t reduction in world supply is significant but would not remove the 70m t additional global stocks since 2007/8.

Where else?

The Russian shortfall is not enough on its own to prop prices at current levels. Speculators, in their herds, look for other supporting shortages and at this time of the year, the only places to look for wheat problems are Argentina and Australia. Both countries' crops are at a critical stage and both report droughts in some areas. In fact, it would be a rare year when water shortage was not a problem in at least one of these regions.

 

Drought has been reported in Western Australia, although on 3 August the US Department of Agriculture staff in Canberra raised their estimate of overall Australian production by 1.2m t to 23.2m t.

Argentina is still planting but area targets may not be reached if the dry weather persists. However, a simple reduction in Argentine exports is also not enough, on its own, to propel prices significantly upwards.

Source: USDA

Stock balances

We calculated in October 2009 that there was a less than 1 in 20 chance that cereal stocks could be eroded sufficiently to raise prices to 2007/8 levels - it is still unlikely. As we have previously observed, total grain consumption has tended to rise linearly at around 27m t per year with wheat consumption increasing at a more modest 8.8m t per year. Deviation from trend is small, varying largely with grain availability (i.e. where production is above trend, so too is consumption). Recently, consumption has only been kept on the 50-year trend by the demand for biofuel. While not so easy to quantify, demand is also influenced by the strength of the world economy. Largely because of increasing crop yield (changes in area are a smaller percentage and there is some substitution of lower yielding cereals for higher yielding grains), grain production has matched the increase in consumption (while consumption is, of course, limited by production, higher consumption can be met by a change in stocks, at least on an annual basis). However, wheat production has often fallen below the trend-line in the last 10 or so years because of a slowing in the rate of yield improvement in many areas and as wheat is replaced by maize. The long-term impact of grain area on production is small compared with the yield increase.

Thus, as we have forecast, in an average year production and consumption are most likely to match approximately, with any imbalance met by a change in stocks. Prices relate to the level of stocks, or the stock-to-use ratio (stock divided by consumption).

Estimated grain stocks (m t)

	------------Stocks----------			Stock-to-use ratio
	2009/10	2007/8	Difference	2009/10	2007/8
Total grain	471.23	365.37	105.86	21%	17%
Wheat	193.02	122.66	70.36	30%	20%

Source USDA analysed Inside Track

Any tightening of stock or reduction in the stock-to-use ratio would be expected to increase price but a return to 2007/8 price levels still requires an exceptional stock reduction.However, data revisions make it hard to derive a fully convincing relationship between grain price and supply and demand, as represented by stocks and stock-to-use ratio. Thus by December 2007, when production estimates are usually reasonably accurate, closing total grain stock estimates for 2007/8 were thought to be
315.22m t while closing wheat stock estimates were expected to be 110.06m t (compare with previous table). The difference is rather depressingly large and larger than has usually been the situation historically.

Based on the relationship between expected stocks and prices for harvest 2007, current wheat prices suggest that the total grain stocks are expected to fall to around 323m t, i.e. well below the actual outcome for 2007/8 and an almost impossible fall from the expected closing stocks for 2009/10. However, the mathematical basis for this estimate is poor and must be treated with caution. There are also occasional structural adjustments that can result in a change from the historical relationship - for example, prices since 2007/8 are higher at estimated stock levels than they were prior to 2007/8.

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