Are soaring wheat prices a storm in a teacup?

25 August 2010

A ban on Russian wheat exports and a bout of bad weather in Canada has sparked wild swings in the wheat price and fuelled fears of higher food prices.

Russia imposed a ban on grain exports on 15 August after suffering its worst drought in more than a century and prompted Ukraine to toy with the idea of capping its own exports.

Fears of a supply deficit sent the price of wheat soaring to a two-year high of $8.41 a bushel and almost double what they were in early July.

The US Department of Agriculture has done little to dampen the feverish speculation after slashing its outlook for world wheat production by 15.3 million tonnes to 645.7 million tonnes, fuelling demand for alternative supplies from the US, Europe and elsewhere.

The grain dilemma

Until recently grain prices were dogged by oversupply but concerns for this year's crops have transformed the market.

Analysts now estimate that Russia - last year's third largest exporter - may have to import significant amounts of grain this year in a bid to fill its shortfall.

While the country has been quick to scotch the rumours, analysts are predicting that Russia could import as much as five million tonnes of grain in the duration of the year.

Furthermore, Canada, the world's second-largest wheat exporter after the US, will harvest 23% less wheat than a year earlier due to unusually wet weather.

Based on the foregoing, the International Grains Council projects a global supply deficit of four million tonnes for 2010/11 for the first time in three years, according to Commerzbank.

The problems occurring in the Black Sea region have prompted key importers such as Egypt to look further afield, including to the US.

While US wheat was often viewed as too costly by many overseas buyers, it has now welcomed its first purchase from the Egyptian government in almost a year.

What next for wheat?

While prices have swung back and forth over the past week or so, taking their impetus first from reassuring talk of rainfall in Russia and then from fears Russia will need to import large quantities, wheat prices are still on an upward trajectory.

Analysts note that while better weather conditions across the globe could help to ease supply concerns, it will difficult to make up for the lost ground this season and the effects are likely to be felt until the end of the year.

Emmanuel Jayet, direct of agricultural commodities research at Société Générale, says the ban understandably "created a panic" among importers who had to find alternative suppliers.

Given that wheat stocks have increased over the past two years, analysts have poured scorn on fears that the world is facing a shortage.

Nevertheless, Jayet says the price of wheat remains high and is unlikely to undergo a correction anytime soon because of logistical constraints connected with exporting out of the US, and fears that Russia's next crop could be disappointing.

Analysts warn that the consequence of severe weather conditions across the globe will extend into next year, despite agreement among them that fears of a food crisis or muted supply have been overdone.

Analysts Damien Courvalin and Allison Nathan at Goldman Sachs agree that uncertainty among investors is likely to keep prices firm.

"The magnitude of this price rally has been exacerbated by a near-record net short positioning and we expect ongoing production uncertainty to continue to lend support to prices in the near term."

Goldman Sachs has revised its six-month forecast higher to 650 cents per bushel from 550 cents per bushel previously.

However, the pair believe that barring further major deterioration in crop production, wheat prices will sidle lower "once the market gains a better grasp on this year's wheat production and deficit".

Commerzbank supports this view, predicting a return to softer prices towards the end of 2010 and start of 2011 when it sees prices limp back down to 600 cents/bushel from the 660 cents/bushel it has mapped out for the third quarter.

The grainy issue

With wheat expected to hold onto its gains over the next couple of months, prices of its fellow commodities corn and soybeans are likely to feel a knock-on effect.

Following Russia's ban, the US has been quick to absorb the slack, exporting more corn and barley for stock feed. Corn prices are up 24% this past year and hit a 13-month high of $4.39 a bushel this month.

US net export sales of the commodity rose to the highest level in nearly 16 years last week, totalling 594,900 tonnes, with the top buyers Japan, Mexico and Egypt as importers look to replace feed wheat with corn.

Russia may also look to import some US corn to make up for its own losses, according to Russian market research company SovEcon.

Société Générale has pegged first-quaerter 2011 average at 420 cents/bushel, but said this will most certainly be revised upwards in light of recent events.

"There is an increasing risk that the coming corn harvest in the US will be revised down from the current record forecast and the corn balance sheet is already tight," Jayet warns.

Goldman Sachs agrees, stating that factors point towards "stronger feed demand for US corn, suggesting further tightening to the corn market than we were already expecting".

The rally in corn prices since late June prompted the US banking giant to forecast 415 cents/bushel in three months and 450 cents/bushel in six and 12 months.

Meanwhile, soybean prices also enjoyed their longest rally since 2007, culminating in a seven-month high earlier in August.

Goldman Sachs believes that over the long term soybeans offer the most compelling drivers as expected strong demand growth from emerging markets will likely leave the market particularly sensitive to negative supply shocks.

"We would therefore take advantage of weaknesses in soybean prices to position for further strength."

High street hit

While the markets grapple with sharper prices for agricultural commodities, the high street consumer could be facing higher prices in the supermarket.

The United Nations' Food and Agriculture Organisation recently said that world food prices rose for the first time in three months in July, on higher costs for cereal and sugar.

In its latest trading update released this month, British bakery Greggs said the pressure on the trading environment in the second half of the year looks likely to increase.

"We now expect an increase in ingredient cost inflation in the second half of the year, following the recent rise in wheat prices," the FTSE 250-listed firm says.

Meanwhile, Premier Foods, the maker of Hovis Bread and Mr Kipling cakes, has warned that the price of a loaf of bread will increase as it seeks to recoup the recent spike in wheat prices.

"With the rising wheat costs, which have in recent weeks begun to escalate, it is unlikely that the division's second-half profit will match its 2009 profit level as this period last year particularly benefitted from wheat price deflation," it says.

Meat products are also likely to rise, as the spike in grain prices results in higher costs for US and European farmers to feed their livestock.

An exchange-traded contract in Chicago reported a 243% rise in 'frozen pork bellies' compared to the start of the year, while fresh pork bellies are trading at a record high, some 53% firmer than a year ago.

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