Will wheat prices spike again?

The grain trade reacted strongly: spot prices are up by US$50 a tonne in a month, and by US$70 a tonne for some export wheats. These increases are the fastest seen since, says the FT, 1973. That year saw the largest spike in cereals prices seen since the Korean War, prompting apocalyptic predictions of future famine, and incidentally added impetus to the green revolution.

As if this was not bad enough, Thursday 5 August produced a bombshell as Russia announced suspension of exports from mid-August to December. In three days of trading, the wheat futures market in Chicago has seen a full US$55 a tonne added, an extraordinary addition to the rises seen in July.

So are we facing the prospect of replay of 2007/08, or even — heaven forbid — 1973/74? Not quite.

This is not 2007 or 1973. First, world production of wheat may fall — perhaps 26M tonnes down on the forecasts — but this is a 4% reduction on a 2010 harvest that was expected to the be the third largest in history. Probably 650M tonnes will be harvested in 2010/11: compare that to 597M tonnes in 2006/07 and 606M tonnes in 2007/08. Second, stocks that had been driven to their lowest levels in more than 30 years by 2007 have been rebuilt. As a ratio of annual use, global end-of-season stocks of wheat that had slumped to 23% in 2007/08 were almost up to 30% by 2009/10. Third, harvests for the other two major grains, maize and rice, are not likely to be affected. Some wheat consumers deterred by higher prices thus have the chance to switch to other grains. Fourth, forecasts of demand for feed wheat by livestock producers have been reduced, as less meat than expected will be consumed in an economic downturn.

Hence supply and demand — ‘market fundamentals’ — suggest that while wheat prices will be pushed up by harvest failures, this will be at most a minor spike. What may we expect from harvest failures on the scale currently contemplated? Before 2007/08 the last minor spike followed the 1994 harvest that was 37M tonnes, 6.6%, down on that of 1993: over the next two years prices climbed from US$167 to US$222 a tonne, or by 33%. If that’s any guide to current events, then it may well be that spot price increases seen in July, at 29%, are the worst of it.

But policy can be as destructive as drought, as the rice market showed in 2007/08 when India’s rice export ban led other rice exporters following suit. Rice prices tripled in the ensuing panic. Will other countries follow Russia’s lead? Amongst the top eight wheat exporters, there are two likely candidates: Kazakhstan and Ukraine, both affected the same drought, both of which also restricted exports in 2007/08. Their combined wheat exports were expected to be not far short of those from Russia, so were they to ban exports, this would be another heavy blow to the market. Furthermore, are markets likely to take fright as they did for rice, with importers over-ordering in a tight market fearing that soon there would no rice at all on offer?

To judge by last week’s reaction on the futures market in Chicago, traders have been shocked by Russia’s move. But not for long. The last two days of trading have seen those same prices fall back, by US$50 a tonne, more or less to where they were before the surprise of the export ban.

Are there lessons from this shock? Yes: things can always go wrong, and hence it is wise to have some resilience in the system — in this case adequate stocks. Trade also helps: harvests fail somewhere pretty much every year and trade can prevent local economies taking the full force of localised mishaps. And abrupt, unexpected policy interventions can throw further spanners into the works.

Finally it is intriguing to read reports of the impact of feedlot decisions on grain markets. Why can’t we reduce their activities when harvests fail? Most of us can live for a while without meat, but not without bread.

Steve Wiggins & Sharada Keats, ODI

9 August 2010