Sunday 25 September 2016

European wheat prices are now below the cost of production

James Nolan

Published 16/03/2016 | 02:30

The wheat price market now appears to be stagnating.
The wheat price market now appears to be stagnating.
James Nolan

After three record crop years throughout the world's main exporting regions, it is clear the market is stagnating.

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It all boils down to the fundamentals of supply and demand.

The big demand drivers have faltered. In the mid-noughties ethanol production in the US was a big driver of maize production in the US, where demand has increased from 40mmt in '05/06 to a current ceiling of 130mmt (38pc of the US crop). This increase in domestic demand resulted in the Black Sea and South America producing more corn for the growing global demand. However, that drive towards the renewable fuel is now beginning to plateau and there is a glut of corn looking for demand.

Other key drivers behind demand were new emerging markets such as Asia, but with globally economies beginning to slow and naturally this is having repercussions on prices.

By 2020 there was an expectation that China was going to become the major corn importer with an expectation 20 or even 30mmt of corn, in the last four this has been 2.5/5.5mmt. This growth is will not happen in the near term as 46pc or 115mmt of the world's stocks of corn are also supposed to be in China, as the Chinese government incentive the farmer to produce there.

The potential Brexit from Europe is also having an impact, with UK grain now more competitive due to the weaker sterling. Oil prices have fallen 60pc in 12 months to level last seen in 2003, as production ramps up due to geopolitical tensions in the mid-east. Which in turn adds more negative incentive to the market place.

We've seen it in Europe where wheat prices have fallen below cost of production, and are now the cheapest in the world. Yet it is still struggling to get demand, despite being cheaper than other origins.

Both France and the UK have increased their area of wheat sown - so already the first catalyst is in place for 2017.

The Black Sea region, and Ukraine in particular, and Brazil corn exports have increased three fold in the last six years. The Black Sea region has now become the price setter in world markets.

Funds, love them or loathe them, they help the farmer and the consumer. They create volatility, deliver both buying opportunities and selling opportunities. Their position in the market currently is a record short, as they are betting on prices going lower. They are currently short 13mmt of wheat with the largest short ever held in autumn of 2014 at 14mmt.

When drought and political unrest in the Black Sea region saw prices rally €30, funds would have fuelled this rally. This large speculative short is also unseasonal for the time of year, as a weather threat could see them buy in their positions. This may create a selling opportunity in the coming weeks or months.

In terms of logistics, the world has become a much smaller place. Shipping has become much cheaper as an oversupply of ships from the downturn in the global economies and falling energy prices. In the last 12 to 18 months currency has also had a massive impact on grain markets. We talk about crops being below the cost of production, yet some countries aren't feeling this impact to the same effect as they are being protected by currency factors.

Farmers in these regions are receiving high ex-farm prices due to weak domestic currencies in Russia, Ukraine, Brazil and to a lesser extent UK.

The last three years have seen closing stocks soar year on year to over 500mmt, up 30pc in 10 years.

Closer to home the winter wheat and winter barley areas are on the rise, while spring barley area decline last year and is set to fall further this year.

In recent weeks the market has seemed jittery, with European farmers pushing grain at the market. Yet there are signs of weather issues emerging which may help turn prices. These include La Niña, which historically has brought drought to the US. These factors along with speculative positions and political uncertainty will be the drivers of prices to the up side into the next crop.

James Nolan is a grain trader with importer and supplier of animal feed ingredients R&H Hall

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