Wheat plants _ image

All the talk in grain markets has recently been around the threat of conflict in the Black Sea region. With two large grain exporters potentially ceasing trade if and when a war kicks off, it would make everyone else’s grain more expensive. There is a risk premium in the market, here we try to assess how far the market might fall if tensions ease.

There is usually a risk premium priced into cereal markets at this time of year.  With winter crops still under snow, and spring crops yet to be planted, there is plenty of time for things to go awry with grain production, pushing prices higher. 

As everyone would no doubt be aware, the tensions in the Black Sea region have added plenty to the risk premium for wheat and corn.  Prices will go higher if conflict occurs, just as they will fall if it doesn’t.

So how much is the premium?  If we look at the CME Soft Red Wheat spot contract, the recent rise doesn’t look that impressive.  Figure 1 shows the downward trend which started in November was reversed in January.  SRW gained around 10% on the initial rally in January, but has since bounced between the 750¢ and 800¢/bu levels.

Looking at figure 1 is seems 750¢ would be the level without the risk premium.  However, we need to look a bit closer at supply and demand.  Figure 2 shows the latest World Agricultural Supply and Demand Estimates (WASDE) figures for wheat.  With all that is going on internationally, a WASDE with few changes almost went through unnoticed. 

The WASDE slightly cut wheat production, increased consumption, and thereby saw ending stocks fall.  However, figure 2 shows wheat stocks are still historically strong, the stocks to use ratio sitting at 35%.

Figure 3 compares the annual average SRW price with the stocks to use ratio.  The last time stocks to use were at 35%, the SRW price was 600¢/bu.  Demand is stronger now, as SRW averaged just over 600¢ last year, despite stronger stocks.  However, the current price around 800¢ is too much of a lift for a 2 point fall in the stocks to use ratio.

What does it mean?

Based on supply and demand wheat prices should be higher than last year, when they averaged 616¢/bu.  But they shouldn’t be above 750¢.  If things don’t escalate in the Black Sea region, wheat prices will quickly ease back under 750¢/bu.  If war is declared, wheat could very quickly move through 900¢ on a panic rally.

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Key Points

  • Tensions in the Black Sea are adding to the normal wheat risk premium seen this time of year.
  • Wheat stocks are still relatively strong, and prices are higher than supplies would suggest.
  • If tensions ease wheat prices are likely to quickly decline back towards 700¢.

Click on figure to expand

Click on figure to expand

Click on figure to expand

Data sources:

CME, USDA

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