Economic Briefing March 2008
The Good ...
Wheat production is expected to be up in 2008.
The current USDA estimate is for world production of 645-655 m tonnes, up by more than 40m tonnes on 2007. This is based on increased plantings, and a return to reasonably good yields. This would be enough to cover anticipated global demand but not big enough to allow for any significant rebuilding of stocks (see chart 1)
Wheat plantings in UK are reported by ADAS to be up by more than 10%, whereas other estimates are up by 4-5% across EU as a whole.
These increased plantings are factored into wheat forward pricing; quotations after 2008 harvest are some £30/tonne lower than current.
... the uncertain ...
Projections for record world wheat production are dependent on good weather conditions and crop performance. Recent rains in Australia may mean that the late 2008 crop will recover to more normal levels there. However, the US winter wheat crop rating at the end of Autumn was the lowest for several years. The crop condition will need to improve dramatically to deliver a reasonable outcome (see chart 2). In recent weeks concerns have also been expressed about the impact of drought in parts of China.
In the late 1990s and early 2000s forward price quotations for bread wheat were normally reasonably close to the actual situation after harvest. In recent years the divergence has been increasingly wide - some 20-30% away from the anticipated level, with a difference of 80% in 2007 (see chart 3). Although bread wheat is currently valued at around £199.00/tonne delivered Liverpool for November 2008, applying recent trend data suggests that the post-harvest price could be as low as £179 or as high as £274/tonne.
Movement in wheat prices is not merely dependent on wheat crops. As stock levels for all grains are at record low levels, problems in the rice, maize or soya sectors could spill across into wheat markets.
Since November 2007 there has been an almost unprecedented increase in the price of quality grain. This is most aptly demonstrated by the movement in Minneapolis wheat futures (see chart 4) but applies equally to Canadian wheat. Gluten prices have also moved up sharply in response. Wheat prices are expected to fall back after the 2008 harvest, but as a sub-sector the quality wheat market is more exposed to weather risk than the general grains complex. In the UK, lower plantings of group 1 wheat could have an impact on new crop premia.
... the economy ...
The strength of Sterling was a bright spot in 2007, helping to keep UK grain prices in check. However, because the UK grain market is exposed to both European and international influences, recent weakness against both the Euro and the US/Canadian dollar has tended to boost prices. A further decline in sterling would continue to support higher sterling denominated grain prices. In the absence of major quality problems, the current new crop discount for UK wheat to French of £22/tonne should revert to a more normal £5 per tonne (see chart 5).
Energy prices were also weaker in 2007, but have turned up throughout the winter as oil has traded in the $90-$100 range. This has already had an adverse impact on overall UK inflation, and electricity costs are up by 60% year on year. If as seems likely the situation is sustained, it will simply add to cost pressure on grain processing and haulage (see charts 6 & 7).
Grain freight rates rose dramatically during 2007 due to demand for vessels for other bulk cargo (eg iron ore) associated with economic expansion. Whilst they have fallen in January and February 2008, freight rates still stand 90% higher than in February 2007 (see chart 8).
... and volatility.
Grain markets have been increasingly volatile, with movements of £10 per day being seen during the current season (see chart 9). This presents the sector with an unfamiliar environment.
Much of the volatility is generated by the increasing involvement of investment funds in grain markets. These businesses are not interested in taking delivery of grain and thrive on movements in market price. It is now estimated that index linked funds (long only) hold £200bn of commodity stocks, up from £15bn in 2002; funds are believed to hold up to 40% of wheat futures open positions in certain US markets. In the UK, the open position on the LIFFE wheat market has doubled over the last twelve months. This investment activity is likely to generate less stability and more volatility for traditional buyers and sellers. 
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