Wheat: Supply side challenges

Wheat (NYBOT:JWN14) prices began to firm in late January when the Ukrainian/Russian crisis started to look serious. Unlike many such rallies that are spurred by geopolitical crisis, this one did not fade away after a few days--or weeks, for that matter. Normally, the headlines create panic and traders react spontaneously, but after assessing the facts, prices retreat. Here we are in May, however, and wheat prices are trading at six-month highs.

The potential fallout from the Ukraine’s new isolation from Russia is proving to be something more than just a knee-jerk reaction. There are two potential issues that could affect the global wheat market.

About 95% of the Ukrainian wheat crop is winter wheat – planted in the fall and harvested in July and August. The 2013-14 crop was harvested last summer. There are still 2.5 million tonnes of old-crop wheat commitments remaining to be shipped. Most Ukrainian grain exports are shipped abroad from Black Sea ports on Crimean shores – now effectively controlled by Russia. Exports from the 2014-15 crop, which will be harvested this summer, also remain vulnerable to the viability of Black Sea ports if there is no resolution to the crisis.

Russia and the Ukraine are the world’s fifth- and sixth largest exporters of wheat, respectively. For the current 2013-14 marketing year, Ukrainian wheat exports are estimated at 9.5 million tonnes, or 6% of world trade. Clearly, if Ukrainian access to its shipping infrastructure is in jeopardy, global wheat supplies could be affected. For the moment, it seems that it is business as usual at Black Sea ports. Still, the market is building a premium in the event that the situation escalates.

Looking further down the road, the second issue, and perhaps a more real concern, is the strong possibility of a strained financial relationship between the Ukraine and Russia, which could restrict credit for Ukrainian farmers and hamper their ability to purchase seed and fertilizer. The size of the 2015-16 crop – which will be planted this coming autumn – can shrink dramatically.

A workable resolution to the standoff would alleviate fears. However, credible analysts are voicing concern that Russia has dug in its heels and that the crisis is far from over.

The other factor driving wheat prices is the outlook for the US winter wheat crop. A brutally harsh winter has left the crop with drought in some regions and early spring frost in others. Analysts are slashing their estimates for the crop that will be harvested this spring. The most recent weekly crop- progress report puts the good-to-excellent portion of the crop at 31%. That compares with the five-year average of 48% at this juncture of the season.

Of note, at this time last year 2013-14 crop conditions looked equally dismal, and by the conclusion of the harvest, the abandonment rate was the highest since the 2002-03 crop year. The US muddled through with a decent- sized crop only because planted acreage was the highest since 2009-10. Unless there is a dramatic improvement, a smaller-than- expected US crop is a near certainty.

Another matter that traders will have to grapple with is the effect that a strong El Niño will have on Southern Hemisphere crops, particularly in Australia. Australian wheat export accounted for 12% of world trade in 2013-14.

Global ending stocks for the current 2013-14 marketing year, which ends on May 31, are estimated at 26.4% of consumption. That’s near the low end of the five-year average, but still well above the dangerously low levels we saw in the mid 2000s.

All the supply-side issues cited above present potential problematic scenarios. We advise establishing long positions in December wheat on a 30¢-per-bushel setback from any new high.

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