WHEAT FOCUS: Futures to relieve price pressures in the wheat market?

By Lindsey Partos

- Last updated on GMT

Related tags: Wheat, World trade organization, Risk, International trade

With demand outstripping global wheat stocks, currently at a 30
year low, wheat prices are in for a volatile ride in 2004.
Strategies to minimise the impact of price rises for food
processors could be rooted in risk management and the futures
market.

Weather conditions across the globe in the past two years have had a major impact on wheat production. In 2003, final harvest figures for Europe and Russia came in 50 million tonnes lower than expected. And despite a 40 million tonnes lift from the US - the world's biggest exporter - as well as Canada and Australia, global yields of 552 million tonnes for 2003 fell short on demand, sending wheat prices high. "The world market needs production to be above consumption this year. One good year and stocks could recuperate,"​ Julian Bell, an economist at the UK's grains body, the Home Grown Cereals Authority (HGCA), told FoodNavigator.com​. From the 1960s to the late 1990s, wheat yields grew on average at about 2.2 per cent per year, but since then they have dramatically slowed down to just over 0.1 per cent growth. "In 1995-96 wheat stocks were low and the price rose sharply,"​ said Bell. "The global response the following year was to boost production - and in fact, 1997 was a very strong harvest enabling huge stocks to build up,"​ he added. The world spent the next few years bringing down these stocks and lowering the price. Today, after two years of bad weather conditions, stocks are so low there isn't enough to meet demand. The world has lost its wheat 'buffer zone' - the high secure stocks witnessed a few years ago - leaving the market even more vulnerable and open to volatility. And, naturally, higher prices for the food industry. Prices are currently trading at £85 per tonne. "The price has shot up by more than 50 per cent on last year's figures when it was trading at £60 per tonne,"​ Bell pointed out. China, as the biggest consumer and producer of wheat in the world, has also contributed to price rises in the wheat market. According to a recent Goldman Sachs​ report, in 1996 Chinese wheat imports accounted for 11 per cent of domestic demand, and 2 per cent of global demand. But with record harvests leading to high stocks in the late 1990s China no longer needed imports to meet domestic demand. In the past two years, China's domestic demand has once again outstripped production, with the Chinese renewing imports. In 2003 the country bought in 3 million tonnes of wheat. Crucially, the Chinese purchase - pulling on diminishing global stocks - sent wheat prices even higher. Despite exporting modest amounts of wheat in 2000, Bell maintains that is highly unlikely that China would pose a threat to other producing countries. "It doesn't make sense for them to produce wheat - they're a demand centre,"​ said the economist. According to Bell, the country has been struggling to supply wheat for the domestic market, a need largely made possible through government support that has kept the prices high. Opportunites for a boost in exports to China could come through the WTO. "Now they are in the WTO (World Trade Organisation) they are under pressure to reduce subsidies on exports. Should they cut support, Chinese wheat imports would surge,"​ said Bell. For the past two years, slices of the food industry have felt a squeeze in margins - notably processors and ingredients companies - as price pressures on wheat were felt and manufacturers continued to tighten the price. If 2003 was tough, 2004 is likely to be tougher, with processors and ingredients companies - unable to ptotect their margins - increasingly passing the price on to customers. For Bell, a key strategy to help processors beat the increasingly volatile wheat market is through risk management and through the use of the futures market. "Risk management provides protection for processors when markets go higher,"​ said Bell. Uncertainty in today's climate is exacerbated by the lack of a 'buffer zone' for wheat - the security blanket of wheat stocks. There is no guarantee that production will be lifted in 2004, so what happens then? With no stocks to fall back on, prices will soar. "Processors can tackle volatility by buying protection. They have two options,"​ proposed Bell. Firstly, they can buy forward at a set price on the futures market (LIFFE in the UK, for example) or secondly, they can buy an option from a broker. In broad terms, the second option provides the buyer - who pays a premium on a calculated risk - with an insurance policy. For Bell, the clear advantage with this second option is in the flexibility - particularly pertinent when dealing with a volatile market like wheat. Essentially, the processors buy at a market price, say £86, and with the insurance from broker, for example £6, the maximum total is £91. But should the market price drop to, say, £65, even by paying the additional £6 premium, the processor is in a stronger position than if they had opted for buying wheat at a fixed price on the futures market. According to Bell, the Europeans, currently shy of the futures market, must turn to this method to cushion volatility and provide stability to revenues. "The US has massive liquidity - last year wheat production was traded up to 20 times the tonnage actually produced,"​ said the economist. By comparison, in the UK, about 60 per cent of the total was traded. "The US model is the model for the future,"​ claimed Bell. Although a guaranteed minimum price from the EU means the market has a 'bottom', there is nothing to stop prices going much higher, to $200-$300 levels. "It is open to unlimited risk,"​ said Bell. Is the futures market an answer to minimising this risk ?

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