Oil and wheat driven by similar forces

by Morton Sosland
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After years in which drawing parallels between the forces affecting wheat and crude oil prices was considered a bit of folly, it is remarkable to realize how this relationship has been transformed by recent events. Now, studying supply-demand projections for crude oil provide telling insights into wheat’s performance, and it is likely that the same is true for the way oil markets probably reflect forces similar to wheat. This is massive change from the situation a short time ago in the grain industry when the dominant view was not just that the forces in the two markets were different, but that mixing the two could produce wrong conclusions.

It was not until processing of grain into motor fuels introduced a new and significant demand force for corn and soybeans that fluctuations in prices of gasoline processed from oil were cited as affecting the volume of grain used. This seemingly direct connection between oil and grain markets had, when it came to price analysis, the same fault as had ruled previously, of studying exclusively forces on the demand side of the supply-demand equation.

Determinants of the use of wheat for food and corn for feed are not the same as for oil, causing the separation that lasted until the start of the new century. While oil use could be affected dramatically by governmental decisions on fuel economy, or by rationing or by the exercise of cartel power, wheat food use was much less susceptible to similar initiatives. Rising incomes suddenly have made demand for both oil and wheat reflect the same forces, centered on the failure of demand to respond to prices. Use has hardly declined in response to record high prices, and expanding use of grains for making ethanol has tied these two together almost as tightly as wheat once related to corn.

While it’s still correct to note that production of wheat and crude oil — one a renewable crop grown and harvested annually and the other a resource being drained from a finite supply — is very different, even here the two have expanding commonality. For example, the global warming issues that once were the exclusive province of converting oil into gasoline and using it for fuel are increasingly factors in wheat.

Inventory levels, essential to supply analysis, are critically important for both. This season the ending wheat stock is projected to be the smallest in years, especially in relation to use. In the case of oil, the International Energy Agency has acknowledged that its data about inventories and production decline rates have been less than accurate. This has prompted a rush to develop new data that will provide a meaningful basis for forecasting when oil production may peak. These possibilities relate to questions asked about the globe’s food production capacity.

The chief economist of the I.E.A. made a comment ringing true for wheat. He said the agency and many in the oil industry "had been placing a lot of emphasis on oil demand, which is wrong. Supply factors should be looked at more closely." This search for new data on oil has been hindered by the absence of transparency when it comes to knowing not just the natural decline rate of producing oil fields, but also having a realistic appraisal of the pace of new discoveries. Understanding the potential for increasing wheat outturns to keep up with expanding food and industrial demand faces similar obstacles.

The I.E.A. action in seeking to assemble new oil data is no different from the International Grains Council moving to discover the reality of global grain stocks. If the outcome for oil proves at odds with the existing series, the result will be worrying. Downward revisions in discoveries or upward revisions in decline rates mean global oil supplies will peak much sooner than has been expected. A similar finding on wheat, to be sure, would have an equally chilling impact on market prices.

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