Being careful about wishing for wheat prices

by Morton Sosland
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As tempting as it may be to wish for continued weakness in wheat, and thus a further lowering of wheat flour costs, anyone so inclined is advised to consider how the market may have already affected plantings this autumn for the 2009 crop as well as similar longer-range prospects. While this admonition may seem overly conservative in light of experiences early in 2008 when wheat and flour prices soared to records, the apocryphal warning to be careful about what one wishes for, comes into play here. It doesn’t require much background to recall the 1980s farm collapse and how it set the foundation for the recent fall in wheat acreage. Further, these problems were accentuated by brief farm prosperity in the early 1990s that was followed by another bust. These booms and busts for agriculture have directly impacted the supply of wheat.

In light of the performance of wheat, corn and soybean prices in the past year or so, it is no surprise that farmland increased dramatically in value, and that this has given rise to concern about another bust. After all, the collapse of the housing and credit market, which is seen as classic bubble bursting, is often cited by those worrying about farmland values. A study undertaken by the Federal Reserve Bank of Kansas City asks whether these values will keep booming. This question reflects a degree of optimism stemming largely from the low level of debt assumed by farmers in response to crop prices, in contrast with earlier booms that saw debt growing to exceed farmland values. While avoiding a forecast of continuing boom in cropland, the study relies on the modest debt level and a stable price outlook to see current values maintained. That would also be a favorable outcome for the wheat-based foods business.

Achieving the proper balance between market prices for the major grains and the cost of production requires a combination of outcomes that is vastly different from recent experience. In the case of wheat, the study uses a baseline price forecast of $5.40 per bushel as the average for the period from 2008 through 2017, and it assumes production costs rising 2 per cent annually. Under a low-price scenario, the wheat price for the next decade would average $4.20 per bushel, while a high-price scenario would have wheat at $7. A high-cost scenario involves annual 4 per cent advances.

Various combinations of these price and cost scenarios are examined. So far as the sharp value rise of the past year is concerned, the study finds it supported by expected profits. Going forward, though, the low price scenario on wheat and the high cost outlook would make wheat farming unprofitable. In the 1980s, prices fell a third from highs and production costs soared at an annual rate of 5 per cent. The same happening currently in corn and soybeans would slash profits, but would leave both crops profitable. The impact of such a development on wheat would be magnified because "energy-based inputs — fertilizer, fuel, chemicals — account for a larger portion of variable production costs for wheat than for corn and soybeans."

In analyzing the risk of low wheat prices and high production costs, the Federal Reserve warns that farmers will not endure negative returns perpetually. It says, "Producers would slash wheat production and plant alternative crops, and the resulting decline in wheat supplies would boost wheat prices and support higher profit levels." It also notes that a situation where wheat production costs exceed revenues would cause downward pressure on the value of land used to grow wheat. There is nothing favorable about such an outcome. Yet, even contemplating these possibilities underscores how important it is for grain-based foods to collaborate with producers in finding ways to reduce costs, such as the embrace of new seed and growing technology, as well as in building domestic and global markets.

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