Kub's Den

Protein: The Saving Grace of 2018 Wheat Spreads

Elaine Kub
By  Elaine Kub , Contributing Analyst
Compared to the futures spreads, the cash markets tend to reflect more extreme discounts or premiums for hard red winter wheat versus hard red spring wheat. (DTN ProphetX chart)

The U.S winter wheat harvest has officially passed its halfway mark, according to the Sunday night observations accumulated in the weekly Crop Progress report from USDA. But in the western states where hard red winter wheat is grown, we might consider harvest to be somewhere around the three-fourths mark, with Oklahoma effectively done, Kansas at 71%, combine crews just starting to roll north into Nebraska, and Colorado 21% harvested so far. Thunderstorms keep interrupting the region's progress, but the forecast calls for things to clear up eventually. South Dakota, Montana, Idaho and Washington will all start to contribute their newly harvested HRW bushels sometime later this month.

That all sounds nice and orderly, but actually, the cash bids for HRW coming to market in Kansas and Oklahoma were anything but calm and collected during the last half of June. There is a 23-cent carry between the September and December KC wheat futures contracts, so grain companies are highly motivated to gain ownership of HRW bushels, fill their bins and store the grain to collect that carry. The only trouble is: After a dry and challenging growing season, there doesn't seem to be enough of the stuff to go around. Originators are experiencing fierce competition trying to attract relatively scarce bushels.

Looking at all the cash bids collected daily by DTN, the average basis for HRW bushels this week is only 21 cents under the September contract, which is astonishingly strong for a time of year when elevators would usually be experiencing an overwhelming crush of incoming grain, called the "gut slot" of harvest. That nationwide average takes into account a bid of 24 cents over the futures price at Catoosa, Oklahoma, plus a spattering of smaller "overs" south of Wichita, Kansas, plus the usual mix of 15 cents to 50 cents under out in western Kansas, Colorado, and Nebraska where more trucking will be involved before the wheat reaches any flour mill. Back when the elevators were bidding off the July contract, nationwide average HRW basis almost became positive. The DTN HRW Index, an average of cash prices collected around the country, was only 2 cents under the closing July futures price on Tuesday, June 26. Unheard of at harvest time!

Of course, the actual flat prices aren't particularly strong or exciting for U.S. wheat producers this year. Wheat futures markets have been dragged down by global economic worries, just like the row-crop markets, and the average flat price received by a farmer selling HRW this Monday was only $4.50 per bushel. That's a little better than the cash prices seen during the past couple of harvests, but it's about $3 per bushel less than the opportunities from the last time the Southern Plains harvested wheat after a major drought, in 2014, when Kansas wheat yields averaged only 28 bushels per acre.

Expressed in relationship to the average cash price for hard red spring wheat, the other U.S. wheat variety used in many of the same milling applications as hard red winter wheat, this year's HRW prices are perfectly in line with expectations. Over the past decade, KC wheat futures contracts (derivatives of the deliverable cash market for hard red winter wheat) have tended to be priced at a 10% discount to Minneapolis wheat futures contracts (derivatives of the deliverable cash market for hard red spring wheat). The HRW-to-HRS relationship fluctuated anywhere from a 35% discount (last July) to a 7% premium (in 2014). But the current ratio, with KC wheat futures at $4.83 and Minneapolis wheat futures at $5.34, is exactly in line with expectations. The cash market reflects the same spread relationship: The DTN HRW Index at $4.50 Monday was just 11% below the DTN Spring Wheat Index at $5.04.

It all comes down to protein.

Why was HRW so cheap compared to HRS last summer? The 2017 HRW crop from the Southern Plains was characterized by beautiful yields -- 57 bushels per acre, on average, in Kansas -- but relatively poor protein. The average protein level observed in Kansas wheat samples last summer was only 11.7%, the lowest since 2009. Accordingly, the cash discount for 11% protein wheat under 12% protein wheat grew wider than $1.20 per bushel at the peak of harvest when merchandisers were scrambling to source the correct blend of wheat to sell to their milling customers.

Why was HRW so expensive compared to HRS in 2014? That HRW crop actually exhibited the highest protein level since 2006. An average of 13.4% protein was observed in Kansas wheat samples from 2014. There isn't an exact, predictable, linear relationship between average Kansas wheat protein levels and the KC-to-Minneapolis wheat futures spreads, but it is true to say that in every marketing year since 1988, whenever average Kansas wheat protein levels were disappointing (below 12.0%), the KC wheat futures price always maintained a discount to spring wheat. And in the marketing years when average Kansas wheat protein levels were impressive (above 12.0%), there was a greater likelihood that KC wheat futures would tend closer to the Minneapolis spring wheat futures price.

In 2018, most anecdotal harvest reports suggest that Kansas wheat protein levels are running right in line with the 12.0% protein expectation, on average. So, protein levels are right in line with historical expectations, and futures spreads are right in line with historical expectations. The markets are efficiently reflecting all the known information, just like magic.

Elaine Kub is the author of "Mastering the Grain Markets: How Profits Are Really Made" and can be reached at elaine@masteringthegrainmarkets.com or on Twitter @elainekub.

(AG/BAS)

Elaine Kub