Even though weather risk remains in corn this year, the ethanol boom that had driven prices higher since late-2006 is over and prices are now likely to find a new, lower trading range in the next few years, I explained in "Understanding Today's Corn Market."
The corn market that needed more acres in 2006 to produce larger amounts of ethanol now has them and is able to again produce more corn than the market needs, weather permitting. Wheat, on the other hand, is at the other end of the production cycle and will need higher prices in the next couple of years to keep up with demand.
In general, the history of grains is best understood as an unorganized effort to guide production decisions in a way that keeps supplies available for the needs of a growing world population. Price is the driving mechanism for those decisions and typically cycles high when supplies are low and then fall back lower again when production increases and supplies become more abundant.
Because world wheat supplies grow over time with growth in the world's population, a nice way to measure and compare supplies over different decades is through the use of the ending stocks-to-use ratio. Over the past 20 years, the average ending stocks-to-use ratio for world and U.S. wheat has been 29%. Ratios below 29% typically bring about higher-than-average prices to encourage production and ratios above 29% typically bring about lower-than-average prices.
However, simply increasing or decreasing production is not always easy. In addition to weighing the economics of various crop choices, a producer also has to consider other factors like climate, soil, costs of taking on additional ground, equipment costs, etc. Of course, after the crop is planted, there is always the additional risk of weather.
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The 1970s were a time of excess in agriculture and the wheat market was no exception. Record farm incomes, a surge in exports, and a mass belief in perpetual inflation led to the optimism that sent planted wheat acres to their peak of 88.3 million in 1981.* The bad timing of that expansion soon became apparent and, in 1985-86, U.S. ending wheat stocks totaled 97% of annual use, far more than the market needed.
Since the 1981 peak, U.S. wheat acres have declined steadily and, in 2013-2014, USDA estimates 56.53 million acres were planted to wheat, near the lowest total in 40 years. Today, the U.S. is not producing enough wheat. If current USDA estimates are correct, 2013-2014 will mark the fourth consecutive year that U.S. wheat production has fallen short of total use.
USDA currently expects ending wheat supplies of 551 million bushels or 23% of annual use. The estimate is below the 20-year average of 29%, but still comfortable enough to keep potential buyers from worrying about a lack of supplies yet. Wheat prices are currently low, thanks to influence from this year's falling corn prices and favorable reports of wheat crops around the world.
In May, USDA estimated it will cost $303.58 an acre to produce wheat in 2013.** If we divide that figure by 46.2, USDA's current yield estimate, the result is a national breakeven cost of $6.57 for all U.S. wheat. With DTN's National Soft Red Wheat Index of cash prices at $6.03 and the Hard Red Winter Index at $6.78 as of Friday, August 23, there is no incentive to increase wheat acres this fall, so ending supplies of U.S. wheat are apt to decline again in 2014-2015.
Another interesting and bullish aspect to the wheat market is how pessimistic producers (and probably their bankers) have become. Unlike the 1970s, producers are no longer eager to increase wheat acres, even when given the opportunity of higher prices. In 2007, wheat prices scored big gains and were trading above $9 a bushel in early-September when the winter wheat crop was being planted. Wheat plantings did increase almost three million acres that year, but that was a modest response and plantings quickly returned to lower levels after the financial meltdown of 2008-09.
At the time, more corn and soybean acres were needed and, today, more soybean acres are still needed to keep up with growing demand. Lower corn prices, exceptionally good weather conditions around the world, and miserable returns for wheat growers are all conspiring to support a bearish outlook for wheat and prevent an expansion of acres.
However, we don't have to look too far ahead to see even tighter supplies from the current combination of growing world demand and lackluster production. I cannot make guarantees, but it seems fair to say that significantly higher wheat prices are less than two years away.
* U.S. wheat acreage data from USDA's Economic Research Service can be found at http://www.ers.usda.gov/… .
** Commodity Cost and Returns from USDA's Economic Research Service can be found at http://www.ers.usda.gov/… .
Todd Hultman can be reached at email@example.com