Care needed when basking in lower wheat prices

by Morton Sosland
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As tempting as it may be for all involved in milling and food processing to express unmitigated pleasure with weak wheat prices, anyone so inclined ought to consider how the declines have already affected plantings for the 2009 crop as well as longer-range production prospects. While such warnings might seem unnecessarily cautious in light of the horrific experiences early in 2008 when wheat soared to record highs, 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 stage for the recent fall in wheat acreage in both developed and developing regions. Further, these problems were accentuated by a brief spurt of farm prosperity in the 1990s that was followed by another bust.

In light of the performance of wheat, corn and soybean prices in the past year or so, it is no surprise that cropland in many countries has increased dramatically in value, and that this has given rise to concern about another bust. After all, the collapse of housing and credit markets, which is seen as classic bubble bursting, is often cited by those worrying about farmland. A study undertaken by the Federal Reserve Bank of Kansas City examines 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 to earlier booms that saw debt increasing to exceed farmland values. While avoiding a forecast of continuing booms, 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 global wheat-based foods business.

Achieving proper balance between market prices for the major grains and the cost of production requires a combination of outcomes that differs from recent experience. In the case of wheat, the Federal Reserve study uses a baseline price forecast of $5.40 per bushel ($201 per tonne) as the average for the period from 2008 through 2017, and it assumes production costs rising 2% annually. Under a low-price scenario, the wheat price for the next decade would average $4.20 per bushel ($157 per tonne), while a high-price scenario would have wheat at $7 ($261 per tonne). A high-cost scenario involves annual 4% 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%. 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 both 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 the importance of grain-based foods companies around the world collaborating with producers in finding ways to reduce costs, such as embracing new seed and growing technology, as well as building domestic and global markets for wheat foods.