At a Glance
- Global oversupply has dragged down wheat prices
- More countries exporting to fill Asia demand
The 2016/17 record wheat harvest in Australia comes at a time when the market is already awash with grain, and wheat producers the world over are grappling with depressed prices. However, a combination of recent serious weather incidents, a dramatic cut in wheat acreage in the United States and challenging growing conditions in Western Australia are eating away at global inventories and can erode the oversupply glut that has gripped wheat markets for years.
Despite a record year in 2016/17 which saw 45 percent year-on-year increase in wheat production, drought concerns suggested by the Australian Bureau of Meteorology’s latest statement doesn’t project a promising outlook for the coming crop. A recent report has lowered its forecast for Australia’s wheat production to 23.3 million metric tons, for the period of October 2017 to September 2018.f
Sharp price rallies in late June/early July were welcome ones for farmers, who have been battling anemic wheat prices for years. Nevertheless, several factors continue to collude to keep wheat prices in a downtrend.
The first one is that wheat is a relatively resilient crop. It has a high capacity for adoption to different climates and soil types. This means that, unlike other cereal markets whose production is more localized — making them more sensitive to adverse weather patterns and poor harvests — the wheat market is well-equipped to withstand shocks purely by sheer geographical diversification.
Because of these characteristics, the crop has also proved attractive to planters, resulting in a steady increase in global wheat production over the past decades.
Most of this increase in production is seen in wheat producing countries such as Ukraine, Russia and the E.U., who continue to ramp up production, adding to the oversupply and dragging global wheat prices further down in the process.
In the face of persistent low wheat prices, some wheat farmers have been tempted to diversify their crops into more profitable ones. But while crop diversification could theoretically help alleviate the excess supply, the reality is that until now the process has done little to reverse oversupply in the wheat market.
The emergence of biofuels, produced from soybean and corn, as an alternative energy resource could perhaps alter the supply dynamics of the wheat market in the long run. As countries seek to become energy self-sufficient and wean off their reliance on traditional fossil fuel, some will look to increase acreage dedicated to corn and soybeans, at the expense of wheat acreage. But here again, it could be a while before the effects are felt across the global wheat market.
India could also contribute, albeit modestly, to the erosion of the supply glut. The country, the second largest wheat producer globally, has for the better part of the past 30 years been able to produce and stock enough grain to feed its population. At times, however, it has had to import large quantities of grain from Australia, Russia and Ukraine in years when its harvest was affected by hot and dry weather conditions. With weather patterns becoming increasingly unpredictable, India could provide the sort of demand needed to reverse the glut.
Asia Demand Rises
Until then, Australian wheat farmers will have to come to grips with profound changes in the global wheat market, as well as contend with the emergence of new grain export powerhouses.
In the face of surging stockpiles, some wheat-producing nations have turned to Asia as a new source of demand, where wheat consumption is on the upswing. As a result the share of Australian wheat, which still accounts for about half of Southeast Asia’s wheat imports, has been declining.
While Australia still provides almost 50 percent of Southeast Asia’s wheat imports, other large suppliers including the United States, Canada and Ukraine have over the years been making headway into the region, and now account for roughly 42 percent of the region’s imports. Countries like Indonesia already purchase large quantities of wheat from Ukraine, even though Indonesia is geographically much closer to Perth than it is to Kiev.
In 2015, Russia, once the largest importer of wheat, overtook U.S. wheat exports for the first time. However, the U.S. reversed this in 2016, retaking the top spot from Russia, in part due to the rouble strengthening almost 18 percent, which is making Russia’s grain less attractive to its buyers worldwide.
Aussie Dollar Falls
Foreign exchange fluctuations thus have a dramatic impact on exports. Wheat farmers Down Under know it too well, and many have the Australian dollar firmly in their sights. Observers argue that the weakening of the Australian dollar against the U.S. dollar over the past years has kept demand for Australian wheat artificially strong, and that Australian wheat farmers will feel the pinch and lose more ground should their currency strengthen against the dollar.
For now, however, CME Group’s senior economist Erik Norland expects the Australian dollar to continue to weaken in response to largely anticipated interest rate hikes in the U.S. later this year, which may continue to buoy demand for Australian wheat. Any strengthening of the Australian dollar down the line, conversely, has the potential to send wheat buyers looking elsewhere.
To navigate the current supply glut, some Australian farmers have also been ramping up on-farm storage capacity, in the hopes of being able to capture seasonal price increases. Grain storage, however, comes at a significant cost, especially in drought years, which will need to be factored in by wheat producers
New Risk Management Tool
There are perhaps other sustainable risk management strategies available to them. CME Group recently launched a U.S. dollar denominated Australian Wheat FOB futures contract, which aims to give farmers a platform to manage their risks, while other market participants can now take exposure to export prices of Australian wheat without having to take physical delivery.
Given the changing dynamics of global wheat, it’s a solution worth considering for producers looking to navigate the increasingly competitive waters of global wheat.