IMF Survey: Wheat Price Jump a Supply Shock That Should Unwind
September 1, 2010
- Wheat price spike driven by weather-related supply shock in key exporters
- Projected decline in global wheat production is biggest for 15 years
- Wheat production should recover quickly in 2011, assuming normal weather
Despite a large rise in the two months to August, wheat prices remain well below levels reached during the boom in 2008 and market pricing indicates that the risks of further large price spikes have eased.
WHEAT PRICE SPIKE
The spillover from wheat to other food prices, in the absence of further large output revisions, should be limited by the temporary nature of the shock, ample wheat inventories, buoyant harvests for other major crops, and relatively stable energy prices. Upside risks include a more widespread supply shock driven by global weather patterns and protectionist government interventions.
Wheat prices spiked almost 85 percent higher in the two months through early August, reawakening concerns about a broad-based surge in food prices. The wheat price spike has been driven by a weather-related supply shock emanating from key exporters in the former Soviet Union.
The catalysts for the wheat price increase were reports of adverse weather conditions in key producers. Specifically, drought conditions and wildfires in Russia and Kazakhstan, together with the cumulative impact of heavy rain in Ukraine, led to significant downward revisions in global production estimates.
For the harvest year ended in June 2010, Russia, Kazakhstan, and Ukraine accounted for about 15 percent of global wheat production. Weather conditions also led to more modest downgrades in the estimates for Canada and the European Union.
Lower global harvest
Over the past two months, the estimated global wheat harvest for 2010–11 has been revised lower by 23 million tonnes or about 3½ percent. This would represent an annual decline in global production of just over 5 percent, with Russia and other former Soviet Union countries accounting for about three-fourths of the total decline.
This projected decline in global production is the largest for 15 years, but within the range of historical experience. Over the last 50 years, the global wheat market has experienced eight declines in global production of at least 5 percent.
International trade in wheat will likely contract this year, in part due to the imposition of export bans by some countries hit hardest by the supply shock. However, some of the shortfall is expected to be compensated by increased exports from the United States, the European Union, and Australia.
Global wheat exports are expected to decline by about 8 million metric tonnes, or 5 percent on an annual basis. Declines of this magnitude have been experienced relatively frequently since 1960 and, as with production, are often followed by a recovery in volumes.
Wheat production should recover quickly next year, assuming a return to more normal weather conditions. Global wheat inventories are larger now than in 2006–07 and should be sufficient to absorb a large part of the supply shock.
Current market pricing—specifically, more modest increases in futures prices as compared with the large increases in prices for immediate delivery—indicates that the wheat supply shock is anticipated to be temporary. Markets have also priced in a modestly reduced risk of further extreme upward price spikes over the next 9–12 months.
Spillovers to other food commodities from the wheat price shock have been limited. The price response from other major crops, including potential substitutes such as rice and corn, has been relatively modest, with few signs of the broad upward price pressures observed during the boom of 2007–08.
The potential for spillover from wheat prices remains limited, going forward, due to the temporary nature of the wheat supply shock; expectations for buoyant harvests in other major crops; and stable energy prices, which can affect the costs of production and biofuels demand.
Food markets will remain vulnerable to more widespread supply shocks given still low levels of inventories, with the notable exception of wheat. Buoyant harvests for major crops this year should help to begin the process of rebuilding stock buffers that declined significantly during the 2000–05 period as demand growth outpaced supply.
Crops for which inventories are significantly below their long-run average levels include corn, millet, and sorghum, which together account for about 15 percent of the world’s total harvested area. Until these buffers have returned to more normal levels, food markets will continue to remain vulnerable to more widespread supply shocks that affect many crops directly.
One risk on the horizon is the global La Nina weather pattern, which has affected crop yields in previous years. Also, as has been evident in recent weeks, policies that restrict international trade in food commodities can exacerbate price volatility and lead to greater uncertainty and instability in food markets.