Oil or Wheat…




If you ask most people, even those involved in commodities markets, what is the most political raw material that trades on the futures exchange, I bet most would answer that it is crude oil. More than half the world’s oil reserves are in the Middle East, which is the most politically turbulent region in the world. Crude oil is a ubiquitous raw material that provides energy around the globe.


Meanwhile, over past decades the international oil cartel, OPEC, has attempted to influence prices by controlling the amount of the energy commodity that flows from wells and is available to consumers all over the earth. We have seen examples of how the leading oil producers have banded together to cut back on output or flood the market impacting supplies over past decades. At times, they have used a dominant position in producing oil as a potent economic weapon. Therefore, crude oil is a highly political commodity, but I would argue there is another that has an even higher profile.


Wheat is the essential ingredient in what is perhaps the most critical foodstuff on earth, bread. Shortages of wheat throughout history have caused starvation and political upheaval. There are so many examples from history of how shortages of bread have resulted in uprisings that overthrew sitting governments. Most recently, the Arab Spring in 2010 commenced as a series of bread riots in Tunisia and Egypt because of shortages of the grain. However, over recent years, availabilities of wheat have been sufficient to meet worldwide demand. The politics of wheat seem to emerge during deficit markets, but a glut means lots of full stomachs and cheap availability which leads to contentment.


Arab Spring in 2010 was not just the result of higher bread prices as discontent in many countries across North Africa, and the Middle East had been suffering from resentment for years. However, the trigger for the event that deposed leadership in some countries was a spike in the price of wheat. In 2008 wheat futures rose to an all-time high of $13.345 per bushel has many producing areas of the world suffered from drought conditions devastating crop yields.


Wheat fell back to earth reaching a low of $4.2550 per bushel in June 2010 as growing conditions improved, but it took a long time for prices and availabilities to recover in the years following the drought. The last time we witnessed a spike in the price of the grain was in 2012 when another drought gripped the United States and other growing locals.


Wheat prices once again moved to the upside in 2012 when they peaked at $9.4725 per bushel in July of that year. While wheat did not climb to levels seen in 2008, corn and soybeans rallied to all-time peaks that year. The United States is the world’s leading producer of corn and beans, but only one of many producers of wheat around the world.


In fact, 2017 was the fifth straight year of bumper wheat crops. When it comes to the global supply and demand equation for the wheat market, inventories have been building and record production has remained steps ahead of increases in global demand.


Russia is a mineral-rich nation and the second largest producer in the world of crude oil with over ten million barrels of output each day. Russia is a significant player in the politically sensitive crude oil market, but they have also become a leader in the production of the world’s most political commodity, wheat.


When the Russians banned imports of some western foodstuffs in the wake of sanctions because of the annexation of Crimea, they increased domestic production of wheat. Excellent growing conditions over recent years has allowed Russian farmers to reinvest in better seeds and farming equipment and the country began to grab export market share from other major producers like the United States. Today, about half the countries around the world import Russian wheat. Some of the most prominent buyers are in the Middle East where Russia can offer lower prices than the United States, the traditional supplier. It is cheaper to ship Russian wheat to Egypt, Turkey, and points in the Middle East and North Africa because the travel time is less leading to a logistical advantage for the Russians when compared to shipments from the United States.


In 2017, Russian shipments of wheat to Turkey were up more than 40% from the level three years ago. Aside from lower shipping rates, bumper harvests have increased Russian supplies.


In 2001 Russia had less than 1% of the world’s wheat export market, and in 2017 that number has jumped to around 18%. Russian wheat often does not meet some of the strict import quality requirements of some nations. However, for the price-sensitive importer, the Russians have become a go-to source for their wheat needs. The Russians have had less luck in other agricultural commodities when it comes to increasing exports. In the sugar market, the nation is not equipped for large-scale exports as it does not do a job shipping in containers which is the preferred method for transporting sugar.


In the corn market, the Russians have banned GMO seeds which make corn production more profitable in other producing countries. When it comes to animal protein exports, widespread African swine fever in Russian export regions have stood in the way of significant pork exportation. However, Russia is now the world’s leading exporter eating away more of the United States’ share of the market each year. And, in Russian and the rest of the world, 2017 was a bumper year for wheat production.


In their November World Agricultural Supply and Demand Estimates report, the United States Department of Agriculture (USDA) told markets that:

Global 2017/18 wheat supplies are down fractionally with decreased beginning stocks but increased production. Global production is raised 0.8 million tons led by a 1.0-million-ton increase for Russia and a 0.5-million-ton increase for the EU on updated harvest results. Partly offsetting is a 0.5-million-ton decrease for Pakistan. Exports are raised 0.6 million tons with the United States and Russia up 0.7 million, and 0.5 million, respectively. Australia exports are lowered 0.5 million. Global use is raised fractionally this month. With supplies decreasing and total use increasing, ending stocks are lowered 0.6 million tons but remain record large.


The USDA increased Russian output and while they lowered ending stocks by less than the increase in Russian production, stocks “remain record large.” The bottom line is that there is plenty of wheat around this year to meet the world’s requirements and there are not likely to be any coups or revolutions over the high price of bread. However, each year is always a new adventure in the grain markets, and even though Russian influence in the market has grown, the countries growing areas are not immune to future droughts, crop diseases or other issues that could impact yields. The world has become accustomed to bumper crops, and memories of sky-high wheat prices in 2008 and 2012 have faded in the market’s rearview mirror.


Over the past five years, with the price of the grain making lower highs and lower lows, consumers have become hand-to-mouth, and hedging activity has declined compared to demand.


Increasing demand for demographic reasons has been a constant in the wheat and all grain and foodstuff markets.


Global demand for all food is rising alongside population. In 1960 there were approximately three billion people on the earth and today that number is up over 7.4 billion. At the same time, living standards are getting better around the world. The traditional rice-based diet in Asia has been changing to include more complex proteins and grains. While technological advances in farming and crop production have increased yields, increases in population and wealth have led to dependence on bumper crops each year. We saw what a poor crop could do to prices 2008 and 2012, and it is only a matter of time until weather or crop disease once again results in a poor harvest that will cause prices to take off to the upside under the weight of demand. Record inventories of wheat weigh on the price in 2017, but demand is also at a record level in the wheat as well as many other agricultural markets.


The next time we get a poor harvest in a critical producing area like Russia, the United States, or any of the other countries around the world that produce the marginal bushel for export each year, watch out on the upside. Wheat is one of the two most political commodities in the world, and I still believe it holds the top spot as bread is a necessity that takes precedence over most others, including energy. Record wheat stocks are weighing on prices after the 2017 harvests. However, 2018 is right around the corner and with it comes another year that will not necessarily be the sixth straight year of bumper crops.


By Vasko Nachev

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