Bracing for the next grain drain

August 13, 2010, 9:49 PM UTC

Chances are, we haven’t seen the last of spiking grain prices.

The price of wheat for December delivery surged as much as 60% in the past six weeks, as a severe drought slashed production in Russia and other Black Sea nations.

Riding the grain elevator

Prices have since eased a bit, and the government has been stressing there is no grain shortage, hoping to avert the mayhem spurred by the last commodity price spike two years ago.

Still, growing demand for agricultural commodities like wheat, corn and soybeans leaves the world vulnerable to further weather-related price shocks, and potentially to food shortages, over the next two years.

“The question is, what kind of crop will we have next year?” asks Jerry Gulke, a grain farmer who runs a Chicago-based brokerage firm. “A drought now just increases the pressure on the next harvest.” 

Since 2006, demand for so-called coarse grains such as corn and oats has shown “uninterrupted growth,” said Dan O’Brien, an agricultural economist at Kansas State. Use of wheat and soybeans has risen as well.

That has raised prices for these grains, used in food for human consumption as well as animal feed and other products, as steadily rising demand met with supply that can vary substantially depending on rainfall and temperatures down on the farm.

“We have seen at least moderate trend growth in use, and that growth has been steadier than production,” O’Brien said. “The weather has a lot to do with that.”

For now, filling the gap left by Russian exports stands to be lucrative for U.S. farmers in coming months. But it will also run down the stores that farmers have built up, meaning that a poor harvest in a big producer next year could send prices soaring again.

“Some combination of dry weather conditions in the Black Sea region, Europe and Canada could have a marked affect on world wheat supply-demand balances and prices,” O’Brien wrote this month in his market outlook. “Similarly, a shortfall in either U.S. corn or soybean production in 2010 would likely have major impacts on world markets for those commodities.”

The silver lining is that yields, the amount of grain farmers can expect to harvest from an acre, have been rising. Rising farm productivity, along with grain users’ habit of substituting corn for wheat and vice versa when prices get out of line, tends to keep a lid on prices.

What’s more, higher wheat prices don’t translate immediately into $5-a-loaf bread, even if food companies do like to blame raw material costs for price hikes.

Since the end of June, the price of a bushel of wheat has jumped as high as $8 from $5. But even a sustained rise in wheat prices would add just pennies to the cost of a loaf of bread.

O’Brien notes that a bushel of wheat translates into 42 pounds of wheat flour that can make 73 loaves of bread. Using that math, the recent price spike, if sustained, would have added just 4 cents to the cost of a loaf of bread.

A bigger driver of the 2008 mayhem that included global food riots, O’Brien notes, was the spike that took crude oil to $147 a barrel that July. That’s about twice the recent oil price.

“The transportation costs are a big factor,” he said. “Right now oil isn’t going gangbusters, so it doesn’t look like we’ll get caught short on bread this year.”

Further muting the impact of the price spike, many food companies use futures to put a lid on their production costs, which will limit how hard they are hit by current price increases.

Even so, insistent demand and uncertain supply will combine in the next year to make harvest time a bit more anxious.

“The world is getting the message that the pot isn’t big enough,” said Gulke.