Wheat prices: The top 10 most important drivers

1) Energy costs

Higher energy costs imply higher costs of production for wheat and higher costs of transporting wheat to market. Energy makes up a significant part of operating costs for most crops. This is especially true when considering indirect energy expenditure on fertiliser because the production of fertiliser is extremely energy intensive, requiring large amounts of natural gas. For some crops – including wheat – the combined cost of energy and fertiliser make up more than half of the total operating expenses in the US.

2) Income growth

Rising incomes drive greater wheat consumption, particularly in developing countries where caloric intake is more responsive to income growth. Moreover, consumers in developing countries adjust their diets in response to newfound wealth, eating proportionately more meat and less grain. This change in diet diverts grain to animal feed use. Around 15%-20% of wheat production is used for animal feed.

3) Weather

The weather has a significant impact on crop yields and thus overall agricultural production. The wrong type of weather at the wrong time in the planting cycle, even if not prolonged or extreme, can also adversely affect the production of certain crops.

4) Substitution effect

Because wheat and other grains are close substitutes an increase in the price of corn for example could lead to a corresponding rise in the price of wheat. If the price of corn rises too far then farmers begin to switch from wheat to corn, reducing the supply growth of wheat. Meanwhile consumers might switch in the opposite direction increasing their demand for the relatively cheaper wheat grain.

5) The US Dollar

Like most internationally traded commodities wheat is priced in US dollars. At its most basic a decrease in the value of the US dollar relative to a commodity buyer’s currency means that the purchaser will need to spend less of their own currency to buy a given amount of the commodity. As the commodity becomes less expensive demand for the commodity rises, resulting in an increase in the price and vice versa.

A weaker dollar can also act as a disincentive to producers to increase output. For example, a depreciation of the US dollar against the Ukrainian hryvnia can reduce profit margins for a wheat farmer in the Ukraine. All of the farmer’s revenues will be received in US dollars, which will now buy less hryvnia, but some proportion of the costs will be denominated in hryvnia and will remain constant (at least in the short term). Therefore, the prospect of a lower profit margin acts as an incentive to decrease the supply of wheat.

Wheat prices have a relatively high inverse correlation against the dollar of around -0.55.

6) Stock levels

Stocks (otherwise known as inventories) act as form of buffer for both producers and consumers of wheat. Typically, falling stock levels occur if demand increases faster than supply, resulting in higher wheat prices. Falling stock levels may, however, make the wheat market more vulnerable to an unanticipated disruption to supply or a sudden increase in demand.

7) Government intervention

Given wheat’s position as one of the most important sources of food, the governments of economies – both developed and developing – may look to restrict the supply of wheat (or stockpile it) with the aim of supporting domestic farmers or consumers or both.

Governments may also restrict exports of certain essential foodstuffs, often when the fear of domestic shortages and / or high prices is greatest. In 2010 Russia and Ukraine imposed wheat export restrictions in order to maintain domestic prices at a lower level and ensure availability. However, such action typically just makes the situation worse. By reducing the amount of wheat available to the global market prices are likely to increase further.

8) Expectations

If wheat farmers expect high price then they will plant more wheat relative to other crops in the following year. When the farmers then go to market with the second year’s harvested crop, supply will be high, resulting in a drop in the price of wheat. And so it goes on. If farmers then expect low prices to continue, they will reduce the planting of wheat for the subsequent year, resulting in a return to high wheat prices yet again

9) Speculation

During the spike in food prices around 2010-12 attention centred on the role of speculators, arguing that unprecedented buying pressure from new financial index investors had created a massive bubble in the price of wheat and other agricultural commodities. Although there is limited evidence to support that theory speculators do play an important role in the wheat market, by signalling to the market future shortages or gluts and taking on risk from farmers looking to hedge future wheat production.

10) Transportation

High cost and unreliable transport and / or poor logistics can affect the supply of wheat, even if the harvest has been good. Given that wheat is exported from a number of large producers (Russia, Ukraine and Australia to name a few of the largest) delays in getting wheat to storage and then poor handling can result in the crop spoiling, reducing the potential crop that can reach the market.

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