High prices, global food insecurity and smaller Russian wheat crops

"With such substantial state intervention, if export taxes stay, the consequences will be very grave for the Russian grain industry"

“I think 2022 could be a more challenging period. We know more or less now how to deal with the COVID. But we have substantially higher prices for food grains, substantially higher wheat prices. While we have strong demand, there are some problems with the supply of wheat in the Northern Hemisphere. We also have some problems with freight and containers…I am afraid that big problems are ahead of us. In real terms global food prices just have returned to all-time highs, as per FAO. We saw similar high food prices at the end of 2010. The Arab Spring started in 2011”

Andrey Sizov
CEO of SovEcon

Adverse weather and drought hit wheat production in North America and Russia. With the concern about shrinking production prospects and tight supplies in the major exporters, wheat prices increased further in September. Importing countries such as Algeria, Turkey and Pakistan have recently bought large amounts of wheat. However,  wheat importers are worried because of the prices. How much will wheat export prices rise? Which factors will drive the markets?

How is the wheat supply outlook for Russia, the world's largest wheat exporter? We asked these questions to Andrey Sizov, managing director of Russian agriculture consultancy SovEcon, one of the most reliable analysts of the grain markets. SovEcon is the oldest research firm focused on Black Sea grain markets providing consistent data and accurate analysis of the region helping funds, traders, buyers and miller to trade better or manage their risks. (More info: sizov.report)

Stating that bad weather and Russia’s wheat export tax affected the wheat production negatively, Sizov expects that Russia will produce 75.5 million tonnes of wheat this season, below-average for recent years. “We also expect a substantial decrease around 1 million hectares decrease of winter wheat because Russian farmers’ margins are falling due to the export tax. I'm afraid if taxes stay, this trend will continue,” he warns.

Also sharing his price scenario for the current season, Sizov expects wheat prices at least 320-$330 per tonne. “We could see prices rallying to as high as $350 per tonne,” he adds.

Mr. Sizov, in your article published in Financial Times on 26th September, you said the Russian government's move to tax grain exports could harm its leading position in the grain market. What are the reasons for this warning? What signs do you see in this regard?

The answer to the first question is relatively simple. We have a very unfavorable setup for farmers currently. The grain prices are being regulated, there is a threshold. It's $200 per tonne for wheat. For barley and corn, it's $185 per tonne. And everything above is being taxed at 70%. So for example, if the FOB price is at $300 per tonne, -like it is now roughly-, it implies that around $70 will be taken out of the farmer's pocket. So, it also implies that farmers receive only 30% of price increase in the global market. So grain prices and also oilseed prices have been regulated heavily (Sunflowers, second cash crop are taxed at 50%!). There is a cap and all major crops’ prices have been regulated. At the same time, input prices are not being regulated. As we see all over the world, fertilizer prices, chemicals and machinery prices…all agricultural inputs are going up and up. Fertilizer prices more than doubled already. This implies that costs are rising fast, but at the same time prices for crops have been more or less fixed. So that's why we expect to see -and I think it's happening already- a fast decrease of margins for Russian farmers. And as a result, it will inevitably lead sooner or later to a decrease in production or to switching towards a crop slide or in some cases they will just cut planted area.

SUBSTANTIAL DECREASE IN WHEAT AREA

As per your second question, what are the indicators? What can we say now? We have relatively modest wheat crop this year. Our most recent estimate is 75.5 million tonnes, which is roughly 10 million tonnes below the previous year. This is already below-average crop for recent years. The biggest reason no doubt is unfavorable weather in the summer, and even in spring in some places, and that held yield substantially because of lack of moisture.

At the same time, we feel that some farmers started to cut ag input applications already this year for this 2021 crop. And that's why yields suffer more than they should. So weather accounts for 80-90% of this decrease but the rest accounts for those problems because of the taxes.

And also we see right now that, we just issued an alert,  we expect a substantial decrease around 1 million hectares decrease of winter wheat, roughly -5% of the previous year. It's based on two factors. One, the weather was very dry, especially in the Volga Valley. Some farmers preferred not to seed anything, afraid that plants won't grow and develop before the winter. But also, I think many of them in the Volga Valley, in parts of the center probably, decided to cut the area because of the taxes because for some of them, margins are already falling despite the historical higher ruble prices.

And I think in some cases, farmers actually could lose money this season, despite high prices because yields suffered as well, especially in the Volga Valley. The weather was bad, it was very dry. One story if you have a yield of three, four, or five tonnes per hectare, but another story when you have a relatively fixed price, and you have less than one tonne per hectare, which for example happened in Orenburg, a large wheat-growing region in the Volga Valley. I think many farmers in Orenburg actually lost money this year on wheat. That's why they are cutting the area for the 2022 crop already. I'm afraid if taxes stay, this trend will continue.

On top of that we would likely see a decrease in inputs application, which implies when the weather is unfavorable, we could see a poor crop. The area is slightly below last year but the farmers started to cut the inputs substantially. So, if we have adverse weather, it could result in a quite unexpected drop in production.

PERMANENT TAXES DESTROY FARMERS' MARGINS

In the FT article, you also talked about the Russian grain industry’s transformation. You mentioned that the factors driving this transformation have changed. What has changed in recent years?

The biggest change is that the government started to mess with the market badly, which is very unfortunate for Russian farmers, Russian traders and importers of Russian wheat, including Turkey.

It hasn't started just one or two years ago, it has been evolving relatively slowly. Our readers remember the Russian wheat exports ban in 2010 but that was temporary. However, starting from this year, we have a permanent wheat tax and other grain export tax. For grains we have permanent taxes and that which will destroy farmers' margins, we already talked about that why it will happen. It's not a question of if this will happen, it is just a question of when this will happen. So and yes with such substantial state intervention, if taxes stay, the consequences will be very grave for the Russian grain industry.

There are some claims that Russia intends to impose restrictions on wheat exports next year. That caused raising fears of a possible drop in supplies globally. Do you expect such a measure? What can you say about the possible effect of such a decision on wheat markets?

Yes, that's what they've been talking about just recently, but it's not really big news. It confirms that the state messes more and more with the market. But compared to the tax, it's not a big story. We've seen those quotas in the previous two seasons. They are very likely to impose that quota again in this season, starting from mid-February.

At the same time, I don't think that is going to be really restrictive. So its effect is likely to be relatively muted. What was more important, when they were discussing that quota, they mentioned that they estimate the Russian wheat exports in the current season at only 31.5 million tonnes. And that's a very low number. That was a pretty bullish number compared to, for example, USDA’s estimate of 35 million tonnes. We estimate exports at around 34 million tonnes and the Russian agriculture ministry says 31.5 million tonnes.

‘WE COULD SEE WHEAT PRICES RALLYING TO AS HIGH AS $350/T

Global wheat prices climbed to their highest since 2013 on expectations of lower output among top exporters. Do you think prices will be even higher? Which factors will drive the markets?

Indeed prices rallied substantially very early in this season, around July and August, and that was driven a lot by the worsening outlook for the Russian wheat crop. Then we see a substantial correction. And now we see pricing pushing higher again if talk about Matif and Chicago. Actually, the Black Sea wheat was around $300 per tonne for many weeks already, and it's gradually pushing higher.

Probably I would say that our basic scenario was that there was definitely some upside left in the market. We could see prices at least 320-$330 per tonne later this season. It's not necessarily going to happen next week, or in a few days, but late in the season, I think there was a good chance that we could see prices around $320-330 for Black Sea wheat with a protein content of 12.5 protein. Potentially, we could see prices rallying to as high as $350 per tonne. I'm not sure about higher prices. But $320-330 is quite a reasonable target.

THE BIGGEST BEARISH FACTOR IN THE GLOBAL GRAIN MARKET

What's driving the market? 

Contrary to the previous season, the wheat market has its own story to tell because the previous season was mainly driven by the corn market. But this time we definitely see some bullish stories in the Northern Hemisphere. Canada has a very poor crop…Russia, quite poorer crop…Strong demand from China... We also see strong demand from many buyers. Algeria just bought about half a million wheat. Pakistan bought half a million and they bought another half million earlier. Importers are worried because of the prices and the freight as well. And they're buying a lot. So we have some supply problems. We have strong demand and the market is rallying. Based on our models, as I said $330, perhaps 350 looks like a reasonable target.

I also suggest watching news from Russia closely – we see a growing number of statements for domestic industries asking the government to regulate exports additionally. This starts to painfully remind us the end of 2020 when it transformed into export taxes. We believe that at this stage risk of additional restrictions is low but I think we will see some speculations around this helping bulls.

The biggest question at this stage, I think is Chinese demand.  Their demand was pretty strong not just for wheat but also for corn. I think it was the biggest driver in the previous grain season. And now there is a big question mark over the demand in the 2021-2022 season for corn. If China decides to cut corn imports substantially in the new season from record-high 28 mmt a yaer earlier that will put pressure on global grain prices. …Good corn crop in the US, and a record-high corn crop in Ukraine, and demand from China all looks pretty weak. And that is the biggest bearish factor at this stage in my view.

I think an additional factor will be the new crop in the southern hemisphere. The outlook for the new Australian crop is pretty good. And if they harvest another bumper crop in this season again, it will likely cool down the wheat market as well. But there is a lot of time before that crop. For now, I think Chinese demand for corn is the biggest bearish story.

NEXT YEAR COULD BE A MORE CHALLENGING

Another hot topic is the worldwide shipping container shortage. A lack of available shipping containers has become a crisis. Do you think the shipping container shortage will continue next year?

I'm not an expert in containers and freight. However, I would just comment on a broader perspective. In 2020, the global market, all the world population was pretty concerned about food security, because of the first wave of COVID-19. Many politicians, many people all over the world were worried about the consequences of the pandemic and all those lockdowns. But now we can say that humanity did a relatively good job. No big problems with supply chains…No hunger…Nothing like that. But in reality, I think 2021, perhaps 2022 could be a more challenging period. We know more or less now how to deal with the COVID. But we have substantially higher prices for food grains, substantially higher wheat prices. While we have strong demand, there are some problems with the supply of wheat in the Northern Hemisphere. And on top of that, back to your initial question, we have some problems with freight and containers. So I think in 2021 and 2022, we could see some huge problems of food security in big poor grain importer nations because their food bills are rising substantially. And I think it could continue till 2022 crop. That's a big problem. The world was concerned in 2020 and but now it's kind of feels like everyone is okay. COVID is still a big story but we survived.

However, I am afraid that big problems are ahead of us. In real terms global food prices just have returned to all-time highs, as per FAO. We saw similar high food prices at the end of 2010. The Arab Spring started in 2011.