As many of you will have realized by now flour prices have increased to historic highs. Here in the United States this has been driven by wheat prices that are currently (September 11, 2007) well over $8.00 per bushel for both Hard Red Winter and Hard Red Spring, the principle wheats used in the production of bread. You will find a general article on commodity pricing here. However, with this article we hope to give you some insight into what is driving wheat and flour prices to their current extremely high levels.

The first thing to look at is both the long term trend in wheat prices and the fact that the recent run up in prices has occurred very quickly. The chart below shows the price of a bushel of wheat from February of 2007 to the present. Looking back to February you can see that prices for hard red spring wheat were running just over $5.00 per bushel. Prices, while high given where the market had been for the last few years, were relatively stable until around the first week of June. Shortly thereafter you can see the dramatic run-up in prices that culminates with the over $8.00 per bushel price that we have today. The two charts below indicate how quickly this run-up has been. The prices on the top are from August 3, 2007 with the prices on the bottom from just a month later (September 11, 2007). These are futures prices taken from the Kansas City Grain Exchange and reflect the current futures contract prices for hard red winter wheat. On the top chart you can see that December wheat finished the day trading at $6.55 per bushel on August 3rd whereas it finished trading at $8.59 per bushel just 6 weeks later. The second column indicates the amount the final price changed over the previous close. Looking at the bottom chart for Decemeber you can see that it closed up $0.30/bushel. This is called ‘limit up’ and basically trading must halt at $0.30/bu until certain conditions are met before trading can resume.

But what does the wheat bushel price mean to the baker in terms of the price of his or her flour? On average it takes around 2.2 bushels to make a hundred pounds of flour (a hundred weight or ‘cwt’ in milling speak). So, if your bushel price rose about $2 per bushel over the course of 6 weeks you would find (if everything else remained the same) a $4.40/cwt increase in the price of the flour, or $2.20 per 50# sack. That is an almost unprecedented rise in the cost of flour over that short of time period.

The pricing of flour is not quite that simple as there are other factors that can influence the final price. These factors include how much the mill will get for the feed produced when the sell the bran and germ by-products that are produced during the milling of the white flour, and the level of premiums being charged for various protein contents. All of those factors work in unison to affect the overall price of the flour, but in this current situation, the run-up in the cost of flour can largely be contributed to the bushel price of the wheat.

But what exactly is driving this situation. In this current market it is largely being driven by worldwide supply and demand pressures. There are a handful of exporters in the world: countries that produce a surplus of wheat (beyond their own domestic needs) and who offer up this surplus for sale on the world market. In this particular crop cycle many of the traditional exporters had poor crops and, as a result, were unable to offer significant quantities for sale on the world market. In the northern hemisphere these exporters who were unable to contribute much wheat to the world market include Eastern Europe, France, India, and China. That primarily left the United States and Russia as the major players in export market.

From the USDA September 13, 2007:

Global 2007/08 wheat production is projected 4.2 million tons lower as reduced output in Australia, Canada, and EU- 27 more than offset higher output in FSU-12 [Former Soviet Union]. Production for Australia is lowered 2 million tons based on early crop stress from dryness during August and early September.

EU-27 [European Union] output is reduced 3.1 million tons as preliminary government estimates indicate sharply lower output, particularly for France, Germany, and the United Kingdom.

In many years the United States is not priced competitively and much US wheat remains available for domestic consumption. Not so this year. The rest of the world seems to think that US ,Canadian and Russian wheat is a good by at any price.

The current situation is exacerbated by the fact that the major producers in the Southern Hemisphere (Argentina and Australia to name two) have crops that are suffering from drought conditions and their expected crops are to be many times lower than they need to be. By ‘need to be’, we mean in order to have a major influence in easing the world supply and demand strains that are fueling these prices (see USDA quote above) once these countries begin to harvest late this year.

In addition to poor crops throughout most of the world, ending stocks, the amount of wheat left over in storage from the previous crop year are at historic lows. Not only that, worldwide consumption on wheat is on the rise.

From the USDA September 12, 2007:

WHEAT: U.S. 2007/08 wheat ending stocks are projected at 362 million bushels, down 42 million bushels from last month reflecting lower imports and increased use. If realized, this year’s carryout would be the lowest since 1973/74.

An additional factor, and one that is hurting US bakers in particular, but fueling demand for US wheat is the weakness of the US dollar. While the price of US wheat is at an all time high for those purchasing wheat in US dollars, those purchasing with other currencies that have strengthened against the dollar are not feeling the price increases nearly as much. For example, Egypt is a long time purchaser of US wheat but, due to the strengthening of it’s currency against the US dollar they have been paying roughly the same price for the wheat for many years now.

And, finally, another factor that has been a part of the grain market is the presence of investment funds. This is a from an article on economist.com:

Increasingly, financial firms have a stake in these [commodity] markets too. Trading in agricultural futures, once a backwater, has boomed in recent years. In addition to agri-businesses, more institutional investors—ranging from hedge funds to pension funds—are investing. Last year nearly $3 trillion in grain futures was traded on the Chicago Board of Trade (now part of CME Group), the world’s largest such market.

The participation of the investment funds in the commodity grain markets has served to magnify the normal swings of commodity prices. What separates investments funds from the other players in the commodity grain markets is that the funds will not actually take delivery of the wheat (as a mill will). The funds are simply looking to maximize their returns so the pump money in and out of these markets and it is this large injection (a subsequent pull out) of cash into these markets that serves to magnify the fundamental swings of real supply and demand.

All this taken together results in the historically high prices that we are seeing today for wheat and, by extension, flour. And for the rest of the year there is not much in the way of ‘unknowns’ that could cause a significant drop in the price of wheat. On the other side, if demand keeps up we could see prices continue to rise through the end of the year. At this point, your best bet is to cover your flour needs through the end of the year and see what 2008 brings. With these high prices we could see a lot of farmers plant wheat which should help prices in the new year.