The big business of wheat and the Black Sea

With tensions high in the region and import demand rapidly shifting, will this result in a truly structural change in the agriculture market?

wheat seeds up close bouncing of surface

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The escalation in tensions around the Black Sea has capped a tumultuous period for a region that has shouldered more and more responsibility for setting the global price and sentiment of key agricultural commodities.

Chief among those is wheat, as Russia and Ukraine collectively account for nearly a third of total global wheat exports, along with a third of barley exports and just under one-fifth of world corn exports.

In oilseeds, Russia and Ukraine are dominant with 58% of total global sunflower production and a third of total world exports, while downstream the two countries account for 78% of sunflower oil and 81% of sunflower meal exports between them, according to USDA data.

But it is in wheat where Russia, in particular, has achieved a seismic change in its industry.

From major importer to benchmark exporter

Within two decades, Russia’s leadership has taken the country from a major importer to a price-setting, benchmark exporter, re-writing global trade routes in the process and establishing the region as the supplier of the incremental bushel to world markets.

That’s a vital first step for price discovery across commodities, a step that becomes even more important as the rise of the Black Sea as a global supplier simultaneously reduces the relevance of typical US-focused risk management tools that are subject to very different fundamentals.

The second problem for diverse regions is that physical delivery – the mechanism that usually ties the value of a derivative instrument to its underlying commodity – is harder to work and oversee.

Financially settled contracts, such as the CME’s Black Sea wheat contract, resolve that issue by using a dedicated, third-party price reporting agency to provide the settlement value, and the principle should be able to unlock a new generation of financial tools.

But it remains dependent on capturing transparent expressions of price – through bids, offers and trades in a typical market environment.

All of that is also at risk.

Renewal

Vladimir Putin’s stated aim in escalating military tensions along the border with Ukraine is to turn the European landscape back to the 1990s, the decade immediately following the collapse of the Soviet Union.

The Russians argue that US representatives made assurances at the time that NATO would not seek to absorb former Soviet states and, while Ukraine remains outside of treaties, it has drifted towards Europe and the US sphere of influence.

Worse, from a Russian perspective, the Baltic countries of Lithuania, Latvia and Estonia have not only joined the US-dominated military pact, but also sought and achieved membership of the European Union.

Harking back to the 1990s – a period that almost half Ukraine’s current population will have little to no memory of – underlines the changing dynamics that have uprooted the typical global trade flows across the region and the wider world.

At its lowest point, in the 1992-1993 marketing year, Russia imported 14.5 million tonnes of wheat according to USDA data and on average, through the decade, the country imported 6.5 million tonnes annually.

Exports, meanwhile, averaged approximately 800,000 tonnes.

The country, listed under its former Soviet name of USSR, still ranks at number 7 in the all-time list of biggest one-day purchases of US wheat after it picked up 1.14 million tonnes of US wheat in a single purchase on September 12, 1991.

For corn, the USSR features only twice in the entire list of biggest one day US corn buyers – but it sits in third and first place – and its purchase of 3.7 million tonnes of US corn on September 1 1991 not only still tops the list, but is over 1.6 million tonnes ahead of China in second place.

Today, Russia’s imports of wheat average around 500,000 tonnes per year while its exports average 35 million tonnes per year.

Wheat is big business.

Wheat business takes top spot

According to UN trade data, wheat exports brought in $7.9 billion to the Russian exchequer in 2020, up 23% on 2019 and meaning its contribution surpassed petroleum gas – at $7.8 billion.

The recovery in Russian production comes hand-in-hand with the arrival of Vladimir Putin as the president of the federation in 2000 and arguably the increase in productive capacity has driven competition across the region, firing Bulgarian, Romanian, and Ukrainian production.

As the shift played out, challenges emerged with traders exposed to a range of counterparty, currency and geopolitical risks that were hard to manage through traditional tools.

That catalyzed the development of new risk management tools, with local exchanges such as Euronext and the Moscow Exchange offering solutions, while the venerable Chicago Mercantile Exchange launched the first financially-settled Black Sea wheat derivative instrument back in 2017.

All of these solutions were predicated on the assumption of stable trade – for unfettered market forces to shape the price in a relatively transparent way.

But even before military tensions ramped up dramatically across the region, a sequence was already unfolding that had shaken that basic premise.

As temperatures soar, so do prices

As the US and Canada baked in searing temperatures, US-based exchanges saw wheat prices ticking higher as the unrelenting heat slashed yield prospects and tightened supply and demand balances.

The Black Sea could not escape that dynamic, as hot local conditions also lashed out at sunflower production in Russia and Ukraine and contributed to a gathering global tightness – prompting a reaction as domestic prices began to spiral higher.

High prices prompted a switch in farmers’ behavior and Russian wheat production fell 11% in 2021-2022, according to USDA estimates, to 75.5 million tonnes, while export estimates were reduced by 4.1 million tonnes year-on-year to 35 million tonnes.

Nonetheless, this year’s production still amounts to the third biggest crop on record.

As wheat prices followed upwards, so too do the limitations being imposed on Russian sunflower exports began to be ported across to the world’s biggest wheat exporter. Each new pricing milestone forced more intricate and elaborate export duty regimes aimed at guaranteeing domestic supply.

Changing trade behavior

Circumstantially, the tax regime that imposes weekly short-notice changes to the floating export tax has already forced a change in trade behavior – with few people able to take forward trading positions amid uncertainty on their potential tax exposure.

By the end of 2021, wheat prices were some 50% firmer than the 2020 average, with the Fastmarkets Agricensus 12.5% FOB Russian wheat assessment standing at $225 per tonne on average through 2020.

By 2021, that had risen to $286 per tonne - a near 30% increase, but much of the price support came through the second part of the year.

Buoyed by renewed weather fears and Russia’s export tax policy, wheat prices were already firm before escalating tensions across the region hit the headlines and sent the 12.5% price racing to $345 per tonne by the end of November - an even more striking 53% increase versus 2020.

While the impact of that price rise is mitigated by a decline in exports – exactly what the new export tax regime was intended to deliver – the slide in the value of the ruble against the US dollar since the escalation in tensions is likely to have delivered bigger returns domestically.

Currently, export data suggests that on a calendar year basis the country’s exports are lagging behind 2020’s pace to the tune of nearly 7 million tonnes when comparing the January-November 2020 period with its 2021 counterpart.

For end-users, many of which are Asia-based, the escalating tensions and their associated uncertainties are a last straw. With Argentina and Australia both boasting huge wheat crops this season, other supply options are available.

Elastic band or structural change

The agriculture market is responding to those tensions, with 7 million tonnes of import demand going elsewhere and much of it since the start of the new marketing year. And the future is uncertain as military action is unclear and any sanctions could bring lasting, longer-term disruption to the region.

One punishment being mulled is cutting off Russia’s access to the Society for Worldwide Interbank Financial Telecommunications (SWIFT), a global communication system linking financial institutions, while Russian banks and the sinews of trade are also being eyed up.

For those with existing financial instruments, measures had already been put in place to address fears that Russian export duties could undermine the free market basis that underpins the existing CME Black Sea wheat contract.

As Russia signaled its new tax regime, European exchange Euronext announced it would launch a Ukraine-based wheat futures contract back in January 2021 – although its French milling wheat contract has seen record volume as tensions in the region ramped up.

The CME followed suit, hedging its current Black Sea activity by rushing out a Ukraine-based wheat future in April 2021.

That contract is currently listed as zero open interest and is unlikely to record much in the way of change under the current environment.

While it may not be the most precious thing that is at risk amid the current tensions, any military escalation would bring another blow to the region’s latent dominance as a supplier of food and a bastion of price discovery.

The question is whether, when all is said and done, the market snaps back like an elastic band, or will this result in a truly structural change? The combination of the aftermath tensions, including a possible sanctions regime, combined with the continued Russian export tax, could be another major step in shifting the agriculture market from major hub structures to more decentralized markets as others build out and promote their own products.

Keep up to date with the wheat market and the trends shaping the agricultural landscape, visit our dedicated wheat market page.

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