With the record fall harvest rapidly progressing and wheat supplies plentiful, wheat futures prices have tumbled to the lowest levels in years. Unfortunately, any hope by bakers and other flour buyers this long-awaited price collapse would translate into a similar fall in flour costs has been frustrated to say the least. The result is a high-stakes disconnect between wheat futures and flour prices, which has been the source of mounting confusion and even tension.
Were flour prices determined by wheat futures alone, prices would indeed be sharply lower. The Kansas City December wheat futures price as of October 10 was down 24 per cent from a year earlier, and the Minneapolis December was down 28 per cent. Spot flour prices are down little if at all, and trade sources indicate quotes for deferred delivery are often significantly higher than a year earlier.
Two factors have blunted the effects of falling wheat futures. Millfeed prices, which represent a byproduct credit in flour pricing, have fallen sharply, even more precipitously than wheat. The millfeed price decline and its effects on flour prices have not been unusual or unexpected. Millfeed prices tend to blunt flour price escalation when grain prices are moving upward and often fall with wheat and corn futures prices.
Far more surprising, disruptive and complicated has been the breathtaking surge in cash wheat premiums, defined as the difference between the delivered cash price of wheat at a specified market and the wheat futures price. Premiums on 14 per cent protein spring wheat in Minneapolis were recently quoted at 220 cents over the Minneapolis December future, about double the level a year earlier (15 per cent premiums have held at a dizzying 600 cents over). With futures down and premiums up, the latter component has gained outsized importance in the price of flour. While the 14 per cent spring wheat premium accounted for 11 per cent of the wheat cost in flour a year ago, the premium accounted for 28 per cent of the total in mid-October.
For buyers and sellers seeking to negotiate deferred flour contracts, this shift in the balance of wheat costs has created monumental difficulties. While futures represent the near height in liquidity, transparency and hedgability, cash premiums are anything but. As a result, a flour buyer who a year ago was able to cover with a wheat futures hedge at a moment’s notice nearly 90% of the wheat cost in spring standard flour is able to book only 72% in the current market. And the remaining unhedged piece, premiums, appears much more volatile than usual. This risk in premiums is multiplied when it comes to flour millers covering wheat needs against forward bookings.
A problem for all classes of wheat, the pain from premiums has been most severe in spring wheat, due to a confluence of forces. For a second consecutive year, spring wheat protein content has been below normal, contributing to the higher basis. Particularly disruptive in recent months has been the effects of tight rail car and other transportation resources on wheat premiums. While freight rates, per se, have not been widely raised, flour buyers at times have had to pay the equivalent of $1.30 a bu extra for wheat in secondary freight markets to assure, within a two-week timeframe, the timing of a rail car placement. Spring wheat mills are more dependent on rail delivery of wheat than their hard winter and soft red counterparts, and grain flows in the Upper Midwest have been subject to considerable disruption by the historic expansion of energy supplies — oil and coal — by rail. The impact of approaching winter is especially nettlesome in deferred flour pricing. Bakers historically could expect to pay 35 to 50 cents per hundredweight more for January-March delivery than the spot quote in October, but the margin in recent days has hovered around $3. If winter weather isn’t disruptive, the premium may disappear. Bakers are left with an ugly choice of paying what is in effect an extraordinary risk premium or holding off on coverage into an uncertain winter. The need for open and transparent communication between flour millers and buyers is more important than ever.