When Black Sea Wheat Is Caught in Conflict

Summary

Between June 1914 and February 1915, Chicago wholesale wheat prices rallied 77%. It is important to separate the price rise into two time periods. June to October 1914 saw close to 20% of Europe’s wheat production fall under conflict, and prices rose 22%. The second part of the price rise was between October 1914 and February 1915, when the Ottoman empire blockaded the Dardanelles Strait, the only route for Russian wheat to move to allies: the UK and France. This period saw the remaining 45% of the 77% price rise. It is important to note that in October 1914, when Black Sea access was lost, prices were 12% above the five-year average, whereas currently (on 22 February 2022), CBOT wheat prices are 49% above the five-year average (2017-2021).

Black Sea Wheat Importance: Then Versus Now

Between 1905/6 and 1909/10, Russia accounted for 22% of global wheat exports. Currently, Russia and Ukraine combined have a share of 28.5% in wheat exports. It could be argued that upside price risk would be higher given increased exposure, with other Black Sea countries also providing exports. Furthermore, ending stocks were above average in the key non-Black Sea markets below in 1914, versus 31% below the five-year average in 2021/22, forecast by the USDA.

What Could Happen to Wheat Trade and Demand?

1914/15-1918/19: insurance skyrocketed, availability of vessels shrunk, and grain exporters all but ceased selling on Cost, Insurance & Freight Terms, instead offering only Free-On-Board terms to avoid the risk and cost of sea freight. The result was that were limited private parties willing to move grain to mainland Europe and the UK. Therefore, governments moved heavily into the grain trade.

Present: if we see a conflict, insurance premiums will skyrocket or not be available for vessels entering the Black Sea. Assuming the Turkish Straits remain open, but depending on non-Black Sea export availability, we could see certain large import nation governments, such as Iran or China, ignore western sanctions on Russian exports, and still procure grain. We could also see a change in global trade flows and usage: 160m tonnes of the world’s wheat (20%) is used for feed and this is where substitution is likely to occur to compensate for a potential annual 60m-tonne wheat export no longer taking place from the Black Sea. China’s hunger for 50m to 60m tonnes of grain, largely for feed, could potentially shift and be supplied by Russia’s 45m to 50m tonnes of grain export surplus. Governments could also remove biofuel incentives to preserve grains for human consumption.

What’s the Production Response to Losing Black Sea Exports?

1914/15-1918/19: 1915/16 was the first season when governments incentivised increased planting. Global production hit a record at the time, of 113m tonnes, compared to 1905/06-1909/10 at an average of 93m tonnes, before declining due to poor seasons and labour shortages. Production for key exporters can be seen in Figure 4.

Could we see a supply side response in 2022?

With prices for other commodities already high, the wheat price will need to rise disproportionately to other crops to incentivise increased planting. Since Russia and Ukraine will still have supply, just sanctioned, the shifting of trade routes will play the more important role.

What Supply Response Can Australia Provide?

Production: Records broken then and now following drought

1914/15-1918/19: the first wheat harvested after the Black Sea closure was drought-stricken, declining 76% year-on-year in 1914/15. In 1915/16, the government incentivised farmers by offering a guaranteed minimum price. National planting hit 5m hectares, and production rose 71% above the previous record. Wheat area as a percentage of all crops increased from 85% to 91%, primarily due to land clearing.

Present: Following the 2017-19 droughts, Australia has produced two consecutive record crops. Due to current policies, land wouldn’t be cleared, but wheat area could rise if farmers switch cropping rotations in favour of more wheat, or if livestock operators switch to cropping. Rotational considerations will be a limiting factor for farmers.

Logistics: Upside for farmers could be muted if logistics remain clogged

1914/15-1918/19: In 1915/16, the crop was at a record level, Australia was yet to develop bulk handling, and freight was in short supply. With the foresight that supply chains would not be able to digest so much wheat and farmgate prices would plummet, the government virtually nationalised the grain trade and farmers received a minimum price for all their wheat.

Present: The majority of shipping slots are booked for the coming months and Australian wheat is already trading at around a 10-year-high discount to CBOT. To move more grains, the Australian export season would need to be extended and capacity could also increase (to an extent).

Price Scenario: Full-scale Russia-Ukraine Conflict and Wheat Export Sanctions

Given high global prices and constrained export capacity, basis is trading at its most negative in 12 years. If, theoretically, basis remains constant and there is a full-scale conflict, Kwinana Free-In-Store prices could rise to AUD 425/tonne in Q2 2022. If the conflict extends into mid-2022 and we assume basis stays at current levels, prices could move to over AUD 600/tonne. In reality, basis would likely move more negative, particularly in the near term, due to large Australian supplies and limits on export capacity, dampening price upside.