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Sell wheat, live in a mansion... or go broke.
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Floods, drought, late planting, freezes, torrential rains, export bans, and disease - you name it, the wheat market has been through it all - even war…
On February 24, 2022, Russia, the largest Wheat exporter in the world, decided to invade a neighboring agricultural giant, Ukraine. Within hours, the global grain trade in the Black Sea was paralyzed. Markets quickly refactored the risk in the region, ranging from war premium insurance on cargo ships to assessing counterparty risk on sanctioned trade houses. Physical trade froze and Black Sea grain became hostage to the world.
Grain to the moon 🚀
While tragedy was unfolding in Ukraine, five thousand miles away, fear and greed began to take hold at the Chicago Board of Trade. In the span of nine trading days, Chicago Wheat futures exploded 54% higher, prompting margin calls from cash hedgers and wiping out any short speculators along the way. ☠️
During this frantic episode, moves in the market were fierce and mostly a one way street. In retrospect, there were five consecutive trading days in which a limit move was recorded in Chicago Wheat, an event not seen in over a decade. 👇
Although the moves kept traders and hedgers awake at night, the Chicago Board of Trade proved to be a reliable market to trade on. That is not to say that everything functioned just perfectly...
When futures die ⚰️
The Chicago Mercantile Exchange (CME) offers two niche contracts to hedge risks for corn and wheat in the Black Sea. In the case of wheat futures, the contract settles based on the price of wheat in a select Russian port, Novorossiisk. With war in the background, Platts, the agency responsible for reporting spot prices, suspended publication data on the day of the invasion👇
Without accurate information on the underlying market, what good is a futures contract? There was a fix however, Platts could change the underlying market via the following clause:
Platts may also refer to other Black Sea ports or CFR (Cost and freight) prices in relevant destinations and will use prevailing spot freight rates and origin adjustments to normalize to FOB (free on board) Novorossiisk (Russia)
What that translates to is the underlying market for Black Sea futures can be any origin port in the Black Sea (Romania, Bulgaria, Ukraine, etc.) OR a destination market (Turkey, Egypt, Lebanon, etc.) then normalized for freight back to the origin port…Russia. In times of peace that probably could work, but Russia is at war with Ukraine and all the while Russia is being sanctioned away from financial transactions with the Western world. That doesn’t help anybody.
We were a bit too early to speculate if Black Sea grain futures were truly dead, but they definitely lost their utility as hedging instruments. As you can see below on Barchart, volume dried up, open interest collapsed, and the contract looks to be on its way to the futures graveyard.👇☠️
At the moment, the Black Sea wheat futures contract is living as a zombie on the exchanges, with an open interest of 200 contracts, a 99.3% drop since the summer 2020 high of +33,000 contracts.
This is just one example of when structural change forces a market to adapt to a new reality or lose relevance. We can only speculate now if it will be rebranded entirely or end up as a delisted contract like other agricultural futures (RIP Pork bellies🥓.)
The drama corridor 🎭
Several weeks after the invasion of Ukraine, grain markets began to settle down. The price swings were more manageable, but food inflation started to take its toll worldwide. At some point Western leaders realized that without Ukraine’s (and Russia’s) ability to export grain and fertilizer safely (or without sanctions), food instability and inflation would continue to spiral out of control.
The West began working with the United Nations to broker a deal with Russia for Ukraine to be able to export grain again. The media did their part and made food security (and Russia) public enemy number one. We paid close attention and compiled news clippings of headlines at the time. 👇
Sell wheat, live in a mansion
There is a saying in the market, that by the time the news hits the front page, it’s time to sell. This was no exception. For the three months following invasion until talk of a grain export deal, the market was pricing in what could be the worst possible scenario - Ukrainian crop and land losses, sanctions on Russia preventing grain and fertilizer exports, and a full stop of Ukrainian seaborne exports. Thankfully, cooler heads prevailed, but this didn’t help people betting on the end of the world.☠️
In the end, a deal got struck in July, Ukraine would be able to export grain again under the Black Sea Grain Initiative. By the time the first Ukrainian grain cargo under the Black Sea Grains Initiative sailed from the port of Odesa, Chicago Wheat futures plummeted 41% from their March high. In fact, the price of Chicago Wheat futures in August was now lower then pre-invasion levels.
The wheat boom now went full circle, unwinding the doom and gloom the media painted only months prior. Ukraine was now exporting grain through the black sea and through rail and truck in Central and Eastern Europe. Russia was harvesting a record crop. Nature was healing.
spice grain must flow 🌾🚢..........🌍
Since the start of the Black Sea Grains Initiative, over 500 ships have sailed from Ukrainian ports loaded with grain. Not only have grains been successfully moved out of the Black Sea, the trade has adopted rail and truck shipments to Ukraine’s bordering neighbors - Poland, Romania, Hungary, and Slovakia. Although the moves to Europe are less efficient due to rail limitations, the trade has adapted to the challenges. In fact, wheat and corn shipments into the neighboring countries are 2,000% higher then pre-war. 👀
We don’t know when and how this conflict will end, but we know from history that grain flows can periodically change. For instance, after World War II, the US became the worlds largest exporter of wheat, in fact, the US held onto that title for nearly after a decade after the war. 🏆
So what’s next for the wheat market? For starters, the US Wheat crop is currently experiencing the worst drought conditions since records began in 2000. Australia is expected to harvest a record crop. Indian farmers have planted 25% more acres. Ukraine planted 36% less acres than last year…. We can go on, but what’s almost certain is the wheat market will keep us guessing. We will continue to keep an eye on it and you out of trouble.☠️
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