Dry Soil and Ukrainian Wheat
The most fundamental law in all of agriculture is that crops require water. Like humans, dogs, and brine shrimp, all life on planet Earth needs a regular influx of hydration to remain alive and well. While humans can circumvent nature in many ways, such as irrigating the Arizona desert to plant carrots or draining marshland to grow orchards, the sine qua non of all agricultural commodities is access to water -- or lack thereof. While wheat in Eastern Europe, and specifically the Black Sea region, recently threatened the prices of other grain commodities, turnaround is fair play and the Black Sea wheat outlook has certainly turned around. New reports out of Ukraine suggest that dry soil conditions are posing a threat to crop yields and reducing the winter crop output in the pivotal breadbasket region. That's fantastic news for wheat investors, who have seen the commodity drop in value almost non-stop in the past 36 months.
You may think of Russia as very cold, and for the most part you'd be very correct. The largest country in the world is "only" the fifth-coldest (behind Iceland, Finland, Mongolia, and Canada) and notorious for freezing winter trends that defeat the armies of Europe's greatest dictators at regular intervals. Yet the Russian and Ukrainian regions around the Black Sea escape most of the winter chill thanks to the Foehn winds that blow down from the mountains of Turkey and carry warm air across the Black Sea and into the heartland for nearly one hundred miles. This makes the Black Sea area a particularly pleasant tourist attraction, much like Hawaii come February, but also an important center for grain growth. The same Foehn winds that power a current of warm air, however, also pick up moisture from the Black Sea to be deposited in the most important grain-growing center of Eurasia; at least in theory. The past month has seen soil moisture devolve to below-average levels throughout much of Ukraine and southern Russia, with reports that after the winter sowing session soils have been drier than at any point in the past three decades. Geologists estimate that a dry-as-a-bone August caused soil moisture to dropped by double-digit percentages compared to the level of last year. The situation looks similar to the 2010 and 2012 wheat harvests, where output fell sharply enough to push wheat above the $350 per-ton level for the only two times in the past five years. What's more, this September was one of the warmest on record in Ukraine, sucking more water out of the ground while pushing the sowing cycle up.
The dry soil has yet to affect wheat on the market, but it has affected other crops. Rapeseed harvests fell by 17% in August, pushing the commodity past $500 per ton for the first time in 2015. The Ukrainian ministry of agriculture believes that if conditions persist, next year's rapeseed crop will fall by as much as 40%, with over a quarter of a million hectares (about 1250 square miles, or twice the size of Texas) of rapeseed planted with other crops that can resist the drought better. If conditions continue, it'll be the smallest rapeseed harvest in the past decade. Barley, an autumn-sowing crop, has declined by about fifty percent, the equivalent of one million hectares. The Ukrainian state weather agency believes that the winter grain cycle could fall by about thirty percent without enough water to bridge the gap. The situation is slightly better in Russia, where shortages of "only" about fifteen percent have pushed back the harvest forecasts. Even so, the Russian ministry of agriculture reports that a full third of winter crops are in "poor condition". Though the southern region of Russia has received about twenty percent more rainfall than neighboring Ukraine, they'll also shuck about half a million hectares, equivalent to about one full percent of last year's crop area.
It should be noted that a lot can happen between when grain gets sown into the ground and when it is harvested months later. A mild growing condition throughout the winter with a decent amount of rainfall can negate most of the issues in Russia, though not Ukraine, and keep Black Sea wheat in its current destabilizing position. In the same fashion, spring rains can deliver rainfall at the same time as the crops' fastest growing phase. Yet on the outset, the cards are stacked against Russian and Ukrainian wheat. The winter and spring could be warmer than expected, meaning that more rainfall and/or snowmelt will work against the harvest by creating rot and infection instead of life-giving growth. What's more, the ongoing conflict in Ukraine makes fertilizers and pesticides scarce, while the bottoming out of the ruble has accomplished much the same thing on the Russian side of the border.
- The Takeaway: at the moment, wheat looks like it'll be a great demand by spring of 2016 when dry soils make for smaller harvests. Investors should consider buying wheat both as a value mechanism -- currently trading at 5-year lows -- and as an engine for growth. A multitude of markets are particularly interested in Black Sea grain due to its lower cost; a decrease in supply leaves a lot of buyers scrambling to find another option. That's the best news a portfolio stocked with wheat has heard in a very long time.
- If the wheat harvest falls too low to satiate global demand, the market will turn to corn. The price of corn is also trading at five-year lows, making it a similar value buy. There's more risk in investing in corn as a hedge against wheat due to the American and Brazilian harvests benefiting from a warmer winter, but a portfolio with an appetite for volatility could capitalize on both cereal crops.