Farmers can expect to Net $3 with $2.50 wheat prices
Dec 2, 2004 12:00 PM
Wheat prices on June 20, 2005 in central Oklahoma and the Texas panhandle are expected to be about $2.60 per bushel. The government wheat loan is about $2.75. Thus, there may be a 15-cent per bushel deficiency payment (LDP). Given current market prices, it is possible to net $3 per bushel if wheat prices fall to $2.50 per bushel.
This price prediction is based on USDA predictions for wheat production, use, ending stocks, potential 2005 wheat production and corn ending stocks. World wheat stocks are tight enough that below average 2005/06 wheat production could result in wheat harvest prices above $3.
United States wheat production of 2.16 billion bushels was 218 million bushels less than last year. This is slightly higher than the 5-year average of 2.09 billion bushels and below the 10-year average of 2.22 billion bushels.
United States 2004/05 marketing year wheat ending stocks are projected to be 568 million bushels, only 21 million bushels higher than 2003/04 ending stocks. The 10-year average ending stocks is 660 million bushels.
Some analysts have predicted that winter wheat planted acres are about the same as last year. The 2004 winter wheat yield was 43.5 bushels per acre compared to a 5-year average of 44.2 bushels and a 10-year average of 42.8 bushels. Wheat production in 2005 could be equal to or higher than 2004 wheat production.
The point is that lower wheat prices have been the result of record foreign wheat production and lower demand for U.S. wheat. Foreign 2004/05 marketing year wheat production is projected to be a record 20.51 billion bushels. This is 2.6 billion bushels higher than last year and 570 million bushels higher than the 1997 record crop.
United States wheat exports are projected to decline from 2003/04's 1.16 billion bushels to 975 million bushels. Foreign wheat exports are projected to increase from 2.89 billion bushels to 2.96 billion bushels.
Foreign wheat planted acres for 2005/06 harvests may increase. Chinese producers may have increased wheat planted acres nearly five percent. An increase in foreign wheat planted acres could result in another record foreign wheat crop in 2005/06.
The 2004/05 marketing year wheat harvests are still in progress in the Southern Hemisphere. It is nearly seven months before the 2005/06 wheat harvests begin. If current wheat production trends continue, 2005/06 wheat prices will be lower than 2004/05 prices.
The Kansas City Board of Trade July '05 wheat contract price is $3.40. Using a minus 40-cent basis, the KCBT July wheat contract is offering $3 for harvest delivered wheat.
An alternative to hedging or forward contracting is to buy July '05 wheat put option contracts. At this writing, a KCBT July '05 $3.30 put option contract may be bought for 16 cents per bushel or $800 for a 5,000-bushel contract.
A $3.30 July put bought for 16 cents would establish an expected minimum price of $2.74 ($3.30 -$0.40 basis -$0.16 premium). The advantage of establishing a price floor at $2.74 is that as the cash price goes below $2.75 (government loan), two cents may gained for each one-cent cash price decline.
For example, if the cash price were $2.50, the LDP would be about 25 cents and the KCBT July $3.30 put will be worth 25 cents more than when the cash price was $2.75. Thus for the 25 cents that the cash price is below the loan, the LDP produces 25 cents and the put options produce 25 cents making the net price received $3 ($2.50 cash + $0.25 LDP + $0.25 put).
Setting up a situation where you receive a higher price if the cash price is above the loan and a higher price if the cash price is below the loan requires a 16-cent per bushel gamble. If I'm correct and the cash price is below $2.75, you will win with this strategy. If the cash price is above $2.75, you'll lose the 16-cent per bushel put premium.
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