Tell me Again about the Cure for Low Prices?
Dr. Todd Davis — Extension Ag Economist, Princeton
Economists in graduate school are instructed to tell farmers that “the cure for low prices is low prices.” While catchy, this phrase might require a little more explanation. The wheat market provides an example of low prices trying to cure low prices.
Figure 1 compares the ratio of the U.S. wheat market’s ending stocks to the total demand for wheat for the marketing -year. Think of this as a measure of excess inventory as the larger the number means that there is more wheat in the bins relative to demand for wheat. This ratio is the blue columns in Figure 1. The line in Figure 1 is the U.S. marketingyear average (MYA) price for U.S. wheat (all types). Figure 1 is a snapshot of the country’s wheat market ignoring location and type of wheat produced.
The corn and soybean demand boom starting in 2006, due to strong exports and biofuel demand, caused acreage to switch out of wheat, sorghum, barley, and cotton to corn and soybeans. Below-trend corn and soybean yields in 2010 to 2012 kept corn and soybean inventories tight, which increased prices and acreage for those crops. Wheat benefited from this price environment as stocks were tight and prices reached record levels. As the corn and soybean markets rebuilt stocks, wheat prices declined along with lower corn and soybean prices. Notice that the stocks-use ratio for 2016 is over 50%. The stocks-use ratio means that before the 2017 harvest begins, the wheat in the bins from the 2016 crop can meet over 50% of projected demand for the 2017 marketing-year.
Figure 1 includes projections from the University of Missouri for marketing-years 2017 to 2020 that forecasts a recovery in wheat prices because the stocks-use ratio is declining. What assumptions are the economists applying to achieve this price increase? Table 1 digs into the supply and demand fundamentals.
Planted wheat area is projected to decline by 4.1 million acres in 2017 as farmers continue to reduce acres in response to low prices. If realized, the 2017 wheat area will be 10.17 million acres less than the amount seeded in 2013 and the lowest area planted since 1909. The economic forecasts for 2017 are for ending stocks to be reduced slightly (146 million bushels) due to lower supply outpacing the continued projected reduction in use. In response to lower stocks, the 2017 U.S. MYA price is expected to increase $0.59/bushel to $4.44/bushel. As stocks continue to decline, the U.S. MYA prices are projected to increase each year. What is behind this price recovery? At this point, the forecasts are for a return to average yield, which would be 6.7 bushels/acre below the 2016 yield. An average sized crop might allow the market to start chewing through the stocks that have accumulated since 2013.
Table 1 also highlights a fundamental problem in the wheat market of declining use that is projected to continue for the 2017 and 2018 marketing-years. As discussed many times in past issues, the U.S. is the residual supplier to the world as several countries compete with the U.S. for exports. Typically, the U.S. share of global exports is about 15%. A production problem in another country will temporarily increase the United State’s export share. Barring that, exports are stagnant and the decline in stocks will be gradual.
Can low prices cure low prices? Table 1 illustrates that this is a slow process as the market is attempting to reduce production and to encourage demand through low prices. As illustrated in Table 1, Mother Nature holds the fate of the market in the yield harvested. The road towards higher prices is a result of average production from reduced acreage and average yields. If 2017 yields are “normal,” then there is potential for stocks to decline and price to improve.