Analysis: The Ukraine-Russia export deal and global wheat stress

By:
on Jul 23, 2022
Updated: Aug 4, 2022
  • Russia and Ukraine entered into a much-awaited export deal to transport grains through the Black Sea.
  • Wheat futures prices declined by nearly 7% yesterday with the agreement being formally unveiled.
  • The parties agreed to a ceasefire and the establishment of a jointly managed command center in Istanbul.

After a see-sawing two months of intense discussions, negotiators from Russia, Ukraine, Turkey and the United Nations have finally broken ground on a much-awaited joint agreement to facilitate grain exports through the Black Sea.

Both countries are systemically important to the global agricultural trade. According to the Food and Agriculture Organization’s (FAO) research, in 2021, either one or both countries were ranked in the top three global exporters of wheat, barley, maize, rapeseed and rapeseed oil, sunflower seed and sunflower oil.

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After the Russian invasion of Ukraine in late February, agricultural supply chains have been left mangled, with commodities prices racing to fresh highs amid ongoing fears of global food shortages and acute hunger in some regions.

Earlier this month, The Wall Street Journal revealed that the Russian military had blockaded 6 of Ukraine’s 18 ports in the Black Sea, routes that channel over 95% of Ukraine’s grain exports.

With Ukraine accounting for an estimated 10% of global wheat exports and being commonly known as the “breadbasket of Europe”, these disruptions have had far-reaching international consequences.

An S&P Global Commodity Insights report noted that during MY (Marketing Year) 2022-23, Ukraine has exported approximately 119,000 MT of wheat, 52% lower than the previous year.

Following relentless aerial bombing and occupation of Ukrainian territory, the Kyiv School of Economics estimated that 4 million tons of grain storage silos were destroyed or had become inaccessible, while over $600 million worth of crops were damaged or seized by Russian forces amid allegations of theft.

Recent price moves

Wheat futures transacted at the Chicago Board of Trade surged to record highs of 1425.25¢ in early March just two weeks after the invasion began.

Source: MarketWatch

However, prices have calmed since and in recent weeks have been experiencing a declining albeit volatile trend on expectations of a resumption in global wheat supplies. Last Friday, the 15th of July, futures contracts bottomed to 765.75¢, a 5-month low, dipping below pre-war levels.

Sensing an opportunity, speculators re-entered the market, driving the price as high as the 830s on Wednesday, the 20th of July.

However, with the agreement being officially unveiled yesterday, prices have dipped to a new low of 755.50¢, a 6.3% drop during the session.

The devil is in the details

The negotiations have been complicated by Ukrainian concerns that any attempt at demarcating safe passage for naval vessels could make them vulnerable to a fresh assault. The Zelensky government has been steadfast in demanding an international security guarantee that would protect the country’s borders.

On the other hand, Russian officials have blamed Ukraine’s sea mines for disrupting ship movements.

Despite the myriad challenges, tireless mediation efforts by Turkish authorities and the United Nations have finally borne fruit.

The key points of the 120-day agreement are as follows:

• Both sides have agreed to a ceasefire in the region to ensure the safety of cargo movement

• The agreement will allow Ukraine to ship 22 million tons of grains (including wheat) via the Black Sea, which have been stranded at various ports throughout the country

• This will be achieved by establishing safe channels for sea transport

• In Istanbul, a central controller will be established to be manned jointly by teams of UN, Turkish, Russian and Ukrainian officials

• The movement of ships will be monitored from the control centre in Istanbul

• Ukrainian officials will guide commercial vessels from ports, without accompanying military escorts

• No Russian officials will be present at Ukrainian port facilities

• The Turkish Navy is expected to examine docking Ukrainian vessels to allay Russian fears that they may be carrying weapons

• Minesweepers will be used as per requirement

Given the unique and tense circumstances that the parties find themselves in, Ukraine signed an agreement with Turkish representatives and the United Nations, while Russia was party to a similar “mirror agreement.”

Defense Minister Sergei Shoigu, the Russian signatory, stated that he expected wheat transport to begin “in the coming days.”

Although the agreement marks a significant step forward, operationalizing the deal may be more challenging in practice.

Potential pitfalls

Firstly, Mykhailo Podolyak, an adviser to Ukraine’s president firmly stated that Ukraine would respond to any “provocations” with “an immediate military response.” With trust between the parties being in short supply, it is yet to be seen if the signatories can co-operate effectively.

Secondly, the heavy sea-mining around Ukrainian ports has been a point of apprehension and confusion. The Zelensky government had claimed that de-mining the zone was out of the question as this may expose the nation to more aggression from the Russian forces.

Yoruk Isik, an Istanbul-based maritime advisor said that “minesweepers would be needed to work around the clock on the corridor,” while Ukraine itself is reported to not possess significant minesweeping capabilities.

However, fresh reports suggest that this was merely “early speculation”, and that “Russia dropped the demand about six weeks ago”, giving confidence to commercial interests such as insurance companies and shipping agencies that safe passage was viable.

Global scenario

The new agreement comes at a time of great urgency for the global food system. Patrick Lockwood-Taylor, president of Bayer AG’s American division echoed this sentiment when he stated in June that “We have an emerging food crisis.”

As of last month, Ukrainian agriculture minister Mykola Solskyi was concerned that the Russian invasion would jeopardize three separate wheat harvests. During a recent interview, he stated that “we cannot take out last year’s crop, we cannot harvest and take out the current one, and we do not particularly want to sow the next one.”

He added that the inability to export wheat will force farmers to re-orient themselves towards growing sunflower and rapeseed which not only see high demand in Europe but require lesser acreage and fetch a better price. He feared that these two crops may “displace everything, clean everything – both wheat and corn”.

In line with these comments, a recent report by The Ukrainian Grain Association has estimated a 37% decline in wheat production this year.

The International Grains Council also tweeted that wheat output among major exporters is set to decline for a second consecutive year, tightening supplies and exacerbating shortages.

Source: International Grains Council

According to research published in the World Agricultural Supply and Demand Estimates of the United States Department of Agriculture (USDA), in 2022/23 global supplies are expected to be reduced by 1.1 million tons, while the EU’s output for the year is forecast to fall by 2 million tons as heat waves grip the continent damaging yields.

The effect of these shortages will be partially offset by a downward revision in global consumption led by “reduced feed and residual use in the EU and Ukraine,” and a global recessionary environment.

An article by Warren Peterson, Head of Commodities Strategy for ING, noted that “China’s wheat imports also dropped 31% YoY” amid on-again-off-again lockdowns.

Despite this, world wheat stocks are forecast to decline to their lowest levels in six years according to the USDA, potentially placing upward pressure on prices.

Future price movements

Factors such as the “shock of war” receding, the new agreement being in place, a slowdown in economic growth and resumption in functional trade flows, should exert downward pressure on prices.

At the same time, futures prices may find support due to drought stress in the US and EU, sky-high fertilizer costs and geopolitical uncertainty which may only be in a temporary lull. Russia’s exports are further complicated by the introduction of a new ruble-based export duty system.

In an ominous piece penned as recently as this week, Andrew Hecht, a commodities trader and analyst with four decades of experience, notes that we “should expect wide price swings in the grain and oilseed futures arena over the coming weeks, months, and even years,” while traders should be prepared for “lots of two-way volatility.”

Sal Gilberte, the founder of Teucrium Trading, cautioned earlier in the month, that “the wheat inside Ukraine is likely going to stay inside Ukraine,” leading to tighter grain balance sheets.

Moreover, with real factors and supply-side components having a deep influence on agricultural products, wheat prices may be “far beyond monetary policy’s reach,” suggesting that prices may lift off at a moment’s notice.

Vulnerable countries

For a right-trade-at-the-right-time subset of market players, supply chain disruptions may boost portfolios and deliver above-market returns.

On the other hand, already soaring food prices are extremely problematic for several low-income developing countries that are heavily dependent on wheat imports for the nutritional security of their citizens.

Egypt, for instance, the largest importer of food grains in the world, is reported to have purchased an additional 120,000 tons of Russian and French wheat earlier this week, after booking a total order of 640,000 tons hoping to cash in on lower prices.

With rising costs, food inflation has rocketed in several countries. This could have significant monetary implications for low-income developing countries where food items usually account for the majority of their consumer inflation (CPI) baskets.

In the image below, we note countries that have high exposure to imports from Russia and Ukraine and are also struggling under the burden of rising food inflation.

Yemen’s food inflation data has not been included. Lebanon’s food inflation was recorded at 332% in June 2022, having moderated from 364% during the previous month. This has not been shown due to scaling issues with the visual.

Source: FAOSTAT, TradingEconomics.com

The prospect of further upside risks may prompt intense competition in the physical markets to secure national reserves at lower prices.

Continuing strength in the greenback may help bring down global commodity prices. At the same time, for several of these countries, arranging to make potentially higher payments in dollars will be very challenging. In the coming weeks and months, we may see many importers substitute into wheat alternatives to the extent possible.

Although we certainly hope that the new mechanism will ease global food stress, political difficulties remain, while it may only have a limited impact on already damaged farmland, the restoration of severed trade routes and global costs at large.

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