The Real Price Of Wheat

When wheat markets rally, it seems everybody pays attention. Yet a walk through a typical grocery store will often leave producers shaking their heads at the contrast between what the farmer gets paid and what the consumer has to cough up.

As a farmer, it’s pretty hard to accept any blame for increases in the cost of food when it seems that our share of the consumer’s dollar is almost insignificant.

So what exactly is the relationship between the price of wheat and the cost of the finished products that consumers find on their store shelves?

Let’s begin with a few numbers from www.prairiewheat.ca, a website set up by the Canadian Wheat Board (CWB) and some grain companies to promote consumption of products made from Prairie crops. The site says that a bushel of wheat, once it is milled into flour and mixed with other ingredients, makes about 67 one-pound loaves of bread.

The CWB 2010-11 Pool Return Outlook (PRO) for #1 Canada Western Red Spring (CWRS) 13.5 per cent protein was $9.31 at the end of January when a good chunk of the crop was priced. That’s the in-store Vancouver/ St. Lawrence price. For a typical Manitoba country elevator location, it has to be backed off by about $1.50 per bushel for freight and elevation deductions.

That translates into an elevator price of $7.80 — nothing to sneeze at by any means, especially for producers who were not drowned out in 2010 and who actually managed to harvest a crop. But even at $7.80 per bushel, the producer’s share of a one-pound loaf of bread is only about 12 cents, i.e. six per cent on a $2 loaf.

Now, let’s say the price falls back to what it was before this summer’s price rally, namely about $6.10 in-store or $4.60 at a Manitoba elevator. That price gave the producer seven cents on the same loaf of bread. In other words, a 70 per cent increase in the pooled price for Western Canada’s highest grade of milling wheat since last summer has added a whole five cents to the producer’s share of the value of a loaf.

Expressed yet another way, for every $1 increase in the farm gate price that producers can achieve for their wheat, about 1.5 cents is added to the cost of bread.

So even if farm gate prices doubled from last summer’s levels, the price to consumers should only increase by mere pennies, right?

Maybe in theory. But in reality, things are a little more complicated. Jim Thompson is the CWB’s senior marketing manager for domestic and U.S. sales and has been at the CWB for the past 16 years. Prior to that, Thompson worked in the milling sector for both Ogilvie Mills and Archers-Daniel-Midland.

Thompson points out that when millers buy Prairie wheat through the CWB, they pay the domestic human consumption (DHC) price that the CWB charges every domestic customer.

“The DHC is based on prevailing market values for the particular grade of wheat that the customer wants,” Thompson says. “It’s a price that’s guided by the overall world price, particularly the values on the Minneapolis Grain Exchange. It also reflects a basis for time and location, depending on where and when the buyer wants to take delivery of the product. It has to be a competitive North American price because millers are under no obligation to buy from the CWB. They can source their raw materials from any origin.”

There is one DHC price for the reference grade, which in the case of milling wheat is #1 CWRS — everything else is priced in relationship to it. For example, #2 and #3 CWRS would be sold at a discount. On February 1, 2011, the DHC for the reference grade in-store Thunder Bay was $417.80 per tonne or about $11.40 per bushel. Customers in Toronto, Thompson explains, would pay this price plus another 80 cents per bushel for freight (a total of $12.20) to get the grain to their mill.

While a buyer in Western Canada would pay a reduced price, backed off for lower freight, there are still significant benefits to “destination mills” like those in Eastern Canada that are built close to large centres of population where the demand for flour and baked goods is the greatest.

“It’s easier for destination mills to provide quality customer service,” Thompson says. “It’s also easier to store, to handle and to ship bulk grain than to ship flour and baked goods. All of these factor into the trend towards mills that are built close to their customer base.”

Needless to say, there can be quite a difference between the DHC price that millers are paying and the price that producers can expect to see for the wheat they’re dropping in the elevator pit. The spread between the February 1 DHC price for a Southern Ontario mill and the late January PRO, backed off for a Manitoba location, was $12.20 less $7.80 or $4.40 per bushel.

Much of this spread is attributable to freight costs, but there are other factors at work as well. The cost of the services that the CWB provides must enter into the equation. Most importantly, there is also the question of pooled versus spot prices. At the time of the January 2011 PRO, the CWB had already priced 57 per cent of the expected 2010-11 crop year deliveries of wheat. While the DHC is a spot price, good for one specific point in time, the PRO is a pooled price that represents the weighted average of the values the CWB has been able to achieve so far in the crop year — including the first part of it when world prices were considerably lower — and what it expects to receive for the remaining 43 per cent of the crop that it has yet to price in all of the markets that it services.

In a rising market like the first half of 2010-11, with tight supplies of high-quality milling wheat, it was not surprising to see spot prices in premium markets like North America outdistance the pool by a substantial amount.

It should be noted that just as price pooling is in place as a risk management tool for producers, many millers and bakers are also doing their own risk management by locking in prices in advance, as Paul Hetherington, the president and CEO of the Baking Association of Canada explains.

“Large chain stores are lining up their supply of baked goods many months in advance,” Hetherington says. “Bakers then try to lock in their own supply of raw materials so they can provide a guaranteed price to their customers. If they don’t, and prices suddenly move up, companies can find themselves in pretty serious financial difficulty.”

The bottom line is that farm gate prices don’t necessarily move in lock-step with the prices further down the value chain because of issues related to the timing of the actual sale, and how risk is managed at different stages in the chain.

Now let’s continue to follow the bushel of wheat that the miller in Southern Ontario bought on February 1. Once it has arrived at the mill, it will be turned into flour with the byproducts going into the feed market.

“The across-the-board standard for extraction rates is somewhere in the range of 75 to 76 per cent for milling wheat,” Thompson says. “In the 2009-10 crop year, it was a little higher at 77.6 per cent. With the lower quality of this year’s crop, it might be closer to 75 per cent. If whole wheat flour is being produced, it can be as high as 80.”

So the 60 pounds of wheat that arrived at the mill door will typically become about 45 lbs. of flour or roughly two 10-kg bags. Depending on the grade of the wheat that was actually purchased — whether it was the reference grade, a lower discounted grade or a blend — the raw material in the flour probably cost the miller somewhere around $6 per bag. The other significant costs that the mill will incur, according to Thompson, relate to its equipment — things like repairs and maintenance, depreciation and interest — as well as packaging (bagging is particularly expensive), advertising and distribution.

By the time these costs as well as a reasonable margin for the processor are factored into the price, it is not surprising to see retailers charging $10 or $12 per bag of flour on their shelves.

As for the wheat flour that goes into the baking industry for further processing, Hetherington says the value of the final product depends on a number of factors.

“First and foremost, there are the other ingredient costs,” Hetherington explains. “Depending on the product, other materials like fat or sugar may be the main ingredients rather than flour. Then, there are machinery and labour costs. These are often inversely proportional to each other: the more the process is mechanized, the higher the machinery and energy costs. On the other hand, artisan breads may rely mostly on manual labour, with equipment costs ending up being very low. But energy costs are not only important in making the baked goods — they also play a huge role in distribution costs.”

Hetherington points out that baked goods must be delivered fresh and that they have a very limited shelf life. This is why, contrary to a lot of other products that are centrally distributed through warehouses, baked goods are more often than not delivered by the bakery directly to the store or restaurant.

As well, a margin has to be built into the cost of the finished product to account for what doesn’t sell on the store shelf or the restaurant menu.

It should also be noted that the price of wheat rarely moves higher in isolation. The winter’s increase in wheat prices is no exception. Like the one in 2007-08, it has also been accompanied by an increase in the oilseed complex and the price of crude oil. As a result, it is not only the cost of wheat that has gone up but also the cost of other important ingredients like vegetable oil and the expense of heating the facilities, operating the equipment and transporting the product. Wheat prices just seem to be the component that garners the most attention.

The last word goes to Hetherington: “Price changes in the commodity sector are not situations where the producer is responsible. Higher commodity values are good news in the farming community. As costs go up, we know as bakers that we’ll end up paying a little more but we fully realize that this is a worldwide event that is beyond farmers’ control.”CG

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