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More production risk than price risk with wheat

Before the April 6 and 7 freeze, some producers forward contracted wheat for harvest delivery. On April 4, weather forecasters forecasted temperatures in the upper teens to low twenties in southwestern Oklahoma and points north. Wheat in the boot and heading stages only require two or more hours below 28 degrees F to sustain damage.

The freeze was restricted to mostly the top two tier counties in Oklahoma and up into Kansas. Oklahoma's wheat yield potential may have been reduced six to eight percent. Since yield expectations were above average and that the freeze was not in areas with the highest above average potential, Oklahoma is still expected to have an above-average wheat crop.

Reports are still coming in but it appears that the damage may have been more severe in southern Kansas.

Some producers whose wheat was damaged by the freeze are buying their way out of forward contracts. Elevators report they are canceling contracts for producers who forward contracted at prices above current price. There may be a five cent per bushel cancellation fee to cover transaction costs for the forward contract and corresponding hedge.

If the forward contracted price is below the current market price, the producer may pay the difference plus a transaction fee.

Research has shown that wheat yields are more volatile than prices. The problem is that many think that prices are the most volatile.

If the expected yield is 35 bushels per acre and the expected price is $4.50, the expected income is $157.50. Which is more likely, a 3.5 bushel reduction in yield or a 45 cent decrease in price? Thirty-two and one-half bushels times $4.50 produces $146.25. Thirty-five bushels times $4.05 is also $146.25. Both are 10 percent reductions.

At this writing, the wheat/corn price relationship is out of line. Since more wheat is expected to be produced than is normally needed in the food and export markets, wheat is dependent on the feed market to support wheat prices.

Wheat has about the same feed value as corn. At harvest, wheat prices should be near the equivalent cost of corn. At this writing, corn shipped into Oklahoma or the Texas Panhandle costs about the Chicago Board of Trade (CBT) July corn contract price plus 60 cents. The corn basis is expected to be 70 cents above the CBT July corn contract during the Oklahoma and Texas harvest.

At this writing, the CBT July corn contract price is $3.82. Using a 70-cent basis, the price of corn delivered in June is expected to be $4.52.

The KCBT July wheat contract price is $5.04 and wheat may be forward contracted for 40 cents less than the July wheat contract price or $4.64 for 2007 harvest delivery. Some analysts predict that the June wheat basis will be 30 under the KCBT July contract price. This implies that the market expects June wheat prices to be $4.74 ($5.04 - $0.30) or 22 cents above the expected corn price.

The price relationship between wheat ($4.74) and corn ($4.52) implies that either the corn price must increase or the wheat price must decrease or a combination of both. The 22 cent spread will likely disappear.

Price factors between now and the wheat harvest will be how much of the 90.5 million projected corn acres will get planted, corn growing conditions and U.S. winter wheat production. Currently, corn planting is slightly behind schedule and the winter wheat crop appears to be above average.

Downside price risk is about $4.50 for the KCBT July wheat contract and about $4.30 for cash price. The most likely KCBT July wheat contract price is June is $4.80 and the upside potential is about $5.30.

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