Flour Pricing Components

Flour prices are influenced each day by three rather independent and potentially volatile components.  

  • The first component, wheat future prices, forms the base from which actual wheat prices are derived.  Futures are standardized, tradable contracts.  Parties swap pieces of paper, obligating them to make or take delivery of wheat some time in the future.

The Truth About Futures

While even the most experienced traders are at times befuddled by the apparent chaos and volatility, the workings of the grain futures markets are actually rather orderly, highly regulated and important to the efficient function of the grain and milling industry.
Futures satisfy three very critical economic needs:

  1. Price determination in a fair and open marketplace where all participants have equal access.
  2. Allocation of grain supply over the entire crop year.
  3. Risk avoidance for mills and other participants through “hedge” positions that “insure” against decreases in the value of stored grain.

In the absence of futures markets, grain and flour prices would almost certainly be determined less honestly and efficiently.  Supply and prices would be less consistent since there would be no way to encourage sellers to defer grain sales to “future” positions during times of surplus.  And grain traders, millers and buyers of flour would shoulder huge risk in owning wheat and flour.

  • The second component is cash basis.  The basis serves to adjust the futures price to better represent the actual cost of delivering wheat to the mill.  It also adjusts for the specific grades and quality the miller needs.  The basis combined with the futures represents the actual price the miller pays to supply wheat to the mill.

Of the three components – futures, basis and millfeed – the cash wheat basis is the least understood and of the greatest focus to the flour miller.

A practical way to understand the basis is to contrast it with futures.  In general, futures markets measure and respond to “macro” or global inputs such as droughts, foreign demand for wheat and government subsidy programs.

The basis reflects the difference between the futures price and the price of “cash” or actual bushels of wheat.

It serves to adjust the futures price for more localized or “micro” factors.  For instance, the basis at a particular location might be influenced by delays in rail shipments, variability in wheat quality or protein needed or even the amount of storage capacity at a particular location.

For example:  If the Minneapolis December futures are $3.50 per bushel but a mill in Des Moines must pay $4.00 to attract sellers of a particular grade of wheat, we would say that the Des Moines basis is +$.50.

  • The third component is millfeed.  Because just under 80 percent of the wheat kernel can become flour, the flour mill must deal with a by-product referred to as millfeed or millrun.  The price that mills receive for by-products is treated as a credit against the cost of the wheat and reduces the price of the flour to customers.

The Impact of Millfeed

Have you ever noticed in the Wall Street Journal the falling prices of wheat futures but the price of flour remaining the same or even rising?  Part of the reason can be falling millfeed pricing. When we mill wheat, we utilize the entire wheat kernel. Approximately 75 percent of the kernel is ground into flour but the remaining portion is sold as animal feed. This animal feed, or millfeed as we call it, competes with other feed ingredients such as corn.  If corn prices are low (almost half of all corn grown is used as animal feed), millfeed prices also will be low.  That “credit” we get by selling the millfeed will not be as great thus forcing the price of flour up.  Conversely, if corn or other feed ingredients are higher priced, we get a better millfeed recovery, offsetting a greater percentage of the price of wheat, reducing flour prices.

Wheat as Animal Feed

You will often hear analysts talk about wheat prices being too high or low relative to corn.  They use the wheat/corn price ratio as an indicator of how much wheat will displace corn (the largest animal feed) as feed.  They then attempt to translate that information into bushels of demand and calculate the impact on future wheat prices.  Nutritionally, wheat and corn are not equivalent. Corn has about 90 percent of the nutritional value of wheat. That is why corn prices are normally lower than wheat.  It seems odd to talk about wheat as a feed grain, but in reality, a sizeable amount of wheat is fed annually. In recent years, because of the significant wheat surpluses, feed use has become important in managing the supply.  In 2006, while still well behind exports and food uses in importance, almost 10 percent of the wheat crop is expected to be consumed as feed. Wheat traders, analysts and flour millers all watch the wheat/corn ratio as a main barometer of future price direction.  Any inequity beyond the nutritional value of the two will ultimately impact the price of wheat and flour.