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Analysis: IMO 2020 challenging wheat trade flows in Southeast Asia

Singapore — A change in trading patterns emerged in the wheat market this year as long-haul freight rates got a boost ahead of IMO 2020, which kicks off at the start of 2020.

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Typically, with harvest pressure from the Black Sea at this time of the year, Australian wheat, which is at the tail end of its marketing year, is pushed to the sidelines, particularly in the Southeast Asian markets, where both the origins compete head-on.

In the last few weeks, however, the opposite has been observed in the Southeast Asian feed market, with Australian wheat the preferred choice over and above Black Sea.

On July 23 and 24, a major Australian supplier won six feed wheat businesses in the Philippines for September to December shipments as Black Sea was overpriced by $2-$2.50/mt CFR Philippines, after accounting for the 7% import tax.

WHEAT PRODUCTION DOWNGRADE, LACK OF LOW PROTEIN IN RUSSIA

Meanwhile, the US Department of Agriculture has yet again cut its 2019/2020 Russian wheat production estimate by 1.2 million mt to 73 million mt on the back of recent dry and hot weather, which took a hit on winter wheat yields.

In addition, farmer retention is unexpectedly strong in anticipation of higher prices in the near future, as the weather has improved crop quality. Of the wheat harvested so far, 78.8% is milling grade versus 68.8% last year, according to the Russian government.

The lack of feed wheat offers at origination has narrowed the price spread between feed and 11.5% protein wheat to flat to $3/mt CFR Philippines.

"Many traders are short because typically there is harvest pressure around this time. Why would Black Sea give away business during their peak harvest time to Australia?" a trader based in Australia said.

ARGENTINA'S GROWING MARKET SHARE IN SOUTHEAST ASIA

While crop yield prospects decline in the US amid floods, and in Europe, Russia and Australia due to dry spells, farmers in Argentina are bracing for a record wheat harvest.

Argentina's wheat production is forecast at 19.7 million mt, while exports are stable at 13.7 million mt for 2019/2020, data by the International Grains Council showed.

During January-May, Argentina had the biggest market share in Indonesia, the world's largest wheat importer, having imported 1.6 million mt of wheat, according to Indonesian Wheat Flour Producers Association, or APTINDO. This was a massive 137% increase compared with full year 2018 Argentinian wheat imports, which stood at merely 0.7 million mt.

Evidently, this was at the expense of Australia's market share, which shrank to 8% during the first five months of the year as the drought-hit exporting nation's prices lacked competitiveness despite having freight advantage given its close proximity.

Nonetheless, the October 27, 2019 general elections cast a shadow of uncertainty over the current export tax formula of 4 Argentina Peso for every 1 US dollar that is exported. The recent depreciation of the peso makes room for a possible hike in export taxes, market sources said.

IMPLICATION OF RISING FREIGHT ON WHEAT COMPETITIVENESS

Freight rates: Ukraine to Indonesia

S&P Global Platts assessed Supramax freight for grains from Yuzhny, Ukraine, to Cigading, Indonesia, was up 42% from mid-June to $37.50/mt on Thursday.

In H2 June to July, Black Sea grains were ready for shipment earlier than the ship owners had anticipated. Since it is a seasonal trade, there were limited ships available in the Black Sea/East Mediterranean spot market, pushing freight rates higher.

Rising freight rates are making it difficult for traders to competitively price cargoes for further out shipment periods, while end-buyers are struggling to make purchasing decisions between the different origins.

ANTICIPATED INCREASE IN FREIGHT COMING IMO 2020

Freight rates are bound to increase as the implementation of IMO 2020 0.5% marine fuel sulfur cap draws closer.

The shipping industry is anticipating a tightness in vessel supply as ships start to enter dry docks for tank cleaning and/or scrubber fitting ahead of the changes to the sulfur cap, following which, these ships will run on a higher-priced, low sulfur bunker fuel.

Theoretically, it is the longest voyages on the biggest vessels that are likely to suffer the most, due to higher proportions of fuel cost priced into the overall freight rate.

Today, a 50,000 mt wheat cargo from Kwinana, Western Australia to Cigading, Indonesia can expect to pay about $14.55/mt for freight, but should it use only IMO 2020-compliant fuel, the freight rate would increase by roughly $2.45/mt to $17/mt, assuming time charter rates remain stable.

From the Black Sea, on the other hand, given the longer duration of the trip and its consequent exposure to increased bunker costs, freight rates would have risen by approximately $4.65/mt to $42.15/mt based on prevailing price projections -- raising overall CFR prices substantially higher.

Therefore, the upcoming IMO 2020 marine fuel sulfur regulation is likely to give Australia an additional $2-$2.50/mt freight advantage relative to the Black Sea.

BATTLE OF THE ORIGINS IN SOUTHEAST ASIA

Australia has been a traditional supplier of wheat to southeast Asia, with Indonesia being its biggest demand center. However, in the last few years, Indonesia has switched to buying from the Black Sea and Argentina as Australia battles with drought.

Indonesia's wheat imports from Ukraine and Russia outpaced total imports from Australia in 2018, according to APTINDO's import data. Indonesia's Australian wheat imports more than halved to 2.4 million mt, while imports from Ukraine and Russia rose 14% to 3.6 million mt in 2018.

While there is a portion of inelastic demand for Australian wheat, the share of demand has shrunk over recent years.

"Black Sea wheat quality has improved and it's a great blending input for medium protein flour," an end-user based in Singapore said.

"The switch [from Australian to Black Sea or Argentine origin] can be done. End of the day, all we care about is the CFR price," another southeast Asian miller added.

The short voyage time and slight freight advantage from IMO 2020 alone may not be enough to restore Australia's competitive edge in the region as it all boils down to factors shaping FOB prices.

Uncertainty in Argentine export tax and currency movement may delay farmer selling and drive domestic prices in either direction, whereas Australia is facing another dry year, where east coast demand may hold prices at elevated levels.

Moreover, as farmers in the Black Sea are selling at a slower pace compared with previous years, more crop could be available for exports in the months ahead, adding to the fierce competition in destination markets.

APW vs Black Sea

Platts assessed Australian Premium White and Black Sea 12.5% protein wheat spread was at $39/mt Thursday, with APW assessed at $231.50/mt FOB Kwinana and Black Sea 12.5% protein assessed at $192.50/mt FOB Novorosissk.

Australian wheat will have difficulties retaining competitiveness over Black Sea above the $25/mt price spread on FOB basis, which is the equivalent of the anticipated freight differential in an IMO 2020 marine fuel compliant environment.

-- Takmila Shahid, takmila.shahid@spglobal.com

-- Samuel Eckett, samuel.eckett@spglobal.com

-- Edited by Norazlina Jumaat, newsdesk@spglobal.com