Price Determination in Agricultural Commodity Markets: A Primer
Released: 2006-01-06T00:00:00

Introduction

This report focuses on the major factors affecting price formation for the five largest U.S.program crops -- wheat, rice, corn, soybeans, and cotton. (1) According to the U.S. Agricultural Census, these five cropsaccounted for 67% of harvested crop land in the United States in 2002. (2) Certain commoncharacteristics make a general description of market price formation relevant across this diverse setof commodities: each of these crops is produced annually; under modest conditions they are allstorable for long periods of time (potentially spanning several years); they all move from farm tomarket in bulk form; and they are all actively traded on at least one of the major commodity futuresexchanges which facilitates hedging and forward contracting. In addition, frequently several or (insome cases) all of them compete for the same crop land in production, thus, indirectly linking theirprices across markets.

This report begins by briefly introducing some economic fundamentals common to mostagricultural commodity markets. This is followed in the second section by a discussion of the roleof futures markets in price determination of storable agricultural commodities with seasonalproduction patterns. The third section reviews the important role provided by the U.S. Departmentof Agriculture (USDA) in monitoring and disseminating agricultural market information. Therelease of timely information facilitates price discovery and helps to level the playing field betweensmall market participants and the large multinational agri-businesses. The fourth and final sectionhighlights some of the differences unique to each of these commodities that make pricedetermination in each market somewhat different.

Agricultural Commodity Market Fundamentals

Market Structure and Prices

Price (P*) represents the equilibrium point where buyers (i.e., demand) and sellers (i.e.,supply) meet in the marketplace ( Figure 1 ). New market information (e.g., crop failure in a foreignmarket, widespread animal disease outbreak, a major revision to a previous crop production estimate,etc.) can alter the expectations of market participants and lead to a new equilibrium price as sellersrevise their offer prices and buyers revise their purchase bids based on the new information.

An outward shift in demand from the market equilibrium (due, for example, to news of aforeign crop failure raising expectations for increased U.S. exports) would raise the price P* asDemand moves to the right along the Supply curve. Similarly, an outward shift in supply from themarket equilibrium (due, for example, to an upward revision in the planted acreage estimate byUSDA raising expectations for higher production) would lead to lower price P* as Supply movesto the right along the Demand curve. Both of these hypothetical price changes would only beshort-term. In the long-run, producers would alter their planting decisions in light of the new priceexpectations.

Figure 1. Price Represents the Equilibrium of Supply andDemand

The speed and efficiency with which the various price adjustments occur depend, in largepart, on the market structure within which a commodity is being traded. Common attributes ofmarket structure include the following.

The number of buyers and sellers -- more market participants are generallyassociated with increased price competitiveness.

The commodity's homogeneity in terms of type, variety, quality, and end-usecharacteristics -- greater product differentiation is generally associated with greater price differencesamong products and markets.

The number of close substitutes -- more close substitutes means buyers havegreater choice and are more price sensitive.

The commodity's storability -- greater storability gives the seller more optionsin terms of when and under what conditions to sell his products.

The transparency of price formation, e.g., open auction versus private contracts-- greater transparency prevents price manipulation.

The ease of commodity transfer between buyers and sellers and among markets-- greater mobility limits spatial price differences.

Artificial restrictions on the market processes, e.g., government policies ormarket collusion from a major participant -- more artificial restrictions tend to prevent the price fromreaching its natural equilibrium level. Some restrictions (e.g., import barriers) limit supply and keepprices high, while other types of restrictions (e.g., market collusion by a few large buyers) maysuppress market prices.

What's Behind Market Price Differences

The general price level of an agricultural commodity, whether at a major terminal, port, orcommodity futures exchange, is influenced by a variety of market forces that can alter the currentor expected balance between supply and demand. Many of these forces emanate from domesticfood, feed, and industrial-use markets and include consumer preferences and the changing needs ofend users; factors affecting the production processes (e.g., weather, input costs, pests, diseases, etc.);relative prices of crops that can substitute in either production or consumption; government policies;and factors affecting storage and transportation. International market conditions are also importantdepending on the "openness" of a country's domestic market to international competition, and thedegree to which a country engages in international trade.

Local Supply and Demand Conditions. Differences in grain and oilseed prices throughout the world reflect differences in local supply anddemand conditions (as well as differences in local market structures). In general, grain and oilseedprices are lower in the inland producing regions where they are in surplus, and higher in grain andoilseed deficit, densely populated and port regions where demand exceeds local production. Similarly for cotton, prices are lowest in the production zones, and highest around processing centersand textile mills.

Product Characteristics. Today's marketparticipants tend to be very sophisticated buyers who carefully compare the price of differentagricultural commodities in terms of their cost per unit of desired end-use characteristic. As a result,supply and demand conditions in agricultural markets -- whether it be markets for export, feedrations, fresh products, food processing, or textile manufacturing -- may depend on a commodity'sparticular variety, quality, or end-use characteristic more than the overall supply of the genericcommodity. For example, a flour processor may base wheat purchase decisions primarily on thespecific variety of wheat and its particular milling and baking characteristics. A yarn or textilemanufacturer may select cotton based on its fiber color, strength, or length depending on the intendedprocessing outcome. A livestock or poultry operation strives for the least-cost, balanced ration(depending on the type of animal) that includes sufficient protein, carbohydrates, fats, vitamins, androughage. An ethanol plant may select corn based on its starch content, while a food processor mayprefer corn with an above-average oil content.

Transfer Costs. Key components of the U.S.grain and oilseed handling network include on-farm storage, trucks, railroads, barges, and grainelevators (including county, sub-terminal, and export elevators). A complex web of local supply anddemand conditions determines how and when commodities move through this network. Pricechanges at any point along the chain can result in shifts to alternate transport modes or routes asgrain marketers search for the lowest-cost method of moving grain between buyer and seller.

For grains and oilseeds, prices at the local country elevator are derived from a central marketprice less transportation and handling costs. Country elevator managers watch the prices in severalmarkets (whether a processing plant, feedlot, export terminal, or futures exchange) to determinewhere the demand is the greatest, then deduct transfer costs to the higher-priced market indetermining the bids they can offer local producers. In competitive markets, transfer costs -- loadingor handling and transportation charges -- are usually the most important factors in determiningspatial (i.e., location-based) price differentials. In the international marketplace, transfer costsinclude barriers to trade such as tariffs and quotas. The more it costs to transport a commodity toa buyer, the less the producer will receive and vice versa. Price differentials between regions cannotexceed transfer costs for very long as marketers will quickly move commodities from the low-pricedmarkets (raising prices there) and ship them to the higher-priced markets (lowering pricesthere). (3)

From the farm to the processing plant or export terminal, trucks, trains, and barges competeand complement one another in moving grain to successively larger elevators. Shipping distanceoften determines each mode's particular role. Trucks traditionally have an advantage in moving grainfor shorter distances (less than 250 to 500 miles) and therefore function primarily as the short haulgatherers of grain product. Railroads have a cost advantage in moving grain long distances, butbarges have an even greater cost advantage where a waterway is available. (4) Most economists and marketanalysts agree that inexpensive barge transportation helps hold down rates charged by the rail andtruck transportation industries.

Any disruption to the agricultural transportation network generally results in highertransportation costs throughout the system as the demand for transportation services shifts toalternate modes and routes in search of the next best means of moving production to market. Forexample, a weather event that dramatically slows or severely limits barge traffic on the MississippiRiver will have the effect of raising barge freight rates as the demand for barge services exceeds theirsupply. Higher barge freight rates for grains will in turn shift these commodities to alternate uses(feed, food, industrial, or storage), to alternate transport modes (rail or truck), or to alternate traderoutes (e.g., to the Atlantic via the St. Lawrence Seaway, or overland to Canada, Mexico, or alternateports along the Gulf coast or as far away as the Pacific Northwest). Because truck and rail aresignificantly more costly than barge transport, shifting bulk commodities to truck- or rail-basedroutes can substantially raise the cost of moving grain and result in a widening basis and fallingprices in interior positions.

Government Policies. Several of the major fieldcrops grown in the United States (including wheat, corn, barley, sorghum, oats, rice, soybeans,peanuts, and cotton) receive support under different types of government programs. (5) Annual direct commoditypayments have averaged over $18 billion in the United States during the eight-year period,1998/1999 to 2005/2006. (6) The intended function of government programs vary from direct price support under commodity loanprovisions to conservation management. Because of their influence on per-acre returns, governmentprograms play an important role in the crop selection and marketing decisions of agriculturalproducers.

The degree of influence of government programs varies greatly from commodity tocommodity. But, in general, government programs increase the incentives to produce the cropreceiving support. As a result, the supply of government-supported crops available to the markettends to be larger than the supply actually demanded by the market under the supply and demandconditions that would prevail in the absence of government programs. The consequence ofover-supply is lower price.

The United States is not alone in the support it provides through government programs to itsagricultural sector. (7) Mostof the other major agricultural producing countries provide some form of support, although in manycases it is in the form of border protection (via tariffs, quotas, and other import restrictions),state-sanctioned monopolies (e.g., the Canadian Wheat Board), rural infrastructure development, oragricultural research rather than direct payments.

Key Role of Market Information

Commodity prices reflect the equilibrium between supply and demand at a particular locationfor a given moment in time. However, the market equilibrium and its associated price level areconstantly changing as new information is received by market participants. The tremendous breadthof relevant information spanning global markets would appear to give an advantage to the largemulti-national agricultural-based companies such as Cargill, Archer Daniels Midland, and Bungethat have employees monitoring crop and market conditions in all of the major grain and oilseedproducing countries worldwide. However, there are three principal sources of market information(described briefly below) that at least partially offset the information advantage of the largemultinational agri-corporations.

Agricultural Commodity Futures Markets. Commodity futures markets function as a central exchange for domestic and international marketinformation and as a primary mechanism for price discovery. Because they reflect domestic andinternational market conditions, futures contract price movements implicitly convey informationabout international supply and demand conditions. This price-based market information functionis described in more detail below in the section "Commodity Futures Markets."

U.S. Department of Agriculture (USDA). USDAattempts to level the "information" playing field for market participants by publishing timely U.S.and international crop supply, demand, and price projections for major U.S. program crops, as wellas for several livestock production activities. USDA's market information reporting process isdescribed in more detail below in the section "USDA Market Information."

Private News Services. In addition to USDA'scommodity market information activities, a large network of private sector, fee-based agriculturalmarket news and information services (including weather information services and commoditymarket reporting services) have developed since the early 1970s to complement and enhance USDA'scommodity reporting.

Commodity Futures Markets

Overview

A distinguishing feature of the U.S. and international commodity markets is the importanceof futures markets. Unlike cash markets which deal with the immediate transfer of goods, a futuresmarket is based on buying (or selling) commodity contracts at a fixed price for potential physicaldelivery at some future date. (8) Agricultural commodity futures contracts are traded on severalcommodity exchanges in the United States and overseas ( Appendix Tables 1 and 2 ).

Each exchange publishes information on the months for which futures contracts are available,the contract size, deliverable grades, trading hours, contract period, minimum price fluctuations,daily price limits, and margin information. (9) A futures contract specifies the grade, quality, amount, andconditions for product delivery (including acceptable delivery locations), as well as the deliverymonth. In most cases, various product grades are deliverable in lieu of the contract's base grade ortype, but subject to price premiums and/or discounts. The contract specifications are written toensure that they closely mirror cash market conditions, and the months of trading are usually selectedbecause of their significance in the crop marketing year. (10)

A futures exchange provides the facilities for buyers and sellers to trade commodity futurescontracts openly, then reports any market transactions to the public. Most futures exchanges publishdaily information on the open, high, low, and closing price of active futures contracts, as well as ontheir volume (reported as either the number of contracts or the total of physical units such as bushelstraded) and open interest (the total number of futures contracts that have been entered into and notyet liquidated by an offsetting transaction or fulfilled by delivery). (11)

As a result of this activity, futures markets function as a central exchange for domestic andinternational market information and as a primary mechanism for price discovery. The reliabilityof a futures market's price discovery function is dependent on the volume of daily transactions. Thinly traded markets, as indicated by low volume, are more susceptible to price manipulation thanare heavily traded ones. In such situations, prices on the futures market may not accurately reflecteither price behavior in the cash market or expectations about the future. (12) It is not unusual for distantcontracts -- that is, futures contracts whose delivery date is a year or more in the future -- toexperience very low volume.

Publicly announced futures prices also play a critical role in facilitating seasonal marketoperations because they provide a forum for forward contracting and hedging. (13) Regional and local grainelevators rely on futures commodity exchanges for hedging grain purchases and generally set theirgrain bid prices at a discount to a nearby futures contract in areas of surplus production, (such as forcorn in the Corn Belt) or at a premium in deficit production areas (such as for corn in NorthCarolina). As a result, cash prices and futures contract prices are strongly linked, i.e., both pricescontain much of the same information about market conditions.

Speculators -- i.e., any person or entity that buys or sells futures contracts to profit fromanticipated commodity price changes in their favor -- provide an important function in futuresmarkets by expanding both the trading volume and liquidity of daily futures market transactions. Today speculators, including private investment funds, comprise the majority of market participants. The presence of many speculative buyers and sellers tends to dampen extreme price volatility andallows hedgers to buy and sell in large volume with ease. (14) As a result of speculation and hedging, most futures contractsare settled without actual delivery of the commodity.

The Price Basis

A key price relationship between the local cash price and the price for the nearby futurescontract is called the basis. The basis is defined as the difference between the cash price of aparticular commodity at a specific location and the nearby futures contract (i.e., closest contractmonth) for that commodity. For example, the basis for soft red wheat in Peoria, Illinois, on a givenday in June would be the difference between the cash price in Peoria and the July futures contractprice at the Chicago Board of Trade (CBOT) as quoted on that same day.

Under normal supply and demand conditions, the basis for a storable commodity is negativereflecting the transportation cost associated with moving the commodity from the local market tothe delivery point specified by the futures contract, and the carrying charges (storage, interest andinsurance costs) associated with holding the commodity during the time period separating the futurescontract transaction date and the delivery (or contract expiry) date. (See Figure 2 .) As a futurescontract expires and the delivery month approaches, the carrying charges go to zero and the cash andfutures prices tend to converge. At the date of actual delivery, the basis represents the puretransportation cost separating the local market from the futures market delivery point.

Figure 2. Basis Convergence

In cases where local demand exceeds local supply, whether due to a crop shortfall or a nearbyprocessing plant, the basis may be less than the transport margin or even exceed the futures marketprice. For example, local corn demand may be bolstered by the existence of an ethanol plant or amajor livestock feeding operation. Geographic basis distributions demonstrate that local corn pricesin the southern plains states (with large cattle feeding operations) and eastern seaboard states (withwidespread dairy and poultry feeding operations) routinely exceed the price of the nearby CBOTcorn futures contract (i.e., an inverted basis) by as much as 10 to 20 cents per bushel due to stronglocal demand from livestock and poultry feeding operations; whereas local corn prices in the primarycorn growing regions of the northern and western Corn Belt average 30 to 40 cents below CBOTcorn futures prices. (15)

Full carrying charges are rarely ever achieved in actual market behavior, except in periodsof substantial oversupply or excess stocks. However, the generally repetitive patterns of the basismovements for storable agricultural commodities make the basis more predictable from year to yearthan the movement of either cash or futures prices. (16) As a result, the basis enables producers and users to estimate anexpected cash price from the currently reported value of a futures contract. This predictabilitygreatly reduces the risk of using the futures market to hedge or forward contract.

Major Factors Influencing the Basis. Factorsaffecting the local basis for grains, oilseeds, and cotton are similar to the factors affecting both cashand futures prices and include 1) the overall supply and demand for each commodity by variety ortype; 2) the supply and demand of other commodities that compete for either the same land inproduction or the same dollar of consumer expenditure; 3) geographical disparities in supply anddemand; 4) transportation and transportation problems; 5) transportation pricing structure; 6)available storage space; 7) quality factors; and 8) market expectations. (17)

Inter-Contract Price Spreads

The price relationships that exist between differing futures contract months for the samecommodity are called inter-contract (or intra-market) price spreads. Under normal supply anddemand conditions, more deferred futures contracts have a premium over nearby contracts thatreflects the carrying charges of holding the commodity until the deferred contract dates. Forexample, suppose that the hypothetical cost of carrying a $4.00 bushel of wheat for one month is 3cents (calculated as: 6% annual interest charges for one month which equals 2 cents; plus insuranceand other fees of 1 cent per bushel per month). (18) Then the premium (based strictly on carrying costs) between theSeptember contract of the current year and next year's March contract would be 18 cents per bushel(calculated as: six months at 3 cents per month per bushel, equal to 18 cents).

However, "normal" conditions rarely persist and the market is always altering its expectationsof future events as new market information becomes available. As a result, price differencesbetween futures contracts rarely equate to simple carrying charges. During periods of supplyshortage, cash prices tend to rise relative to futures contract prices, and nearby futures contract pricestend to rise relative to more distant contract months. As a result, both the basis and the price spreadsbetween nearby and deferred contracts will narrow. If a severe scarcity develops, the carryingcharges may disappear or actually become negative -- a situation called an inverted market. Scarcitycauses high prices in the cash and nearby futures contracts because the market gives priority to thepresent and discounts the future.

Old-Crop/New-Crop Price Spreads

While inverted markets resulting from severe scarcity are rare, a period of normal inversion(i.e., cash or nearby futures contract prices above more distant futures contract prices) frequentlyoccurs between the last futures delivery month of one crop year (when marketable supplies are attheir lowest point) and the first delivery month of the next crop year (when supplies are expected tobe relatively abundant due to the new harvest). (19) This type of inversion is often referred to as theold-crop/new-crop inversion. For wheat, the old-crop/new-crop price spread is represented by theprice difference between the May and July futures contracts; September and December contracts forcorn; August and September contracts for soybeans; and July and October contracts for cotton.

As an example of how these price spread relationships may vary, consider theold-crop/new-crop price spreads at the three major U.S. wheat exchanges in the spring of 2004. OnMarch 1, 2004, the May (04)-July (04) price spread for Hard Red Spring (HRS) wheat at theMinneapolis Grain Exchange settled at +4 cents per bushel indicating a relatively tight supplysituation for high-protein spring wheat. In contrast, the May (04)-July (04) price spread for HardRed Winter (HRW) wheat settled at -2 cents at the Kansas City Board of Trade (KCBOT), and at-2.5 cents for Soft Red Winter (SRW) wheat at the Chicago Board of Trade (CBOT). If carryingcharges were the sole determinant then the May-June price spread would be about -5 to -6 cents perbushel. Instead, the KCBOT and CBOT old-crop/new-crop prices spreads of -2 and -2.5 cents wereless than the full carrying charges for the two-month time period separating the May and Julycontracts suggesting relatively tight supply conditions. However, the market conditions for HRWand SRW wheat appeared to be significantly less tight than for HRS which had an inverted basis of+4 cents. This example demonstrates how protein premiums plus differences in old-crop/new-cropsupplies can cause market prices to vary across both time and location. Local elevator price bidsbased off of futures market contracts can be expected to follow a similar pattern of pricedifferentials.

USDA Market Information

Introduction

USDA routinely releases a series of commodity market information reports to the publicincluding U.S. and international crop and livestock production and commodity marketing activityfor historical, current, and future time periods. USDA reports are released on a predetermined andpublically announced schedule. (20) (See Appendix Table 3 .) Commodity markets rely heavily onUSDA reports for guidance on supply and demand conditions. Most private sector market newsservices design their own reports and activities around USDA data releases, and market watchersroutinely offer their own "guesstimates" in advance of major USDA reports.

The crop estimates, projected supply and demand conditions, and farm price projectionscontained in USDA reports are used as benchmarks in the marketplace because of theircomprehensive nature, objectivity, and timeliness. The release of USDA supply and demandestimates has the potential to substantially alter market expectations about current and futurecommodity market conditions and are, therefore, closely watched by market participants. Onoccasion, when USDA estimates represent a substantial deviation from market expectationsconcerning the supply and demand conditions for a particular commodity, significant pricemovement occurs.

An annual calendar is prepared in December of each year showing the date and hour of thecoming year's data releases. The reports are released electronically from USDA headquarters inWashington, D.C. State statistical offices further facilitate transmission of the reports through localnews releases and reports.

USDA relies on a formal structure for assembling and disseminating market informationfrom across its various internal agencies. (21) The cornerstone of this process is USDA's National AgriculturalStatistics Service (NASS) which collects and publishes reports on an array of data on U.S.agricultural activities including crop area, yield, production, and growing conditions; livestock,poultry, and dairy production activities; input prices paid; farm prices received; and other agriculturaldata covering most agricultural activities undertaken in the United States. (22)

Crop Production Reports

For grains, oilseeds, and cotton grown in the United States, NASS publishes a number ofreports which estimate the production of each commodity based on data collected from farmoperations and field observations (see Appendix Table 4 ). (23) Monthly NASS CropProduction reports include estimates (for the nation and by major producing state) of harvestedacreage, yield, and production. Crops included in each month's Crop Production report vary basedon each crops seasonality of production. (24) Other crop-related NASS reports are released in accordance witheach crops production cycle as described below and in Appendix Tables 3 and 4 .

Estimates, Forecasts, and Projections. USDA'scrop reporting schedule encompasses forecasts made during the growing season and estimates madeafter harvest. Forecasts and estimates represent two distinct concepts. Estimates generally refer toan accomplished fact, such as crop yields after the crop is harvested. In contrast, forecasts relate toan expected future occurrence (but generally within the crop year as supporting data is becomingavailable), such as crop yields expected prior to actual harvest of the crop based on availableinformation such as current growing condition, measurements of fertilizer usage, etc. Projectionsare an extension of forecasts, but made further into the future -- e.g., for the next crop year (T+1) --where no objective supporting information is available. (25) Instead, projections are based on extending historical supply anddemand relationships, trade and demand patterns, and government policies into the future. Examplesof projections include USDA's 10-year baseline projections which project commodity supply-and-usebalances starting in the year T+1 and extending for an additional nine years into the future.

Crop Area. NASS conducts three major acreagesurveys in any given year (T). The prospective plantings survey in March provides early indicationsof what farmers intend to plant; the midyear acreage survey, conducted in early June, is used toestimate spring-planted acreages and acreages for harvest; and the end-of-year acreage andproduction survey is conducted after most of the field crops have been harvested.

Prospective Plantings. Field crop planted-acreageintentions are based primarily on a survey -- conducted during the first two weeks of March -- of thecurrent crop planting intentions for about 55,000 randomly-selected farm operators from across theUnited States. These estimates are published in the Prospective Plantings report scheduled forrelease at the end of each March (in accordance with a pre-announced schedule). The acreageestimates are intended to reflect grower planting intentions as of the survey period and give the firstindication of potential plantings for the year. Actual plantings may vary from intentions inaccordance with changes in weather or market conditions.

Acreage. Mid-year estimates for planted acreage aremade based on surveys conducted in early June when field crop acreages have been established orplanting intentions are firm. These estimates are published in the Acreage report scheduled forrelease at the end of each June. Winter wheat is an exception since seeding generally occurs duringSeptember-November of the preceding calendar year (T-1). The first forecast of winter wheat andrye planted area is released in January (T) in the Winter Wheat and Rye Seedings report. Anychanges in winter wheat planted acreage estimates in the Prospective Plantings and Acreage reportsare considered revisions.

Mid-year estimates of harvested acreage are based on reported acres for harvest for theearliest harvested crops, such as the small grains. The first forecast of the harvested acreage ofwinter wheat is published in the May release of the Crop Production report. The winter wheatplanted and harvested acreage is subject to revisions in the June Acreage report. The first forecastsof harvested acreage for spring wheat is published in the July Crop Production report.

For the crops harvested later in the year, such as corn and soybeans, initial estimates makenormal allowances for abandonment and acres used for other purposes. Estimates of acreage forharvest are subject to monthly revision, although they usually remain unchanged through the season. Current monthly acreage indications are obtained from the objective yield measurement program forcorn, cotton, wheat, and soybeans and for other crops from special surveys conducted when unusualweather or economic conditions could affect the acreage to be harvested. For rice, cotton, oilseeds,and coarse grains, harvested acreage is first forecast in the August Crop Production report.

Yield and Production Forecasts. The firstforecasts of yield and production are published in the May Crop Production report for fall-plantedwinter wheat (with monthly updates through October); in July for barley, oats, rye, durum, and springwheat; and in August for the remaining field crops -- corn, cotton, hay, oilseeds, peanuts, rice,sorghum, sugar cane, and sugar beets -- with monthly updates through November. Cotton yieldestimates are updated again in the December Crop Production .

Objective yield surveys are conducted during the principal growing season for cotton, corn,rice, sorghum, soybeans, and wheat in each commodities' major producing states. A forecast ofprospective yield or production on a given date assumes that weather conditions and damage frominsects, diseases, or other causes will be about normal (or the same as the average of previous years)during the remainder of the growing season. If any of these variables change, the final estimate maydiffer significantly from the earlier forecast.

Growing Conditions. In addition to the monthly Crop Production reports, NASS also publishes a weekly Crop Progress report during the principalgrowing season (April to November) including growing condition indexes for the major crops aswell as pasture and forage conditions. (26) USDA, through its Joint Agricultural Weather Facility (JAWF),also publishes weekly information on U.S. and international weather in its Weekly Weather and CropBulletin . (27) Theseweekly reports on crop progress and conditions, as well as weather, provide a basis for evaluatingcrop yield prospects across the various global production zones for each commodity. As a result,they are closely watched and reported on by other secondary market information sources.

Year-End Estimates. Year-end estimates ofacreage, yield, and production for barley, durum, oats, rye, and wheat are published in the SmallGrains Annual Summary , released at the end of September (T). For all remaining field crops,year-end estimates of acreage, yield, and production are published in the Crop Production AnnualSummary report the following January (T+1).

Market Demand Information

Demand for agricultural products originates from a broad range of sources including thelivestock sector, food and industrial processors, and foreign markets. USDA informs agriculturalmarkets about commodity demand conditions by publishing various reports on domestic use, trade,stocks, and prices for major agricultural commodities. The cornerstone of USDA market demandreports is the monthly World Agricultural Supply and Demand Estimates ( WASDE ) report -- published by USDA's World Agricultural Outlook Board (WAOB) in collaboration with otherUSDA agencies. (28) The WASDE report is released simultaneously with the Crop Production report each month in order toincorporate new NASS production forecasts into the commodity supply and demand estimates. These estimates also combine and synthesize U.S. and foreign market information and governmentprogram information assembled by the various USDA agencies.

In the WASDE report, data are assembled into brief supply and demand balances, completewith projections of the national average U.S. farm price received, for each of the major U.S.program crops (feed grains -- corn, barley, sorghum, and oats; wheat by class; rice by grain length;soybeans and its products; sugar; and cotton) for both the United States and the world with breakoutsby major foreign producer, consumer, or competitor as the case may be for each commodity. The WASDE report is supplemented by monthly commodity situation and outlook reports and annual datayearbooks for wheat, feed grains, rice, soybeans, and cotton -- published by USDA's EconomicResearch Service (ERS) -- which provide market analysis and more detailed supply and demandtables for these same crops. (29)

Domestic Use. Based on the particularcommodity being monitored, domestic use may be broken into various sub-categories such as feeduse, seed use, and food and industrial use. Market information for this diversity of potential demandsources is less survey-based and less systematic than the information provided by USDA's manycrop-production related reports.

Stocks. The Grain Stocks report -- published quarterlyin January, March, June, and September by NASS is based on surveys of farmers and elevatoroperators. The Grain Stocks report covers all wheat, durum wheat, corn, sorghum, oats, barley,soybeans, flaxseed, canola, rapeseed, rye, sunflower, safflower, and mustard seed. A separate RiceStocks report is issued in January, March, August, and October. These reports are closely watchedby market observers as an important first indicator of U.S. domestic demand. Although the stocksreport is intended to estimate the amount of grain stored on and off farms at different points duringthe marketing year, quarterly usage may be approximated as the difference between the currentquarter's stocks and the previous quarter's stocks.

Feed Use. No survey of feed use is undertaken byUSDA; however, several USDA reports provide information about the potential for feed demand aswell as the prices and availability of substitute feeds. Three specific NASS reports -- the monthly Cattle on Feed report, the quarterly Hogs and Pigs report, and the monthly Poultry Slaughter report-- provide information about the location and sizes of animal populations during certain periods ofthe year. These reports are supplemented by the monthly Livestock, Dairy, and Poultry Outlook report published by ERS that presents detailed economic analysis of the implications of NASSlivestock reports. The NASS Weekly Weather and Crop Bulletin , with its index on the quality ofpastures, provides an indication of grazing availability -- an important offset to feedlot use and feeddemand.

Seed Use. Seed demand is directly related toplantings and will, therefore, move up or down with changes in the projections for crop area planted. However, seed use traditionally represents such a small portion of total disappearance that anychanges to expected seed demand rarely, in and of themselves, elicit a market response. Both the WASDE report and ERS commodity outlook reports provide data on seed use for various (but notall) crops.

Food and Industrial Use. Projections of food andindustrial use tend to be fairly stable and, therefore, more predictable than feed use or exportdemand. In most cases a simple trend line is used to predict future food and industrial demandlevels. This results, in large part, because primary agricultural products usually represent only a verysmall portion of the final cost of most processed products, whether it be a food product such as a loafof bread, a box of breakfast cereal, or a jar of baby food; or an industrial product such as soap orpaint. As a result, changes in this demand category are rarely unexpected, and rarely produceunexpected market price movements.

Basic data for industrial use comes from the Census Bureau's survey of manufacturingindustries which is issued every five years. Industry reports such as the Milling and Baking News provide information on demand for wheat and other cereals by food processing sector. Similarly,specific agricultural processor's associations, such as the National Oilseed Processors Association(NOPA), provide information on processing capacity and use. In recent years, federal support forethanol production has promoted industrial use of corn and some sorghum. (30) However, this newdemand is largely recognized by the marketplace (with announcements of financing and constructionof new processing plants) well before it plays a role in boosting demand, thus mitigating itsshort-term price impact.

Export Demand. Since the market events of1972, most market observers consider exports to be the great uncertainty underlying commoditysupply, demand, and price forecasts. (31) In 1972, the Soviet Union made unexpected purchases of largeamounts of U.S. grain. Prices for corn, wheat, and soybeans climbed to record-levels in 1973, thento still higher levels in 1974. Congress responded by mandating export sales reporting by USDAbeginning in 1973. (32)

Today, there are three primary data sources which monitor the U.S. trade situation andunderlie USDA projections of U.S. agricultural trade.

The weekly Export Sales report published by USDA's Foreign AgriculturalService (FAS). The Export Sales report indicates the amounts of major U.S. agriculturalcommodities that have been exported, as well as outstanding sales which have been contracted forbut not delivered, during the current marketing year compared with the same period from theprevious marketing year. (33)

The weekly Grains Inspected for Export report issued by USDA's AgriculturalMarketing Service and based on inspections undertaken by the Federal Grain Inspection Service ofUSDA's Grain Inspection, Packers, and Stockyards Administration. (34)

The Census Bureau (Department of Commerce) which issues a monthly exportreport that indicates not only grain exports, but also product exports including soybean meal and oil,and wheat flour. (35) Atthe end of each commodity's marketing year, the Census Bureau export data become the officialUSDA export estimate.

The Census Bureau data are released with a nearly two-month lag; for example, export datafor the month of January is not released until mid-March. As a result, both the Export Sales and the Grains Inspected for Export reports are closely watched for clues about the likelihood of meetingcurrent USDA export forecasts -- shortfalls or excesses reflect unexpected changes in commoditysupplies and their related price forecasts. Many market information services routinely publish theirown forecasts of weekly grain sales and inspections ahead of the release of the official reports. Market prices have been known to react to significant differences between the average of expectedweekly exports by private forecasters and the actual weekly export announced in the official USDAreports.

In addition to monitoring U.S. agricultural trade, FAS routinely monitors and reports oninternational commodity market conditions through an international network of agricultural attaches. Although their data are not considered official, FAS attache reports -- which provide detailedcountry- and commodity-specific market information for major foreign countries -- are regularlypublished and made available to the public. (36) In addition, FAS's Production Estimates and Crop AssessmentDivision (PECAD) provides regular reports on foreign and world crop area, yield, and productionestimates. (37) Variouscommodity divisions within FAS also produce monthly circulars on international market conditionsfor grains, oilseeds, cotton, and other commodities. (38)

U.S. Government Program Activity

In addition to crop production and marketing demand information, government programactivity can have a significant influence on market prices. Several USDA agencies monitor andreport on market-relevant government program activity. USDA's Farm Service Agency (FSA)provides information on government price and income supports, government stock-holding activity,and participation in the Conservation Reserve Program. (39) The Risk Management Agency (RMA) of USDA oversees andreports on the implementation of government-subsidized crop insurance. (40)

The various crop-specific subsidies and price and income supports provided under thesegovernment programs play an important role in producer planting decisions by altering the relativeprofitability of different crops in different regions. The Conservation Reserve Program also has animportant effect on agricultural production because it removes large tracts of cultivable land fromproduction for extended periods of time. (41) USDA's FAS monitors and reports on U.S. food aid programs,as well as on government programs that promote or assist U.S. agricultural exports. (42) Government-assistedexports draw from U.S. agricultural supplies and tend to support market prices. An unexpectedlylarge shift in program exports can alter market expectations and prices.

Market Price Information

USDA projects the season-average farm price (SAFP) for all major program crops containedin the WASDE report except for cotton. (43) The SAFP projection is usually presented as a range of high andlow values that is tightened with each succeeding month until a single point estimate is reported nearthe end of each commodity's marketing year. Market observers and the various private marketinformation services tend to use the mid-point of the USDA projected SAFP range as a referencepoint from which all comparisons are made (such as "too high" or "too low").

In support of the SAFP estimates reported in the WASDE report, NASS releases a monthly Agricultural Prices report that contains monthly and marketing year average prices received(weighted by the monthly share of annual marketings) for most major crops at both the national andstate level for major producing states.

USDA's Agricultural Marketing Service (AMS) provides a portal to price and marketinformation for a range of agricultural commodities. (44) The Livestock and Grain Market News Branch of AMS monitorsand reports on: cash, barge, rail, and truck bids for grains and oilseeds at major terminal and exportmarkets, including barge loading positions on the Mississippi, Ohio, and Illinois Rivers and atCentral Illinois (Decatur) corn and soybean processing location; nearby futures contract prices andcash-to-futures basis; and recent export sales by grain type with details on tonnage and delivery datesin the Daily Grain Review , Export Grain Bids , Daily National Grain Market Summary and WeeklyNational Grain Market Summary reports. (45)

Ending Stocks as a Summary of Market Conditions

USDA projects season-ending stocks for all major program crops contained in the monthly WASDE report. Ending stocks are calculated as the difference between total supplies (beginningstocks plus production plus imports) and total disappearance (all domestic uses plus exports). Assuch, season-ending stocks of an annually produced commodity summarize the effects of both supplyand demand factors during the marketing year.

In the early months of the marketing year, when most components of the supply and demandbalance sheet are being forecast rather than estimated, expected ending stocks -- expressed as a ratioover expected total use -- are frequently used as an indicator of a commodity's expected priceoutcome by USDA and other market observers. (46) For most seasonal commodities, annual prices tend to have astrong negative correlation with their ending stocks-to-use ratio. (See Figure 2 for an example.) As a result, expectations for high stocks relative to use typically result in lower prices, whileexpectations for low stocks relative to use tend to raise prices.

Figure 3. Season-Average Farm Price Received for All Wheat vs.End-of-Year Stocks-to-Use Ratio

A certain amount of stocks at the end of the marketing year are necessary to provide acontinuous flow of grain to processors and exporters before the new crop is harvested. These stocksare referred to as pipeline supplies. Although there is no hard and fast rule on what volume of stocksrepresents pipeline levels for the major grain and oilseed crops, whenever stocks approachhistorically low levels market analysts speculate about what pipeline-stock levels might be. Forwheat, pipeline stocks are thought to be in a range of 350 to 400 million bushels; for corn, 400 to 500million bushels; and for soybeans, about 150 to 200 million bushels. Whenever USDA ending stockprojections approach these levels, market prices become very sensitive to unexpected market newsand prices tend to be more volatile than during periods of abundant stocks.

Overview of Commodity Markets

Macroeconomic Linkages to Commodity Markets

Long-run commodity demand is driven, in large part, by population and income dynamics. A country's demographic make-up by age and ethnicity may play a large role in determining foodneeds and preferences. However, demographic changes generally occur slowly and in accordancewith well-know behavioral patterns. Similarly, per-capita income growth usually trends upward ordownward gradually and predictably with the national economy. As a result, short-term pricemovements are rarely driven by either of these phenomena. However, an important exception is the1997 Asian financial crisis which dramatically and quite suddenly curtailed commodity importdemand in several major agricultural importing countries of East and Southeast Asia. (47) The 1997 Asian crisiscontributed significantly to the price declines in most international commodity markets of the late1990s.

Changes in currency exchange rates between trading nations can occur more suddenly andcan have significant effects on international trade and prices. For an exporting country, a devaluationof its currency against other exporting countries has the same effect as a lowering of its export priceagainst those competitor nations, thereby making its product more competitive. In contrast, for animporting country, a devaluation of its currency against the currency of exporting nations will makeproducts from those exporters more expensive, thereby lowering its import demand. Currencyappreciation will have the opposite effect. Currency exchange rate fluctuations and their economicimplications are not unique to agricultural commodities, but affect all goods and services tradedbetween nations. (48)

Special Considerations for Agricultural Markets

In general, agricultural commodity prices respond rapidly to actual and anticipated changesin supply and demand conditions. However, certain characteristics of agricultural product marketsset them apart from most non-agricultural products and tend to make agricultural product prices morevolatile than are the prices of most nonfarm goods and services. (49) Three such noteworthycharacteristics of agricultural crops include the seasonality of production, the derived nature of theirdemand, and generally price-inelastic demand and supply functions.

Seasonality. Most agricultural crops grown intemperate-zone countries like the United States where freezing winters limit crop production to a 6-to 9-month period (the growing period is shorter at higher latitudes) have strong seasonal productionpatterns. As a result, the biological nature of crop production plays an important role in agriculturalproduct price behavior.

In particular, the production of spring-planted crops has a lag in its response to marketsignals. Producers must make their planting decisions by early spring in order to purchase the seedand other inputs needed for production. However, producers do not receive a price for theirproduction until after the harvest when ownership of the physical commodity is transferred. (50) As a result, growers'planting decisions are based partly on their expectations about future yields, prices (of both outputsand the inputs needed to produce those outputs), and government program support rates foralternative production activities. Also, expectations concerning international market conditions andthe possibility for unexpected changes in the trade outlook are often relevant for most major U.S.field crops.

A region's agronomic conditions, such as weather and soil types, may influence the viabilityof producing a particular crop or undertaking a livestock activity; however, expectations of marketconditions such as harvest-time output prices influence the final choices. As a result, changes in theexpected supply and demand of crops or other activities that compete for land, or of other foodsources that compete for demand can ripple through the various agricultural markets, thus alteringprices. Furthermore, since the end result of a planting-time production decision does not materializeuntil several months later at harvest time, it is possible that market conditions will have changedsubstantially or that a producer's actual production may be very different from the plannedproduction due to unexpected variations in weather, pests, diseases, or other circumstances.

Derived Nature of Many Agricultural ProductPrices. Demand for agricultural products originates with consumers who use thevarious food and industrial products that are produced from "raw" or unprocessed farm commoditiessuch as grains, oilseeds, and fiber. At the consumer level, such final demand is referred to asprimary demand. The term "derived demand" refers to demand for inputs that are used to producethe final products. (51) For example, corn and other feedstuffs are important inputs in the livestock industry; wheat is usedto make various bakery products; and cotton is used in the production of textiles. Thus, the demandfor corn, wheat, and cotton is derived from the demand for their various end products. Similarly, thedemand for soybeans is derived from the demand for soybean meal and soybean oil -- the majorproducts obtained from crushing soybeans.

A diner at a restaurant may be seeking a particular flavor or texture in her steak whichresonates back through the supply chain to the feeding decisions made at the ranch or feedlot wherecattle are fattened and readied for market. As a result, the potential buyers of raw agriculturalcommodities are generally seeking a particular end-use characteristic. For example, a livestockfeeder is generally trying to obtain the least-cost set of feed ingredients that yield a particular balanceof protein, energy, fiber, and other nutrient components. A baker or miller might be looking forparticular baking or milling qualities in their wheat purchases.

It is possible for the overall supply of a generic commodity to be in abundant supply, whilea specific variety of that commodity possessing the desired end-use traits may be in short supply. As a result, substantial price premiums and discounts may develop based on the commodities'end-use characteristics. This occurs frequently in the wheat market where the different wheatvarieties have very unique baking and milling characteristics. But it is also not uncommon in othergrain and oilseed markets, e.g., rice (based on grain length), corn (based on color, and oil or starchcontent), soybean (based on protein or oil content), barley (based on malting quality), etc.

Price-Inelastic Demand and Supply. In general,the demand and supply of farm products, particularly basic grains and oilseeds, are relativelyprice-inelastic (i.e., quantities demanded and supplied change proportionally less than prices). Thisimplies that even small changes in supply can result in large price movements. As a result,unexpected market news can produce potentially large swings in farm prices and incomes. Thisprice dynamic has long been a characteristic of the agricultural sector and a farm policy concern.

The supply elasticity of an agricultural commodity reflects the speed with which new suppliesbecome available (or supplies available in the marketplace decline) in response to a price rise (fall)in a particular market. Since most grains are limited to a single annual harvest, new supply flowsto market in response to a post-harvest price change must come from either domestic stocks orinternational sources. As a result, short-term supply response to a price rise can be very limitedduring periods of low stock holdings, but in the longer run expanded acreage and more intensivecultivation practices can work to increase supplies.

On the other hand, when prices fall producers might be inclined to withhold their commodityfrom the market. The cost of storage, the length of time before any expected price rebound, theanticipated strength of a price rebound, and a producer's current cash-flow situation combine todetermine if storage is a viable alternative. If a return to higher prices is not expected in the nearfuture, storage may not be viable and continued marketings may add to downward price pressure.

Similarly, demand elasticity reflects a consumer's ability and/or willingness to alterconsumption when prices for the desired commodity rises or falls. Consumers consider bothown-price and cross-price movements of complementary and substitute products in making theirexpenditure decisions. Willingness to substitute another commodity when prices rise depends onseveral factors, including the number and availability of substitutes, the importance of thecommodity as measured by its share of consumers' budgetary expenditures, and the strength ofconsumers' tastes and preferences. Since the farm cost of basic grains generally amounts to a verysmall share of the retail cost of consumer food products, changes in grain prices generally have littleimpact on retail food prices and therefore little impact on consumer behavior and correspondingfarm-level demand. For example, grain is estimated to account for only a 5% share of the retail priceof a one-pound loaf of bread. (52) A 20% rise in wheat prices would translate into only about a 1%rise in the price of a loaf of bread. Few consumers would notice a 2-cent increase in the price of a$2 loaf of bread.

Figure 4. Price Changes Due to a Supply Shift Are Larger thanQuantity Changes under Inelastic Demand Curves

Figure 4 displays examples of both inelastic and elastic supply and demand curves. Thediagram on the left-hand side of Figure 4 shows fairly price-unresponsive (i.e., inelastic) demandand supply curves -- typical of those associated with most seasonal agricultural markets. A suddenoutward shift (i.e., expansion) in demand from D 1 to D 2 moves the market equilibrium outward alongthe supply curve S. This change in market equilibrium results in only a modest percentage changein the quantity supplied to the market, ÎQ/Q, compared with a much larger percentage increase inprices, ÎP/P. A similar large price change is obtained from a sudden shortfall in supplies representedby a leftward movement of the supply curve. In contrast, greater than expected supply (representedby a rightward shift of the supply curve S) would lead to a large drop in the market price (ignoringthe effects of government programs).

The diagram on the right-hand side of Figure 4 displays more responsive (i.e., more elastic)demand and supply curves -- typical of those associated with many higher-valued, non-agriculturalmarkets. For comparative purposes, assume the same sudden outward shift in demand from D 1 toD 2 moves the market equilibrium outward along the supply curve S. Here, however, the change inmarket equilibrium results in a much larger percentage change in the quantity supplied to the market,ÎQ/Q, compared with a smaller percentage increase in prices, ÎP/P.

Increasing demand for grains and oilseeds by the industrial processing sector, whether fromfood or biofuels processing industries or from expanding industrial hog and poultry operations,further reinforces the general price inelasticity of demand for many agricultural commodities. Industrial use of grains is generally less sensitive to price change since, as with retail food prices, theprice of the agricultural commodity usually represents only a small share of overall production costsof the finished product. Furthermore, industrial users have generally made tremendous investmentsin plant equipment and machinery, and must continue to operate at some minimal level of capacityyear-round as a return on that investment.

In contrast, feed demand for grain and protein meals, particularly for cattle feeding in theSouthern and Central Plains States, is far more sensitive to relative feed grain prices, since similarfeed energy values may be obtained from a variety of grains. Cattle feeders in these regions haveconsiderable leeway to vary the shares of different grains in their feed rations as relative priceschange.

In general, inelastic demand and supply responsiveness characterizes most agriculturalproducts. However, distinct differences in the level and pattern of responsiveness do exist acrosscommodities. Some of these differences are briefly introduced below.

Wheat

Background. Wheat is grown in almost everytemperate-zone country of North America, Europe, Asia, and South America. The largest wheatproducing countries are China, India, the United States, Russia, Canada, and Australia. U.S. wheatproduction accounts for about 9-10% of world production; but the United States is the world'sleading wheat exporter with roughly a 25% share of annual world trade. However, the internationalwheat market is very competitive and foreign sales often hinge on wheat variety and productcharacteristics as well as price.

The U.S. marketing year for wheat runs from June 1 to May 31. (53) U.S. wheat is producedas both a winter and a spring crop. Winter wheat is usually seeded in September or October of thepreceding year. The United States produces all six of the world's major wheat classes -- hard redwinter (HRW), hard red spring (HRS), soft red winter (SRW), hard white, soft white, and durum. Hard wheats generally contain higher protein levels -- a desirable trait for bread making, while softerwheats may be preferable for making noodles, crackers, and pastries. Durum wheat is ground intoa coarse flour called semolina that is used for making pastas. In local markets, the demand for aparticular wheat class (and quality) relative to its nearby supply will determine local prices. However, linkages to national and global markets bring a variety of additional factors -- such astransportation costs, competitors supplies, and foreign demand -- into play in determining the priceof a particular wheat type and quality.

Wheat is the principal food grain grown in the United States; however, a substantial portion(8%-10%) of the annual U.S. wheat crop is used as a feed grain. As a result, wheat must competewith other cereals for a place at the consumer's dinner table, while also vying with coarse grains andother feedstuffs in livestock feed markets. Almost half of the U.S. wheat crop is exported annually,although the importance of exports varies by class of wheat. White wheat and HRS wheat rely morethan other wheat classes on sales into export markets. The larger the share of exports to production,the greater the vulnerability to international market forces.

In the U.S. domestic market, flour millers are the major users of wheat, accounting for over70% of primary domestic wheat processing in 2000 and 2001. (54) In most cases, a wheatbuyer at a flour mill will "source" wheat by general location and primary quality attributes such asprotein quantity and quality (i.e., gluten share), and baking performance. Price premiums and/ordiscounts reflecting quality differences often develop and can also influence buyer preferences. Othermajor wheat processors include breakfast food, pet food, and feed manufacturers. Wheat may beused directly in feed rations when alternate feedstuffs are lacking or when production-related qualitydamage makes the wheat unmarketable as a food. Wheat milling by-products such as bran, shorts,and middlings are also used by feed manufacturers in the production of animal feeds. (55)

Key Market Factors. Several factors that aresomewhat unique to the wheat market suggest that the U.S. wheat market structure has greater supplyand demand elasticity than most other field crops. In other words, wheat supply and demand appearto respond faster than the supply and demand of other grains when confronted with some externalshocks such as a crop failure in a competing exporter country or a financial crisis in a majorpurchasing country. Thus, wheat prices are generally subject to less dramatic price swings than mostother grains. (56)

These characteristics include the confluence of food and feed markets; seasonal differencesbetween U.S. winter and spring production; seasonal differences between northern and southernhemisphere crops; a large number of foreign export competitors, and U.S. government food aidprograms which rely heavily on wheat.

First, the feed potential of wheat can dampen wheat price variability, either preventing pricesfrom falling too low by introducing an additional source of demand or by shutting off that samedemand source when prices rise too high relative to other feed grains. For example, if wheat pricesfall too low, wheat begins to compete with traditional feed grains (e.g., barley, sorghum, oats, andcorn), particularly in the Southern and Northern Plains States where local feed grain production isfrequently insufficient. On the other hand, as wheat prices rise above a certain threshold in relationto feed grains, livestock feeders are quick to reduce the share of wheat in their feed rations thusremoving demand pressure underlying the wheat price rise.

Second, U.S. wheat production is marked by two independent seasons, winter and spring,with planting periods nearly six months apart. If it is apparent that winter wheat acreage issubstantially below market expectations due to prevented plantings or that expected yields havesuffered due to unusual winter weather during the October-March period, some of the potentialproduction losses can be offset by increased spring wheat plantings. Given the correct price signalsrelative to other crops, spring wheat can crowd out other spring-planted crops that compete for thesame acreage (e.g., barley, sorghum, sunflowers, soybeans, or corn). Or fallow acreage -- rotatedout of production to rebuild soil moisture -- can be prematurely brought back into production in thespring provided prices are attractive.

Third, two of the U.S.'s major wheat export competitors -- Australia and Argentina -- are inthe southern hemisphere where their production runs on a cycle that is offset by about six monthsfrom the U.S. cycle. As a result, Argentina and Australia have the opportunity to expand plantedwheat acreage in response to supply and demand circumstances in the United States within the samemarketing year, dampening the potential year-to-year variability of prices in the U.S. andinternational market. While this potential additional supply limits price rises, it may deepen pricedeclines because high storage costs and limited storage capacity in those countries frequently pushtheir surplus production into international markets even when prices are low.

Fourth, the potential for surplus production to enter agricultural markets from severalcompeting wheat exporter nations (principally Canada, Argentina, Australia, the EU, and the BlackSea region) increases the supply responsiveness of wheat beyond that of other major grains. Forexample, U.S. corn generally faces direct export competition from only two countries, Argentina andChina.

Fifth, most government export programs have been directed at wheat and have dampenedprice variability in much the same manner as feed demand -- they introduce an additional source ofdemand that offsets price declines. Because export programs are funded to deliver a fixed value ofcommodities, the volume of U.S. program grain exports rises during periods of excess supply andlower prices, but falls when supplies are tighter and prices higher.

In summary, the price sensitivity of wheat feeding and government export programs, coupledwith the opportunity for U.S. spring wheat growers and southern hemisphere producers to respondto northern hemisphere winter wheat conditions, provides an important stabilizing effect on U.S.wheat market prices in the face of variable world demand.

Corn

Background. Like wheat, corn is grown in almostevery temperate-zone country of North America, Europe, Asia, and South America. However,global corn production is less well distributed than wheat, and only a few countries tend to dominateproduction and trade in corn. Three countries -- the United States, China, and Brazil -- account fortwo-thirds of world production. The United States is the dominant corn exporter with a two-thirdsshare of world markets. China and Argentina account for another 20% share of world trade. TheUkraine, Brazil, and the Republic of South Africa are inconsistent exporters, but have shown anincreasing trend since 2000. This small pool of potential exporters can make international cornprices vulnerable to a weather disruption in one of the major exporter countries.

The U.S. marketing year for corn runs from September 1 to August 31. (57) Corn is the most widelyproduced feed grain in the United States, accounting for more than 90% of total value and productionof feed grains. Other U.S. feed grains include grain sorghum, barley, and oats. Around 80 millionacres of land are planted every year to corn, making it the single largest crop grown in United States. A majority of the U.S. corn crop is grown in the traditional Corn Belt region encompassing a swathof states running from Ohio westward through Indiana, Illinois, Iowa, southern Minnesota, northernMissouri and into the eastern Dakotas and Nebraska.

Since 2000, about 58% (on average) of the U.S. corn crop has been fed to livestock as aprimary energy source. Another 24% has been processed into a multitude of food and industrialproducts including starch, sweeteners, corn oil, beverage and industrial alcohol, and fuel ethanol. Finally, about 18% of U.S. corn production has been exported into international markets.

Key Market Factors. As a feed grain, corn mustcompete with a broad range of feedstuffs including other coarse grains, as well as feed wheat andin some cases low-priced protein meals. This makes feed grain markets particularly sensitive torelative prices among the various feed components. In the United States, the other two major feedgrains -- feed barley and grain sorghum -- have roughly 95% of the feed value of corn. (58) As a result, they are oftenpriced against corn futures on the basis of their relative feed value.

Because most U.S. corn exports are destined to be used for livestock feed, U.S. corn exportsare particularly vulnerable to the availability of alternate feed sources. For example, an early harvestfreeze in late August in the Canadian prairies has been known to convert a significant portion ofCanada's high-value, high-protein wheat crop into low-priced feed grain in a single night. As such,Canadian feed wheat traditionally has been very competitive in East Asian markets, particularlySouth Korea, at the expense of U.S. corn exports. However, the extent to which corn is crowded outof certain feed markets depends on the feeding operation involved. Some livestock species, e.g.,feeder cattle or dairy, are better able to adjust to feed rations than others, e.g., swine or poultry whichare more corn-dependent.

A factor of growing importance in U.S. corn markets is the increasing use of corn for ethanolproduction. This growth has been supported by several national and state programs. (59) An increase in the shareof total demand attributed to industrial use could lead to greater price variability in the face ofweather-driven supply shortfalls. In the 2005-2006 marketing year, USDA projects that 15% of U.S.corn production (or about 1,575 million bushels) will be used for ethanol production. This compareswith a 4% share in 1990/1991 and a 6% share in 2000/01. Continued growth in corn-based ethanolproduction without concomitant growth in corn production will tend to support prices and possiblysqueeze U.S. corn out of price-sensitive feed and export markets. (60)

Rice

Background. Rice is the most important foodstaple for much of the world's population, particularly in Asia and parts of Africa and the MiddleEast. Rice is produced and consumed throughout the world in climates that range from temperateto tropical. However, Asian rice production accounts for nearly 90% of global rice production withtwo countries -- China and India -- accounting for over half.

U.S. rice production generally accounts for a very small share (less than 2%) of worldproduction. However, the United States exports nearly half of its annual production. As a result,the United States is among the world's leading rice exporting nations, traditionally behind Thailandand Vietnam. India, Pakistan, China, and Egypt are also important rice exporting nations.

In the United States, the marketing year for rice runs from August 1 to July 31. (61) Domestic productiongenerally uses slightly more than half of the U.S. crop every year. U.S. rice use falls into three majorcategories: table rice used directly as food; rice processed into other types of consumables such assnacks or ready-to-eat meals; and rice used in the brewing industry.

Key Market Factors. Only a small share,estimated at about 6%, of global rice production enters world markets. As a result, the very limitedamount of rice entering world markets (24-28 million metric tons annually) relative to the large levelof annual world consumption (roughly 415 million metric tons) makes the international rice marketfairly sensitive to an unexpected production shortfall in one of the major exporting or consumingcountries, particularly if the lost production must be made up by importing rice from the internationalmarketplace.

In world markets there are two principal types of rice -- long grain (indica) and short grain(japonica) -- each with very specific cooking qualities and appearance. Consumers tend to have strictpreferences for one or the other and rarely switch. As a result, it is not uncommon for overall worldrice supplies to be in surplus while supplies of one or the other type of rice may be in short supplyrelative to market demand. The United States produces and exports both indica and japonica typesof rice.

Rice processing further differentiates rice products and markets. Rice quality is oftenassociated with the degree of polishing (removing the hull and bran layers) or whiteness of the grainand the percentage of whole versus broken grains. Both of these attributes are highly dependent onmilling infrastructure -- a market feature that the U.S. rice industry has used to its advantage tocompete in international markets. Parboiling rice (a process of steeping, then precooking rough riceunder pressure with its bran hull rice, then removing the hull through abrasion) results in a productthat is preferred by certain markets (e.g., Saudi Arabia, the Republic of South Africa, and Nigeria).

Cotton

Background. Cotton is the single most importanttextile fiber in the world, accounting for over 40% of total world fiber production. (62) While some 80 countriesfrom around the globe produce cotton, the United States, China, and India together provide over halfthe world's cotton. About one-third of annual world production is traded in international markets. The United States, while ranking second to China in production, is the leading exporter, accountingfor over one-third of global trade in raw cotton.

The U.S. marketing year for cotton runs from August 1 to July 31. The U.S. textile industryhas been in decline for the past decade. As a result, domestic use of cotton has represented adeclining share of annual production and the U.S. cotton sector has increasingly turned tointernational markets to sell its output. Since 2002/2003, slightly more than 60% of the U.S. crophas been exported.

Key Market Factors. Cotton competes withseveral other fibers in U.S. and international textile markets. Cotton's principal competitor ispolyester, but rayon, wool, jute, flax, and silk are also used in the production of yarn for fabric. Asa result, local and international market conditions for these substitutes play a role in U.S. andinternational cotton price formation.

The phaseout of the Multifiber Arrangement (MFA) and other forces have been reshapingworld textile and cotton markets in recent years. (63) The MFA and its predecessor agreements -- through their set oftrade rules and import quotas -- directly influenced world textile and clothing trade patterns (andindirectly influenced world cotton markets) for nearly 50 years. These agreements protected U.S.and European Union (EU) textile and clothing producers from imports, but raised prices and reducedconsumption in both U.S. and EU markets.

The elimination of the MFA (concluded on December 31, 2004) is helping reduce clothingprices in the United States and the EU and causing a shift in industrial demand for cotton to China,India, and Pakistan. At the same time, world cotton consumption has accelerated along witheconomic growth since 1999, especially in developing Asia, where an emerging consumer societyis driving increases in household consumption of clothing and other cotton products. In the long run,income growth and technical change are expected to have a greater effect on world cottonconsumption than the elimination of the MFA.

Government programs such as Step-2 payments for domestic users and exports, have alsoplayed an important role in facilitating both domestic consumption and exports of U.S. cotton. (64) However, following awidely publicized ruling in 2004 (upheld on appeal in 2005) against certain features of the U.S.cotton program in a dispute settlement case brought by Brazil at the World Trade Organization(WTO), U.S. government cotton programs are likely to be altered with important potential marketconsequences. (65) TheAdministration has already announced changes to the U.S. export credit guarantee program designedto accommodate the WTO ruling, and the U.S. Congress has proposed eliminating the Step-2 userpayments in legislation that has passed both chambers ( H.R. 4241 , S. 1932 ). Conference action is pending. The effects of altering U.S. export credit guarantees and theelimination of Step-2 user payments (if enacted) are likely to reduce U.S. cotton exports and, bysoftening demand, put downward pressure on domestic market prices.

In addition to the WTO case, intense international pressure has been brought to bear uponcotton subsidies in general and U.S. cotton subsidies in particular at the on-going Doha Round ofWTO trade negotiations. It remains to be seen if these pressures will elicit further changes to theU.S. cotton program. The market effect of further reductions in U.S. cotton program support woulddepend on the specific nature of the changes and how they would be implemented.

The Oilseed Complex

Background. The demand for oilseeds is derivedprimarily from the demand for edible oils and protein meals. The international oilseed marketconsists of a large variety of oil-bearing crops produced throughout the world includingtemperate-zone crops such as canola, rapeseed, and sunflowerseed; tropical-zone crops such as palmkernel and coconut copra; and multi-zone crops such as soybeans, cottonseed, and peanuts. Mostof these crops, when crushed for their oil, also yield high-protein meals that are widely used inlivestock and poultry rations. As a result, most of them are relatively close substitutes and theirprices are strongly correlated.

Processed soybeans are the largest source of protein feed and vegetable oil in the world. Unlike many other commodity markets, only a few countries tend to dominate soybean productionand trade, making the market sensitive to any supply disruption in one of the major producingnations. Major soybean producers include the United States, Brazil, China, and Argentina whichcombined have accounted for nearly 90% of global production since 2000. Three countries -- UnitedStates, Brazil, and Argentina -- dominate world soybean trade, accounting for about 92% of soybeanexports since 2000; while two countries, the EU and China, have accounted for nearly two-thirds ofworld imports.

The U.S. marketing year begins on September 1 for soybeans and on October 1 for soybeanmeal and soybean oil. (66) Soybeans equal about 90% of U.S. total oilseed production, while other oilseeds -- such ascottonseed, sunflowerseed, rapeseed, canola, and peanuts -- account for the remainder. The UnitedStates is the world's leading soybean producer and exporter. Soybean and soybean product exportsaccounted for 43% of U.S. soybean production in 2003. In the United States, soybean oil accountsfor about two-thirds of all the vegetable oils and animal fats consumed. Similarly, soybean meal isthe dominant protein meal consumed in the United States. U.S. vegetable oil exports are heavilyinfluenced by concessional food aid to developing nations through such programs as P.L. 480. (67)

Soybean meal is the world's most important protein feed, accounting for nearly 65% of worldsupplies. Livestock feeds account for 98% of soybean meal consumption. Similarly, soybean oilis the world's largest source of vegetable oil. An important market development of the past decadehas been the phenomenal growth of soybean output and exports by Brazil and Argentina. Togetherthey currently account for about half of the world soybean export market, up from less than 15%before 1980; they have each surpassed the United States in soybean meal and soybean oil exports. Vast untapped reserves of farmland in Brazil's interior region could permit a continued significantexpansion in soybean area, production, and exports.

The tropically-produced palm oil accounts for an important and growing share of globalvegetable oil production (USDA projects a 30% share in 2005) and vegetable oil trade (a projected58% share in 2005). Malaysia and Indonesia are the world's leading palm oil producers andexporters. Indonesia still possesses substantial untapped territory for further expansion of palm oilplantations. The rapid growth in Southeast Asian palm-oil output means it will likely surpasssoybean oil's top ranking within a few years.

Key Market Factors. Because of their primaryprocessed products -- protein meal and vegetable oil -- oilseeds are affected by market conditionsin both the feed-grain and edible oil sectors of U.S. and international markets. Foreign importdemand for whole oilseeds depends on the deficit between a countries' domestic oilseed output andits consumption. Divergent requirements for protein meal and vegetable oil, as well as limits ondomestic processing capacity, determine the ratio of oilseeds to oilseed products that a country willimport.

Some oilseeds have higher oil content than others; and some oilseeds yield a higher proteincontent meal with less fiber, making them more easily digestible. For example, a unit of soybeanwhen crushed will yield, on the average, about 18%-19% oil and 74%-80% meal with about 44%protein content. Soybean meal is the most valuable component obtained from processing thesoybean, ranging from 50%-75% of its value (depending on relative prices of soybean oil and meal). As a result, an importer must weight the relative prices for vegetable oils and protein meals againstthe oil and meal yields for each type of oilseed, as well as the protein and fiber content of theresultant meal. Another consideration is fiber content. High-fiber meals are better suited forruminants (e.g., feeder cattle and dairy) than for non-ruminants (e.g., swine and poultry).

For soybean crushers, the processing decision involves choosing when to commit to buyingsoybeans (e.g., from farmers), to processing them, and to selling soybean meal and oil (e.g., to foodand feed manufacturers). The main decision variable in making binding commitments on futuredates to sellers and buyers is the gross soybean processing margin. This margin equals theper-bushel revenue of soybeans processed into oil and meal minus the per-bushel soybean price. Ifthe gross soybean-processing margin is high enough, a processor will commit soybean-processingresources for that date. If it is too low, the processor keeps the processing resources available fora future date and a higher margin.

Compared with trade in other agricultural commodities, trade in whole oilseeds, particularlysoybeans, is relatively unrestricted by tariffs and other border measures. But oilseed meals, andparticularly vegetable oils, typically have higher tariffs. Successful completion of the on-going DohaRound of multilateral trade negotiations could reduce import tariffs and quantitative restrictions toglobal oilseed product markets offering increased growth in demand.

An important demand-side market development has been the rapid growth of China's andIndia's economies which has spurred their domestic food consumption. China is now the world'sleading soybean importer, and both China and India are among the world's largest vegetable oilimporters. The EU is self-sufficient in vegetable oil production, but its protein deficit still makesit the world's largest importer of soybean meal and second-largest importer of soybeans. Changesin agricultural and trade policies for all three of these countries have greatly influenced world oilseedmarkets.

Appendix Tables

Appendix Table 1. Major Agricultural Commodity FuturesExchanges

a. The Euronext is a synthesis of stock markets within the European Union including the previous London and Paris Commodity Futures Exchanges.

Appendix Table 2. Major Agricultural Commodity FuturesContracts, Futures Exchanges, and Contract Months

Source: Compiled by CRS from sources listed in Appendix Table 1 .

na = not applicable.

a. Jan = F; Feb = G; Mar = H; Apr = J; May =K ; June = M; July = N; Aug. = Q; Sep. = U; Oct. =V; Nov. = X; and Dec. = Z.

b. Refer to the contract specification information available at each exchanges website provided in Appendix Table 1 . In general, other grades are available for delivery at quality premiumsand discounts.

c. The MGE introduced a durum futures contract in 1998. However, the durum contract was endedon March 20, 2003, due to low volume.

d. Cash settlement only, no physical delivery of the commodity is accepted.

e. For 2004, the April (J) and June (M) contract months are available.

Appendix Table 3. Annual Release Schedule for Key USDACrop and Market Information Reports

Source: USDA, NASS for Winter Wheat and Rye Seedings, Prospective Plantings, Acreage, CropProduction, Grain Stocks , and Rice Stocks reports; USDA, WAOB for the WASDE report.

a. T represents the current calendar year; T-1 represents the previous calendar year; and T+1represents the next calendar year. Season-average prices and supply-and-use balances arecalculated for a crop's marketing year, i.e., the 12-month period starting from the first harvestmonth in the crop's primary growing region. Because most of the marketing year for mostcrops extends over parts of two different calendar years, they are represented by theexpressions T/T+1. For example, the 2005-2006 marketing year is often referred to simplyas the 2005 marketing or crop year. For the specific release date of a USDA report in 2006,see a calendar of 2006 release dates at http://www.whitehouse.gov/omb/inforeg/pei_calendar2006.pdf .

b. In USDA reports the terms estimate, forecast, and projection have very distinct and differentmeanings. See section "Estimates, Forecasts, & Projections" for a description.

c. These preliminary U.S. S&U projections use: linear-trend yield forecasts; planting intentions areafrom the Prospective Plantings report; and the historical harvested-to-planted arearelationship to derive harvested area for U.S. spring-planted crops. Winter wheat harvestedarea is available from the Crop Production report for May.

Appendix Table 4. Major NASS Crop Production Reports

Acreage

Winter Wheat and Rye Seedings report (January) contains the first forecast of winter wheat and ryeplanted area.

Prospective Plantings report (end of March) is a survey of farmer planting intentions allspring-planted field crops as of early March.

Acreage report (late June) is a survey of actual and intended farmer plantings of all field crops as ofearly June. This survey represents the first area forecast for crops.

Small Grains Summary (late September) contains the first estimate of winter and spring wheatharvested area for the just-finished marketing year.

Yields

Crop Progress reports are released weekly between April and November. Each report contains state-and national-level information on:

(1) Crop progress as of the report date in terms of plantings, various plant growth stages, andharvesting. Comparisons are made with the previous week, the previous year, and thefive-year average.

(2) Crop condition rated as percent that is: very poor, poor, fair, good, and excellent.

The Weekly Weather and Crop Bulletin provides a weekly weather update for the principal cropproducing regions. It includes weather map contours and indexes for crop moisture, extrememinimum and maximum temperatures, weekly precipitation, departure from average temperature,growing degree days, and a summer review of national weather, as well as the long-term Palmerdrought severity index. In addition, the bulletin contains an international weather and crop summaryfor major foreign production regions.

Production

Crop Production reports are released monthly throughout the calendar year. Each report containsstate-by-state area, yield, and production estimates for major field and specialty crops. The cropcoverage varies in each report with a focus on those crops that are currently in an active seasonalgrowth pattern.

Prices

The Agricultural Prices report, released monthly throughout the calendar year, contains estimatesof previous month's average farm price received for major field and specialty crops, as well as forlivestock, poultry, meat, and produce. Each report also contains a preliminary farm price estimatefor the current month. Monthly average prices are weighted by marketings. Each report alsoincludes an all-farm products index of prices received and prices paid index for commodities andservices, interest, taxes, and farm wages paid. The July issue includes an annual summary.

Crop Values -- Annual Summary , released in February, includes state-by-state estimates for averageprices received and the value of production for the preceding crop marketing years for major fieldand specialty crops.

Source: USDA, NASS.