Two articles last week, "State Reserves Keep Stocking up on Grain: Underground War" and "5-fen per Jin Profit Enticement: Sinograin Market Support Purchase Wheat Mystery", discussed a "wheat war"--hot competition to buy this year's wheat.
Eager subsidized government-purchasers, massive new flour mills, and older mills are competing for a wheat crop of unknown size. Farmers are reportedly holding their wheat off the market. This competition for wheat is bidding up prices, but the wheat market has become so convoluted that it's hard to tell whether this is an artificially-induced shortage.
China has had a support price for wheat since 2005. Under this program, Sinograin Co., and designated regional affiliates buy wheat for government reserves when the market price is below the support price set by authorities each year. This year, COFCO and the state-owned China Grain Logistics Group have also been approved to purchase under the support price program.
The warehouses get subsidized loans from the Agricultural Development Bank of China plus subsidies to cover the costs of purchasing and holding the wheat. A warehouse gets a free loan and a subsidy of .025 yuan for purchase cost and .035 yuan for management costs for each jin of wheat. But the actual costs are .01 yuan, so it adds .05 yuan of profit.
The warehouses find this program quite attractive, so they have been enthusiastically buying wheat to collect the subsidies. They have been so enthusiastic that "grain round-tripping" has become an "open secret" in the industry in recent years. In this practice, old grain from warehouses is sold off and then bought back as new grain through the support price program. The buyer collects the subsidies on the grain that never left the warehouse. This practice was suspected when, in 2008, Sinograin claimed that 80% of the wheat produced that year in Henan was bought through the support price program.
The support price purchase warehouses have been competing with a growing cadre of flour mills to buy this year's wheat. In past years, they would have people lined up outside the warehouse waiting to buy wheat; now they have to scramble to buy it. The support-price purchasers have set up buying stations in villages. Many new grain warehouses have been built, some nearby State warehouses. Big companies like the state-owned agribusiness giant, COFCO, and a Singapore venture, Yihai Kerry, have been opening a string of large flour mills that are competing to buy wheat. One mill in Shandong reportedly can use the county's entire wheat crop. With all these competing buyers, the result is rising wheat prices. Processors are having trouble getting enough wheat to keep their mills at capacity. Some are buying wheat from neighboring provinces.
Procurement under the support price program is supposed to cease when the price rises above the support. The price is now over 1 yuan per jin, well above the support price of .9 yuan for white wheat and .86 yuan for red wheat. Officially, Sinograin has stopped purchases, but local warehouses continue to buy. The support price purchase program is described as "out of control."
Privately-operated warehouses complain that the subsidies give the support-price purchasers an advantage. Counting on the subsidies, the support-price purchasers offer 4-to-5 fen above what private millers can pay and still make a profit. According to one article, "Everyone wants to get a piece of this 'fat meat.'"
Moreover, private flour mills complain that they can't compete with the new large companies who are willing to lose money on their "strategic investments" in the flour industry. COFCO and Yihai Kerry are engaged in processing and trading all kinds of commodities--COFCO is in all kinds of feed, grain, oils, and livestock, Yihai Kerry is primarily engaged in vegetable oils--and they are investing in upstream (their own farms and importing) and downstream (processing and distribution). Competitors in the flour industry think Yihai Kerry can't possibly make money at the prices they pay for raw materials.
The articles say that supply cannot meet demand. There are varying opinions on this year's production. Farmers think it's roughly the same as last year. Some think production is down 20%-30%. Another factor is that farmers have been hesitant to sell, either because they expect higher prices or they were too busy planting fall crops.