Pricing

VI. Pricing of Rice

Pricing to the Farmer. Ultimately, the world market conditions for rice determine what the miller pays the farmer for his rice. But the farmer receives additional funds from the U.S. government. Farm support programs play a very large role in what the farmer receives for his crop. In 1996, the government came out with new farm programs that; gave farmers more flexibility with the type of crop that they could grow, loosened the links between subsidies and world market prices, and provided for gradual reductions in subsidies over a seven year period. Farmers signed 7 year Production Flexibility Contracts (PFC’s). In the case of rice, farmers would be provided with a payment per cwt of rice on 85% of the contracted acreage. The payment was supposed to start at $2.77/cwt in 1996 and go down to $2.00 in 2002. These payments are limited to $40,000 per person for PFC payments and $75,000 per person for PFC payments and LDP payments. Farmers could at anytime plant crops other than rice and receive similar payments.

The government has a farm loan program is used by the farmers and milling industry to finance the rice crop. At harvest, the farmer is able to put his rice into the loan program with the Commodity Credit Corporation. The Commodity Credit Corporation essentially takes title to the farmers rice. The loan amount paid to the farmer is based on the type and quality of rice. For the 1999 crop, loan rates for long grain whole kernel are $10.66, medium grain whole kernel are $9.66, and broken kernels are $5.33. These factors are multiplied by the percentage of whole grains and broken kernels in paddy rice to determine the loan rate. For example the loan rate on a 54/68 medium grain would be $5.96. (54% whole kernels times $9.66, plus 14% brokens kernels times $5.33). So in this case, a farmer putting his medium grain in loan would receive $5.96 from the Government. If the farmer is able to sell the rice for more than loan value, he may do so and then pay back the loan to the government. If the farmer is unable to sell his rice for more than loan, then he may forfeit the rice to the government and keep his loan payment. Typically the miller offers to buy the rice at a "premium" to loan. In this example, if the miller buys the rice at a $1.00 premium over loan, then the miller pays the government back its $5.96 and pays the farmer $1.00. Or the miller could pay the farmer $6.96 and the farmer repays the government loan. Either way the farmer receives $6.96 (loan plus a $1.00 premium).

The government is calculating a world market price on a weekly basis. Values for whole kernel and brokens are calculated to a level that would allow paddy purchased at those levels to compete on the world market. When world market prices exceed loan values, the farmer is not effected. When world market prices are below loan, then the government may subsidize the difference between world market price and loan. (otherwise, the government would end up owning huge inventories of forfeited rice.) This subsidized difference is called The Marketing Loan Gain when rice is in loan or Loan Deficiency Payment (LDP) when taken by the farmer in instead of going into loan. For example, if the LDP is $1.96, then the rice in this example can be bought out of loan for $4.00. (The farmer keeps the $5.96 that he got when the rice went into loan). The LDP payment reduces the cost of rice to the miller and allows him to be competitive when selling the rice into the world market. In this case, the miller can pay a "premium" of $1.00 and only pay $5.00 for the rice (the farmer still got his $6.96 as in the previous example).

In simple terms, the total amount that the farmer receives is loan value, plus the premium that the miller pays, plus some subsidy from the government that is usually limited by $40,000 per person.

The cost of milled rice to the miller. Almost half of the rice is exported from the United States and world market prices play a great role in determining the price that the miller can pay to the grower. In the paddy market, the price that millers are willing to pay is usually described as the premium (referring to a premium over loan, or loan less LDP). The price of milled rice is related, but not perfectly correlated to the cost of paddy. The miller must buy paddy, transport the paddy, and then mill the paddy. The yield of whole kernels is only about 50% to 60%, and so the value of byproducts has a great effect on the cost of milled rice. Hulls make up 20% to 22% of the weight of paddy. Hulls can have some value, $.50 to $2.00/cwt if burned to generate electricity or sold as chicken bedding, or in some cases mills incur costs to dispose of them. Rice bran at 10% of paddy weight can be worth $1.50 to $6.00 per cwt depending on the animal feed market. Brokens usually make up 10% to 20% of the weight of paddy. The broken market is very complicated, and broken prices can be as low as $6.00/cwt or almost as high as whole kernels. (Brokens recently sold for $7.00/cwt and $15.00/cwt within the same year.) A typical cost formula for bulk milled rice would look something like the following.

Loan Rate for 54/68 medium grain rice $5.96
LDP payment (1.70)
Premium paid to grower 2.00
Freight to mill .40

Total Cost of Paddy $6.66
Cost of Milling Rice $1.60
Value of 22% hulls at $.00/cwt .00
Value of 10% bran at $3.00/cwt (.30)
Value of 14% brokens at $8.00/cwt (1.12)

Total cost into the rice, paddy basis $6.84
Divide by Milling yield 54%
Cost of bulk milled rice $12.67

Milled Prices are affected by World Market Prices. Almost half of U.S. rice produced is exported. U.S. rice commands a premium in many export markets, but this premium rarely exceeds $60 per MT, and so U.S. milled prices closely follow world market prices. This is especially true for long grain rice, since it is the most commonly grown and traded type of rice in the world. The amount of rice traded in the world is very low (less than 5% on average) and so the market fluctuates wildly. Demand is relatively steady and somewhat inelastic with regards to pricing. Supply is determined by crop conditions in the large growing countries like China, India, and Bangladesh. One year, a typhoon can damage China’s crop causing China to import rice and the milled market can go to $400.00/MT. The next year, China can have a good crop, start exporting rice and cause the market to drop to below $200.00/MT. Most people look to Thailand when referring to world market prices. Vietnam, India, and Pakistan sell at discounts to Vietnam. Long grain in the U.S. usually sells at premiums ranging from $40.00/MT to $100/MT over Thailand. In unusual years, a poor crop of long grain in the U.S. can cause the premiums to go up to as high as $100.00/MT. When the spread is too high, the U.S. will start losing customers to other country origins and so the world market price does limit the price of U.S. rice. (There are exceptions to this, as will be explained below.)

Pricing of Long Grain Rice versus Medium Grain Rice. As explained above, long grain prices tend to follow world market prices. Medium grain, particularly California medium grain is different. Consumers of Japonica type medium grain rice will not switch to long grain rice at any price. The supply/demand situation in the world can differ greatly between long grain and medium grain. Weather patterns can cause problems in large Japonica growing countries like Japan or Korea, while countries growing long grain can have excellent crops. In the United States, an unusually situation is now occurring because of government intervention (the world is rarely a free market). The Japan has been forced through the GATT agreements to import increasing amounts of U.S. rice. Japan prefers California japonica rice to other U.S. rice types (even for industrial use). This has pushed prices in California much higher than world prices and much higher than prices in the south. For crop year 1999, prices in California averaged about $6.00 per cwt higher than long grain and medium grain in the south. There is some trade off between California medium grain rice and southern medium grain rice, but not a great deal. Most consumers of table rice will not trade off between the two, but industrial users like Kelloggs (rice crispies) will switch from California to the South when large price differentials occur. Some consumers in countries like Turkey will switch when the differential is great. But the shift in demand was not enough to prevent a $6.00/cwt differential in 1999.

Can Rice Prices be Hedged? Unlike other commodities such as corn, wheat, and soybeans, rice cannot easily be hedged on the Chicago board of trade. Long grain paddy rice (it is called rough rice on the exchange) is traded on the Chicago board of Trade. There is a reasonably good correlation between rough rice futures and milled long grain rice prices. But changes in values for bran and brokens make this correlation less than perfect. Medium grain prices and broken prices have almost no correlation with the rough rice futures. Even parboiled rice prices often do not follow a predicable correlation to rough rice futures because a shortage of parboiling capacity can change the differentials.

Many industrial customers of Sage V Foods like to price their product for a year’s term. Sage often accepts this request of the customer, but the sale cannot be hedged. Someone must take the risk of price fluctuation. Either Sage V Foods or Sage’s supplier of raw rice must take the risk. Most rice mills do not like to contract out for a year, and usually charge a premium when they do so.

Broken pricing for Rice Flour. High quality broken rice is used to make rice flour. The factors that affect broken prices are fairly complicated and make for an unpredictable market. In general, animal feed prices set the floor for broken prices and whole grain prices set the ceiling.

For many years, up until about 1995/1996, broken prices were somewhat predicable and followed a pattern. During this time, Anheuser Busch was buying broken rice for use in Budweiser beer. Anheuser’s demand far exceeded supply and Anheuser operated two rice mills to produce whole kernel rice to make up for the shortage of brokens. Anheuser set the price for brokens. Obviously, they acquired brokens for as low a price as possible. The only alternative market for brokens were export markets, and so for years, broken prices in the U.S. were just high enough to prevent the exportation of brokens. World market conditions set broken prices in Thailand, and the U.S. prices followed very closely. The countries that import brokens are closer (less freight cost) to Thailand than the U.S. and so broken prices in the U.S. were slightly lower than broken prices in Thailand.

Prior to that time, domestic uses of brokens for purposes other than beer were not very large. Rice flour usage was growing, but was not a great factor in the demand equation. Then in the mid 1990’s, rice was introduced in dog foods, and "lamb and rice" formulations became very popular with consumers. The demand from dog food users and the growing demand for rice flour created competition for Anheuser and in 1997 and 1998 broken prices had moved to within two dollars per cwt of whole grain prices and started tracking whole grain prices. Whole grain rice was being ground into flour during those years.

In early 1999, Anheuser announced that they would permanently withdraw from the broken market, and the market immediately started dropping. The market is currently very unstable and unpredictable. There are three usages for broken rice. Broken rice is often blended with whole grain to make deep mixes (15% to 30% brokens) for export purposes. There is still a great demand from dog food companies, but this demand is now flat. Demand for brokens use in rice flour has become large and is growing. Demand from dog food users and flour customers are stable throughout the year, and is currently about equal to total supply of brokens. Unfortunately, supply is very unstable throughout the year as well as from year to year. The quality of the crop (milling yield) varies each year and can created big changes in the supply of brokens. The nature of the export market also causes big swings in the supply and demand of brokens. Export sales of high quality rice (less than 4% brokens) generate brokens. Exports of deep mixes utilize brokens. The U.S government exports a great deal of deep mixes for food aid programs, and the timing of these government sales (if they occur) is very erratic. When the U.S. is exporting a lot of high quality rice, the supply of brokens exceeds demand. When the U.S. is not exporting much rice or is exporting deep mixes, demand exceeds supply. Mills do not like to store broken rice and so prices fluctuate dramatically according to supply. For this reason, prices during 1999 and 2000 have not been stable from month to month.

Every year new varieties of rice are introduced in the United States, and in general, milling yields are improving. Improvements in drying and milling equipment is also reducing the percentage of brokens generated in the United States. Less high quality rice is being exported. More paddy rice and brown rice is being exported. Japan takes all the brokens generated in the milling of its rice. All these factors are causing the supply of broken rice is shrink over time. The only offsetting factor is an increase in sales of high quality domestic rice, but this is too small to offset the shrinking supply. At the same time, demand from flour milling and other users of brokens are increasing. At some point in the near future, broken prices will approach the price of whole kernels and then start tracking (within $2.00 per cwt) whole kernel prices.