AUGUST 1999 Economic elements of quality in wheat buying Use net wheat pricing when buying wheat by Robert Drynan The milling industry in Latin America has undergone dramatic change in the past decade. Only a few years ago, most of the millers’ problems could be solved by negotiation with the government authorities responsible for controlling the prices of wheat and flour. Reality for the miller today is defending his customer base, investments in new equipment and technology, development of technical and administrative staff, organization of efficient systems to purchase, ship, unload and deliver wheat to their mills and managing the financing necessary to purchase wheat and carry inventories. In the past, the Latin American miller did not have to globalize his perceptions. Today, his field of operations is the world. The entry of the miller into international wheat commerce has changed his world forever, but it has also changed the world of the international grain trade. Today, in order to survive in a competitive environment, the miller must carefully assess his wheat buying — not just in terms of the price he pays, but also with a view toward conversion values into finished products, standards of quality and sanitation, planning of shipments and management costs and financing inventories. The criteria for negotiating wheat purchases are changing. The wheat exporter to Latin America also faces new challenges. His customers are greater in number, buying in smaller quantities, without established credit histories, with less experience in international trade, more demanding of quality, more price sensitive and above all, having access to more alternative sources of supply. The criteria applied to selling wheat are also changing. In the previous decade, the standard of quality in Colombia, for example, was U.S. No. 2 Hard Red Winter Wheat, 12% protein. Since that time, Colombian millers have used wheat of multiple classes and origins other than the United States, including Canadian, Australian, Argentine, European and Saudi wheat. At first the buyer’s criteria was to seek the lowest price, the same as it was for government buyers. However, after purchasing shifted to the private sector, flour extraction, cleanliness of wheat, functional quality and commercial financing also became important considerations. The miller began to seek new ways to evaluate the various offers of wheat. The "millable wheat value index" has become one such approach. As a method to screen the specifications in a wheat purchase, the MWVI permits the buyer to establish a reference value for wheat committed to the first break roll of the mill by nullifying the variables of moisture and screenings content. This concept could be called the buyers’ extraction, since it measures the repercussions of the decision of the buyer on the results in the mill. Nevertheless, the MWVI does not take into account other factors of equal or greater importance to the miller, such as potential flour extraction, the value of the recovery of screenings as millfeed and the relative values of the various finished products. Another means to assess the purchase could be the "value added computation." It takes into account moisture and screenings to determine the quantity of wheat to the first break. Afterward, using projected extractions, it arrives at a cumulative value of flours, by-products and screenings. The total, less the cost of the wheat, is the value added. The purchasing concept of "net wheat pricing" places all wheat on an equal standing. Moisture and screenings are factors of great economic importance to millers, but aside from contract specifications for maximum allowable, the content of moisture and screenings is subject to random occurrence. But, if price is calculated solely based on net wheat, excluding moisture and screenings, these factors lose their importance. This system of negotiating on the basis of net wheat will permit the miller and seller to arrive at a price that provides an economic benefit to all. As a straightforward evaluation tool, net wheat pricing can demonstrate that both parties to a sale frequently waste an opportunity for substantial gain by using standard pricing and random shipments, rather than exploiting the sellers’ capability to select wheat of superior net value for customers willing to pay for it. MILLABLE WHEAT VALUE INDEX. The presence of unmillable material and the content of moisture in wheat are important factors in purchasing decisions. The price of dry, dirty wheat can be converted to a price of wheat that has been cleaned and tempered, ready for milling. It is called the millable wheat value index or MWVI. The use of this simple index permits buyers to evaluate those factors in terms of the price they must pay for wheat. The MWVI equation (see Page 38) is a simple mathematical expression of what takes place when wheat is prepared for milling. Using the official U.S. Inspection Certificate, the equation first removes screenings — foreign material (F), shrunken or broken kernels (S) and dockage (D) — from the dirty wheat, which is expressed as 100%. Once screenings are removed, moisture must be added up to the tempering level, usually about 16%. Mathematically, the certificate moisture (M) is removed to obtain dry matter and the temper moisture (T) is added. The result is the quantity of wheat to the first break roll of the mill, or cleaned, tempered wheat (CTW). The MWVI is obtained by dividing the CTW into 100%, the ratio of millable wheat to the quantity purchased. Multiplying the MWVI by the price paid for the wheat will assist the buyer to determine the real milling cost of the wheat. VALUE ADDED COMPUTATION. The concept of value added is another method of assessing the economic potential of a wheat purchase. The miller takes into account the content of moisture and screenings in the wheat, as well as the expected extraction of flour and by-products and the prices at which the finished products are sold. The miller is able to assess the value of the wheat not only in terms of its purchase price, but also can take into account its potential yield on the mill. By computing the CTW, the miller can determine the quantity of wheat available for milling from a tonne of wheat purchased. The miller may use the normal extraction obtained from the mill or an extraction that he expects to obtain. Invisible loss also is taken into account, which might normally oscillate between 1.5% and 2.5%, depending on such factors as temper moisture, ambient conditions and the idiosyncrasies of the mill itself (not to mention the temperament of miller). For the finished product values, one may apply the official company price list, but it is preferable to make use of net prices after sales, taking into account discounts and other accommodations to customers, which might change the relative values between the milled products. The quantity of wheat at the first break roll multiplied by the extraction for each product, by the sale price of each product, is added together to arrive at the total value of a tonne of milled wheat. Where screenings are recovered by adding them to millfeed by-products or sold separately, that value should be added to the total. The miller may make an estimate of the sale value of a tonne of wheat, and subtracting the cost of the wheat from it, will arrive at the value added. This value does not take into account fixed costs for administration, financing, manufacturing and marketing. The value added in this case represents only the difference between the cost to acquire the raw material and the value received for its finished products. Calculating the value added will allow the miller to anticipate the consequences of buying his raw material solely on the basis of price, without considering its potential to yield greater value. As the saying goes, "Cheap can be expensive!" NET WHEAT PRICING. When importing wheat, the goal is to obtain wheat, not screenings and moisture. Nevertheless, the product will likely contain all three elements, and the price quoted includes the total. The presence of variable quantities of moisture and screenings tends to obscure the real price being paid for the wheat. In the following example, a shipment of wheat is bought with the following data appearing on the official export certificate: "U.S. No. 2 or Better Hard Red Spring Wheat, Dockage 0.5%, Test Weight per bushel 58.4 lbs, Moisture 11.3%, Heat Damaged Kernels 0.0%, Damaged Kernels (total) 0.3%, Foreign Material 0.1%, Shrunken and Broken Kernels 1.7%, Defects (total) 2.1%, Contrasting Classes 0.0%, Wheat of Other Classes 1.8%." The key data for net wheat pricing purposes are: Dockage 0.5% Foreign material 0.1% Shrunken and broken 1.7% Total screenings 2.3% Clean wheat 97.7% Dry basis (100%-11.3%) x 88.7% Net wheat 86.66% The wheat in this shipment represents only 866.6 kilograms in each tonne. If the market price quoted for the wheat were U.S.$147 per tonne, the real price would be U.S.$147 for 866.6 kilograms of wheat, or U.S.$169.63 for 1,000 kilograms (net wheat price). The economic consequences of apparently minor variations in the content of screenings and moisture are significant. If the moisture content were reduced by 1%, net wheat would be 876.6 kilograms. Discounting the non-wheat factors from the invoice, the buyer would pay U.S.$148.70. Nevertheless, his net wheat cost would remain U.S.$169.63. There is reasonable incentive for the buyer to encourage the seller to minimize the content of water and screenings, and maximize the proportion of wheat in the shipment. The first step would be to establish a benchmark as to the "expected" content of screenings and moisture in a shipment. This benchmark could be based on the buyer’s experience with wheat from specific origins and adjusted by up-to-date crop reports and FGIS average export data. Another approach is to request that the seller establish the benchmark. The buyer may ask the seller to indicate the absolute minimum guaranteed moisture and screening content at the stated price. The buyer can then calculate the net wheat value and provide an incentive based on the seller’s response. Once a buyer has established his benchmark, the net wheat-based counter-offer would protect him from the economic risks associated with a shipment containing more non-wheat than the benchmark, while providing the seller with an economic incentive to improve on the benchmark without additional net cost to the buyer. In fact, the buyer could improve his economic return while compensating the seller for cleaner, dryer wheat. Using the above example, which was taken from the 1997 average for 13.5% protein, HRS Pacific Northwest shipments, the buyer could make the following counter-offer: "U.S.$169.63/tonne, discount from the commercial invoice the factors Dockage, Foreign Material, Shrunken and Broken Kernels and Moisture as indicated on the Official Inspection Certificate." The counter-offer can become the basis for further negotiation. It is important for the miller to establish in advance what his net benefit will be so that the "net wheat price" assures a profitable return while furnishing the seller with an adequate incentive to ship cleaner, dryer wheat. OTHER CONSIDERATIONS. It is important to consider maximum limits of certain factors that reflect on the intrinsic value of the wheat, including numerical grade factors such as minimum test weight, heat damaged kernels, damaged kernels, total damage and wheat of other or contrasting classes. It is always best to include a maximum limit on moisture content. If protein is important, minimum or maximum protein should also be specified. The counter-offer gives the exporter an incentive to ship the cleanest, driest wheat in his inventory. The buyer pays a higher "gross price" if the proportionate net wheat exceeds the accepted benchmark, but the price paid for the net wheat remains the same. The buyer benefits by paying less ocean freight and handling costs per tonne of net wheat. Discounted screenings would no longer be considered "dirt" but could be resold by the miller as feed, usually at a profit over the cost of shipping and separation at the mill. However, C&F ad valorem duties on the imported wheat might be higher in proportion to the higher invoice value of the shipment. The miller obtains economic benefit from the wheat that he mills, after removing screenings and adding water for the end-product. The exporter obtains his economic benefit through his ability to move a high volume of grain through his elevators and by acquiring wheats of diverse qualities and prices, and exploiting his ability to blend and segregate them to increase their value. Using the net wheat pricing system, the miller obtains more wheat for his money. The exporter gains from his ability to provide higher value wheat for those willing to pay for it. Robert Drynan is executive director of the Wheat Marketing Center in Portland, Oregon, U.S. He can be reached at 503-295-0823 or by fax at 503-295-2735. | World Grain | | Search Sosland.com | News & Data | Industry Calendar | | MarketFAX | Recent News & Articles | Web Links | | Sosland Publishing | Contact Us | Employment |

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