Grains suppliers are starting to default on previously agreed sales to major importers, including top wheat buyer Egypt, rather than deliver on contracts that are now losing money because of the huge rally in prices sparked by the U.S. drought.
The worst drought in more than 50 years is wilting crops in the U.S. Midwest and sending prices into overdrive, with corn alone surging by around 50 percent in the last month. Soybeans have also hit record highs, with wheat not far behind.
Crop downgrades in Russia, Ukraine and Kazakhstan as drought followed a bitterly cold winter have added to global price rises, stoking fears of unrest especially in Middle Eastern countries, where high food prices can trigger political protest.
Traders say some private grain sales to buyers in cereals importing giant Egypt have fallen apart, but they stress that multinational trading houses will deliver on contracts and the default problem is likely to focus on smaller firms. However such firms often put together deals of up to 100,000 tonnes.
"We are talking a few Egyptian private buyers who had contracts from suppliers in the Black Sea not executed and it's both for corn and wheat. The type of cargo sizes are small and between 10,000 and up to 25,000 tonnes," a Middle East-based trader said.
Doubts are also being raised over whether recent wheat sales to Libya will be delivered.
"Only in June, traders were selling wheat and other grains to buyers in the Middle East in expectation that a record U.S. corn crop and Russian export surge would push down global grains prices," one German trader said.
"The price rises mean some sales were made at huge losses, people are now looking at the terms of their performance bonds to see if it is worthwhile not delivering."
On most contracts in international trade, sellers have to provide a guarantee that they will pay a penalty if they do not fulfil their contract called a performance bond.
In some grains deals, the performance bond means sellers must pay 10 percent of the contract value to the buyer if a default talks place.
Grains purchases are traditionally made months in advance, with traders using their market knowledge to calculate whether supplies will be plentiful or tight at the future time when the grain has to be bought and ships loaded.
Until about four weeks ago, traders were expecting falling prices with a record U.S. corn crop on the horizon, providing the import supply chain with low cost grain many sellers had not bought yet.
Any rise in such defaults could cause a huge increase in costs, especially for Middle Eastern and African countries which depend on grain imports for their bread and farm animal feed.
Adding to the pain, dry bulk shipping costs have risen in recent weeks due to firmer commodities cargo activity. Average daily panamax bulk carrier transport earnings hit near two month highs this week. .
"Sales in some grain tenders could not have been covered by purchases of physical supplies because the prices bet on in May and June never materialised in Black Sea, EU or U.S. markets," another trader said.
Sellers in some individual international tenders could be facing losses running into millions of dollars on single deals.
"Some people with a 10 percent performance bond on deals could be financially better off defaulting than delivering," another trader said. "Naturally you can ruin your relationship with the buyers, you have to decide what is worse."
One major Egyptian importer said he had heard that some defaults to private Egyptian buyers of Black Sea origin wheat had taken place. The trader added that the cargoes were believed to be relatively small.
Another deal thought to be endangered is Libya's purchase of 50,000 tonnes of milling wheat on July 4.
"A lot of people will be surprised if that deal goes through as it looks like a loss-maker," one dealer said.
Private and state buyers who held off purchasing a month ago now face a huge rise in bills if they have to buy at current high prices.
"Jordan and Iraq made big mistakes cancelling past tenders," a European trader said.
Iraq cancelled a wheat tender earlier this month, issuing a new tender on July 12, while major wheat importer Jordan cancelled an international purchase tender for 100,000 tonnes of wheat on Tuesday because of high prices and issued a new tender on Wednesday.
"Jordan made its last wheat purchase in a tender on June 27, with the offers it received for wheat on Tuesday Jordan faced an extra cost of $4.5 million to buy 100,000 tonnes of wheat in just four weeks," a trader said.
There is also market talk some Egyptian mills are facing severe cash flow and credit problems.
"A lot of buyers waited in the hope that rain in the U.S. and east Europe would cool prices," a trader said. "But this is just not happening and the U.S. drought is not over." (Reporting by Michael Hogan in Hamburg, Jonathan Saul and Sarah McFarlane in London, Maha El Dahan in Abu Dhabi; editing by Veronica Brown and Keiron Henderson)