June 27, 2013 5:55 pm

Fertile futures

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wheat being harvested©Bloomberg

Playing it by ear: grain futures trading has been a tough learning experience for many farmers

It is 9am on a Wednesday and a group of farmers is beginning two days of training in global commodity markets and futures trading at the Cambridge office of Offre & Demande Agricole (ODA), a fast-growing European consultancy.

The same scenario is being played out around the world. With shifts in commodity markets in one hemisphere almost instantly mirrored at remote grain elevators and farm gates in the other, the complexity of bringing crops to market has increased dramatically for farmers. In the past decade, success has become as much about selling a crop at the right moment as producing it.

“We sometimes make three trades [spot, futures or options] in a day,” says Cherilyn Nagel, who farms on the Canadian prairies.

Trading in commodity futures – the forerunner of today’s mainly financial futures markets – goes back centuries. While dealers now predominate, farmers and food processors have become more active in the past 10-12 years, says Dave Lehman, managing director of commodity research and product development at CME Group, the world’s biggest futures exchange operator.

The reasons are many. In Canada and Australia – both top four global grain exporters – farmers are no longer obliged to sell through pools controlled by national wheat boards. In the EU, production-based subsidies that underpinned sale prices have been replaced by land-based payments. Everywhere, there are better information flows and electronic trading, and now smartphones mean farmers can even access markets from their combine harvesters.

The single biggest driver, however, has been the marked increase in price volatility. “Before 2005, price shifts were usually small and farmers weren’t interested in using the markets,” says Benjamin Bodart, who heads ODA’s UK operations. “Now, wheat prices can move by 100 per cent over a campaign.”

For Peter Kuhlmann, managing price has come on top of managing extreme weather and yields that can vary threefold from year to year. Working in South Australia, one of the driest parts of the world’s driest inhabited continent, he has won national recognition for his farming skills. But in 2007-08, the first year of free trading after the Australian Wheat Board’s monopoly was lifted, he lost some A$500,000 ($476,000) on a wheat swap. Not only did grain prices soar above the price he had fixed but drought wiped out much of his crop.

“Grain marketing has become another skill set,” he says. “I am reluctant to put my foot in the market again. It burnt me.”

But some welcome the chance to manage their cash flow more actively, with many farmers adding more storage in recent years in order to do so.

Last year it was western Canada’s turn to lose its grain monopoly. Nagel became one of the first local farmers in 70 years to sign a forward contract with her local grain elevator.

If she was quick off the mark she was also astute, locking in a good price. “I had the biggest smile when I could take the grain to the elevator and come back with a cheque,” says the 33-year-old, whose family has farmed locally for more than a century. “Before, it was months until we got our money [from the Canadian Wheat Board].”

Among the traded tools, options are the most widely used by farmers, says CME’s Lehman. Paid for up front, these give rights to forward sale contracts at a fixed price without a commitment to a sale. Reflecting increased demand, the Chicago exchange last year introduced shorter expiry date new-crop options for maize, soybeans and wheat.

“For me, options are key. They give you a floor price but enable you to keep the upside if prices rise,” says Stephen Vandervalk, a wheat and canola farmer from Alberta, Canada, who sometimes also buys currency spreads.

The president of Grain Growers of Canada, a lobby group, Vandervalk estimates only about 10 per cent of his peers buy options, although the number is rising, he says.

Following the markets is time-consuming and even addictive, however. Vandervalk sometimes finds himself checking prices every couple of hours. Since the end of the wheat monopoly he has had, like other western Canadian farmers (and their Australian counterparts before them), to field calls from local grain elevators looking for quick spot deals, while newsletters offering trading advice pile up in his inbox.

In Europe, options tend to be more expensive than in North America and direct participation in the traded markets by farmers is lower; in the UK the number is less than 2 per cent, says Bodart.

A typical European arable producer might forward sell up to half of a crop through non-traded contracts with grain merchants or food processors, keep a further quarter for January and sell the rest, also on a spot basis, in the run-up to the next harvest, says Joe Nagel, a farming consultant based in Germany. “Selling in January is a bit of a gamble on the southern hemisphere,” he says. “Prices might rise if there are bad harvests in Argentina and Australia.”

Back in Cambridge, Bodart’s message to his farmer students is that the price volatility of recent years is here to stay. On top of climate change, more fragile supply and growing demand, commodity markets are far less driven by fundamentals than they were just five or six years ago.

“Many farmers think the markets are just for speculators and hedging is complicated, when in fact it is really simple,” he says. “Increasingly, farmers will have to know how and when to fix their margins.”

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