Agri-trading and Hedging: Opportunities for Farmers

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Agri-trading and Hedging Opportunities for
Farmers

• Ann Berg
• Futures and Commodity Markets Specialist

National Conference on Emerging Platforms for
Agriculture Marketing
Commodity Futures Market Project
Implemented by Financial Markets International of
Washington, DC and Mumbai, India.
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What is hedging?
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Hedging is the transfer of risk from one party to
another by buying or selling futures contracts

• These risks include
• Price risks
• Counterparty risks

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Futures defined

• Futures are purchase and sales agreements
• Futures are cleared by a central counterparty
  called the Clearing House
• Futures are a zero sum game

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Futures defined

• Futures are not stocks no equity ownership
  exists
• Futures are not bonds -No fixed income return is
  guaranteed
• Futures are proxy instruments held until
  exchanged for the underlying good

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Value of futures contracts

• Price transparency
• Price discovery
• Markets integrator
• Liquidity
• Infrastructure booster
• Forward price indicator

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Forward price signalsClosing CBOT wheat prices
Sept 14 2007
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Why hedge?

• Lock in an attractive price
• Achieve income stability
• Avoid risk
• Plan cropping mix
• Obtain better credit arrangements

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Who should hedge?

• Warehouses that stock seasonal inventories (short
  hedgers)
• Millers, processors, feedlot operators (long
  hedgers)
• Exporters
• Importers
• Any supply chain player wanting to avoid price
  risks

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Which farmers should hedge?

• Large capitalized farmers able to withstand
  margin calls
• Farmers with year to year stable production
• Farmers with skill set and sophistication for
  futures trading
• Only about 30 of US farmers hedge

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Short Hedging

• Short hedging involves the sale of futures
  contracts against ownership of the underlying
  commodity

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Short hedging by warehouse

• Cash transactions

• Futures transactions

• buy 1200 quintals Potatoes _at_Rs. 800/q
• Sell 1200 quintals Potatoes _at_ Rs.500/q
• Loss Rs. 300/q

• Sell 4 contracts _at_ Rs. 850/q (30MT each)
• Buy 4 contracts _at_ Rs.500/q
• Profit Rs. 350/q
• Net profit Rs.50/q

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The HAFED ExperienceTextbook case of wheat
hedging

• HAFED began using futures soon after launch of
  wheat contract in July 2004
• Strictly a short hedger sold futures against
  cash purchases
• Quickly increased its use of the NCDEX wheat
  futures
• Quickly increased its use of the delivery
  mechanism

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HAFEDs hedging program
Year Qty purchased MT (physical wheat) Qty hedged MT (short futures sales) Qty delivered MT (against futures short)
2004-05 70000 4770 10
2005-06 31814 35710 13300
2006-07 107043 81450 20860
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HAFED took advantage of large carrying charge
between harvest and mid-year prices and placed
short hedge in December contract to maximize
returns
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HAFEDS hedge executions
MSP Bonus of Wheat (April 2006) 700
Mandi, VAT Transportation Charges 110
Interest Storage Charges (for 8 months - i.e., up to Dec 2006 72
Cost of MSP Wheat in Dec 2006 882
Selling Rate of Wheat in Dec 2006 on NCDEX (Rs. 1017 Rs. 27 expenses) 990
Net Profits per Quintal 108
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Deliveries in NCDEX were scant during April May
harvest months, occurring later in the year.
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HAFEDs assessment of futures

• Auditable records of sales prices i.e., futures
  transactions
• Aggregation of small purchases
• Quality assurance - achieved by strict assaying
  methods by registered warehouses
• Liquidity
• Price stabilization

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Aggregation can optimize results for farmers

• Avoid margin calls
• Reduce distressed selling
• Benefit from quality production
• Reduce exploitation
• Increase credit availability
• Increase income
• Profit share in aggregation

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Thank you