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Agri-trading and Hedging: Agri-trading and Hedging: Opportunities for FarmersOpportunities for Farmers

Ann BergAnn Berg

Futures and Commodity Markets Futures and Commodity Markets SpecialistSpecialist

Implemented by Financial Markets International of Washington, DC and Mumbai, India.

Commodity Futures Market Project

National Conference on Emerging Platforms for Agriculture Marketing

What is hedging?What is hedging?

Hedging is the transfer of risk Hedging is the transfer of risk from one party to another by from one party to another by

buying or selling futures contractsbuying or selling futures contracts

These risks include:These risks include:• Price risksPrice risks• Counterparty risksCounterparty risks

Futures definedFutures defined

Futures are purchase and sales Futures are purchase and sales agreementsagreements

Futures are cleared by a central Futures are cleared by a central counterparty – called the Clearing counterparty – called the Clearing HouseHouse

Futures are a zero sum gameFutures are a zero sum game

Futures definedFutures defined

Futures are not stocks – no equity Futures are not stocks – no equity ownership existsownership exists

Futures are not bonds -No fixed Futures are not bonds -No fixed income return is guaranteedincome return is guaranteed

Futures are proxy instruments held Futures are proxy instruments held until exchanged for the underlying until exchanged for the underlying goodgood

Value of futures contractsValue of futures contracts

Price transparencyPrice transparency Price discoveryPrice discovery Markets integratorMarkets integrator Liquidity Liquidity Infrastructure boosterInfrastructure booster Forward price indicatorForward price indicator

Forward price signalsForward price signalsClosing CBOT wheat prices Sept 14 2007Closing CBOT wheat prices Sept 14 2007

Wheat Prices

500

600

700

800

900

1000

1100

1200

1300

14002

/26

3/1

2

3/2

6

4/9

4/2

3

5/7

5/2

1

6/4

6/1

8

7/2

7/1

6

7/3

0

8/1

3

8/2

7

9/1

0

days

in R

s.

per

Q

Spot Market (Karnal) CBOT Sept 07 Prices

Why hedge?Why hedge?

Lock in an attractive priceLock in an attractive price Achieve income stabilityAchieve income stability Avoid riskAvoid risk Plan cropping mixPlan cropping mix Obtain better credit arrangementsObtain better credit arrangements

Who should hedge?Who should hedge?

Warehouses that stock seasonal Warehouses that stock seasonal inventories (short hedgers)inventories (short hedgers)

Millers, processors, feedlot operators Millers, processors, feedlot operators (long hedgers)(long hedgers)

ExportersExporters Importers Importers Any supply chain player wanting to Any supply chain player wanting to

avoid price risksavoid price risks

Which farmers should hedge?Which farmers should hedge?

Large capitalized farmers able to Large capitalized farmers able to withstand margin callswithstand margin calls

Farmers with year to year stable Farmers with year to year stable productionproduction

Farmers with skill set and Farmers with skill set and sophistication for futures tradingsophistication for futures trading

Only about 30% of US farmers hedge Only about 30% of US farmers hedge

Short HedgingShort Hedging

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

Short hedging Short hedging by warehouse by warehouse

Cash transactionsCash transactions

buy 1200 quintals buy 1200 quintals Potatoes @Rs. 800/qPotatoes @Rs. 800/q

Sell 1200 quintals Sell 1200 quintals Potatoes @ Rs.500/qPotatoes @ Rs.500/q

Loss Rs. 300/qLoss Rs. 300/q

Futures transactionsFutures transactions

Sell 4 contracts @ Rs. Sell 4 contracts @ Rs. 850/q (30MT each)850/q (30MT each)

Buy 4 contracts @ Buy 4 contracts @ Rs.500/qRs.500/q

Profit Rs. 350/qProfit Rs. 350/q

Net profit = Rs.50/qNet profit = Rs.50/q

The HAFED Experience:The HAFED Experience:Textbook case of wheat hedgingTextbook case of wheat hedging

HAFED began using futures soon after HAFED began using futures soon after launch of wheat contract in July 2004launch of wheat contract in July 2004

Strictly a short hedger – sold futures Strictly a short hedger – sold futures against cash purchasesagainst cash purchases

Quickly increased its use of the Quickly increased its use of the NCDEX wheat futuresNCDEX wheat futures

Quickly increased its use of the Quickly increased its use of the delivery mechanismdelivery mechanism

HAFED’s hedging programHAFED’s hedging program

YearYear Qty Qty purchased MTpurchased MT (physical (physical wheat)wheat)

Qty hedged MTQty hedged MT (short futures (short futures sales)sales)

Qty delivered Qty delivered MTMT(against futures (against futures short)short)

2004-052004-05 7000070000 47704770 1010

2005-062005-06 3181431814 3571035710 1330013300

2006-072006-07 107043107043 8145081450 2086020860

HAFED took advantage of large HAFED took advantage of large carrying charge between carrying charge between

harvest and mid-year prices and harvest and mid-year prices and placed short hedge in placed short hedge in

December contract to maximize December contract to maximize returns returns

HAFED’S hedge executionsHAFED’S hedge executionsMSP + Bonus of Wheat (April 2006)MSP + Bonus of Wheat (April 2006) 700700

Mandi, VAT & Transportation ChargesMandi, VAT & Transportation Charges 110110

Interest & Storage Charges (for 8 Interest & Storage Charges (for 8 months - i.e., up to Dec 2006months - i.e., up to Dec 2006

7272

Cost of MSP Wheat in Dec 2006Cost of MSP Wheat in Dec 2006 882882

Selling Rate of Wheat in Dec 2006 on Selling Rate of Wheat in Dec 2006 on NCDEX (Rs. 1017 – Rs. 27 expenses)NCDEX (Rs. 1017 – Rs. 27 expenses)

990990

Net Profits per QuintalNet Profits per Quintal 108108

Deliveries in metric tonnes

0

5000

10000

15000

20000

25000

30000M

ay05

Jul0

5

Sep

05

Nov

05

Jan0

6

Mar

06

May

06

Jul0

6

Sep

06

Nov

06

Jan0

7

Mar

07

Deliveries in NCDEX were scant during April May harvest months, occurring later in the year.

HAFED’s assessment of futuresHAFED’s assessment of futures

Auditable records of sales prices – Auditable records of sales prices – i.e., futures transactionsi.e., futures transactions

Aggregation of small purchasesAggregation of small purchases Quality assurance - achieved by Quality assurance - achieved by

strict assaying methods by strict assaying methods by registered warehousesregistered warehouses

LiquidityLiquidity Price stabilizationPrice stabilization

Aggregation can optimize Aggregation can optimize results for farmersresults for farmers

Avoid margin callsAvoid margin calls Reduce distressed sellingReduce distressed selling Benefit from quality productionBenefit from quality production Reduce exploitationReduce exploitation Increase credit availabilityIncrease credit availability Increase incomeIncrease income Profit share in aggregationProfit share in aggregation

Thank youThank you