Thursday, July 7, 2011
A fundamental benefit of the disposal of the single desk is the ability of producers to respond to market signals. When we talk about market signals, the attention usually goes to whether the price is simply high or low. But there’s more to it than just the flat price (the actual full price of a commodity).
To most grain merchants, basis is as important as, or more important than, flat price. When a company runs a fully hedged book, it means that everything it does is hedged; the aim is to reduce its price risk to basis risk. And basis is more than just the difference between the cash price and futures.
Spreads – the difference between two futures months – are closely related to cash basis. In fact, spreads are a basis of sorts – what drives basis also drives spreads. Both are market signals that producers should be allowed to exploit.
In an open market, price – both flat price and basis – is an incentive to attract sales and deliveries into the system, or is a disincentive to put off deliveries. The CWB system mutes those signals and passively draws grain in on the basis of the CWB’s program. Even though the CWB operates in markets where it’s exposed to market signals or price incentives to either store or ship grain, it appears it doesn’t respond to or exploit them. If it does, it certainly doesn’t translate that back to producers in a meaningful way.
Without the single desk, producers will gain the advantage of exploiting market signals to the benefit of their own farm operations.
A simple example; let’s assume it’s September 2012 and spring wheat futures are trading at ICE futures in Winnipeg and street prices are based on them. On this day the nearby Dec contract is trading at $340.00 and the March contract is trading at $349.00; together they are showing a spread of $9.00 under (Dec under the Mar). If we assume a static (unchanging) cash basis, the market is willing to pay an additional $9.00 for delivery in March. In other words, the market will pay to store or carry grain. Additionally, if you believe the basis will improve by March, there are ways you can exploit that as well – for your gain.
In simple terms, you have two choices. You can sell for spot delivery off the combine and get $340 or sell for March delivery and get $349. You decide whether $9.00 is worth the trouble of storing. If the market needs product now and doesn’t want to see it stored, the spread will narrow, giving an incentive to move it now, not later. All you have to do is act on it. It’s a great system – very efficient.
A full description of the various strategies you can use to exploit this is beyond the purpose of this article. The point here is that without the single desk, you CAN exploit this for your benefit. Imagine: by reacting to market signals, you can get paid to store your grain.
With the single desk, you can’t do that. (Don’t even begin to bore me with the CWB’s storage program; $1.20/tonne over 12 months is a token at best; it is not an incentive – mostly because you can’t react to it, you just can get it if you don’t get shipping right away on some programs.)
With access to market signals on the two major crops in Western Canada – canola and wheat – producers will be able to make real marketing decisions on both – not just one. This is important because producers that grow both have always been forced into selling canola for cash flow and waiting to be told when to deliver wheat. In the future, producers will be able to decide for themselves which to sell for cash. This is when understanding spreads become very useful. If you are indifferent which crop you deliver – wheat or canola – and the canola market is paying a bigger storage premium than wheat, you will be able to exploit that by delivering wheat in a nearby (spot) period and selling canola for a future position.
With the single desk, you can’t do that.
Under the current CWB system, producers sell non-CWB crops like canola when they need cash; because they are not free to sell and deliver wheat, more canola gets sold and delivered in the fall than the market really wants or needs at the time, pushing canola prices lower as the market tries to find a price where it can clear the excess being thrust upon it. This drives spreads wider, giving buyers an incentive to buy now and store; there’s a reason why the crushers all have loads of storage space.
Being able to read signals and sell and deliver more wheat means less reliance on canola for cash flow, and less pressure on harvest canola prices. Ultimately, as markets compete for producers’ affections, the playing field for producers gets more level than it’s ever been. When producer have multiple options – deliver wheat now, deliver wheat later, deliver canola later – the spot price for canola – the one relied on most for cash flow – switches from being pressured lower to find buyers, to moving higher to find willing sellers.
Understanding how markets work and how producers can exploit them without the single desk is one of the most exciting opportunities ahead.
Posted by John De Pape at 7:30 PM