Ultimate magazine theme for WordPress.

Trade or not, wheat risk tools need to be careful

A barley harvest in the central north of South Australia. Photo: Quadra raw materials

GRAIN SWAPS have been a popular marketing tool for farmers and traders for years. On the surface, they are relatively easy to use products and, in many cases, can be very valuable marketing tools.

So what are the dynamics of entering into swaps and what are the advantages of using swaps? The answer to that is far from easy. More in-depth research is required to determine the individual requirements and risk profiles of farmers and to understand whether the broader market environment appears favorable to swap products.

A swap usually involves selling (or buying) a futures contract on another exchange and converting it into Australian dollars. Using the example of wheat, a typical swap product would be to sell a Chicago futures contract and convert it to AUD to get a local wheat price.

The process is simple enough, but it is not without its risks. Several factors should be considered before entering into swap products:

  • The risk profile of the individual farmer
  • The local conditions and production risks.
  • Local Market Dynamics – What Are The Factors Driving Local Values?
  • Global Market Relativity – How Do Australian Values ​​Compare To Global Values?
  • Global Market Dynamics – What Factors Are Driving Global Values? This is a broader risk discussion, but it is essential in determining whether swaps are appropriate from a risk perspective.

Minimize risks

The main reason for using swap products is usually to reduce local production risks. Forward selling of physical grain during dry seasons can leave farmers vulnerable to market volatility. The last few seasons in Australia have highlighted this point very clearly.

The domestic grain seasons 2018-19 and 2019-20 were characterized by severe drought conditions on large parts of the east coast, which decimated grain production and led to significant domestic supply problems. This led to a surge in local grain values, trading Australian domestic premiums so far above global benchmarks that significant quantities of grain were shipped from Western Australia and South Australia to ports on the east coast to meet our domestic deficit.

The local market dynamics prevailing during these two seasons were ideal for farmers to use barter products as local prices outperformed global values. This allowed farmers to make some sales and mitigate some of the local production risks and then benefit from the strength of the local market due to the drought conditions on the east coast.

However, in the 2020/21 season, Australian production returned in style, particularly a sharp rebound from record production on parts of the east coast. This has been a fantastic result for both the grain farmers and the Australian grain industry. The biggest disadvantage was, of course, a weakening of grain values ​​in Australia compared to global values. The 2021-22 season is also doing well, with some favorable conditions at the start of the season with domestic values ​​lagging global markets.

Australian plants hum, others dense

The local market dynamics that we saw last year and are developing again this season are exactly the opposite of the 2018/19 and 2019/20 seasons. While they are not necessarily bad for swap products, the market structure is different and needs to be reviewed. While Australian manufacturing is doing reasonably well this season, the global balance sheet appears to be tightening significantly, adding to the risks surrounding swap products to some extent.

Brendan Dart

The global market dynamics are changing. In particular, a large part of the change is due to production losses that were caused in the main export zones of Russia and North America. In addition to the loss of around 18 million tonnes (Mt) of production, we have also identified some quality problems in Europe, which has further restricted the supply of milling wheat from the main exporters. As a result, global wheat values ​​have skyrocketed, widening the spread to include Australia.

The fact that Russia, the world’s largest wheat exporter, has introduced a pending export tax that has completely skewed export values ​​in the region and put Russian exports out of the picture in many ways adds to the fire. Although there is still a healthy supply of wheat in Russia, it is realistically unavailable for the market today.

The market dynamics in North America require special attention from swap sellers. If there are significant production problems in the region, the risks increase as most swap products are traded on the Chicago futures exchange. A strained balance sheet in the US market creates a situation in which the US futures markets can be traded at elevated levels for an extended period of time. This can distort the value of swap products and, in extreme situations, add significant undesirable risk. 2008 was such a situation.

The United States and Canada together have lost 13.5 million tonnes of wheat production this year since the June WASDE report, which pushed domestic inventories to multi-year lows. The world market is trying to understand whether it needs additional exports from the US to meet the potential shortage of world milling wheat stocks. This equation is far from clear as global demand has yet to be fully determined. Risks remain in the game, however, and the market is likely to trade cautiously. US futures values ​​can stay high for much of the season or until we have more clarity about global demand.

The bottom line is that the risks for swap sellers have increased this season.

Global wheat values ​​have rallied strongly over the past six weeks and while Australian values ​​have also risen, we are noticeably lagging the world market. The sudden surge in wheat values ​​surprised many consumers around the world. It will take some time for the market to adjust to these higher values ​​or, alternatively, to start rationing elastic demand.

Towards balance

The challenge for swap sellers today is that the world market has not yet found equilibrium and the risks may remain elevated for some time. Global wheat demand remains unclear, and this will ultimately determine how scarce global inventories will become and where wheat values ​​need to be traded to balance supply. Should global demand for milling wheat remain strong despite a dwindling supply, there are upside risks for the wheat markets.

Ultimately, futures prices can easily outperform physical markets in a bull market, creating additional risk for swap sellers. Therefore some caution is advised in the current environment.

NOTE: The information contained in this article is for general advice only. Trading in futures and derivative products involves considerable risks. This article was provided by Grain Brokers Australia.

Grain Central: Get Our Free Daily Harvest News Direct To Your Inbox – Click here

Comments are closed.