Price risk management alternatives for the 2017-18 marketing season

At the end of a season it is usually easy to look back on the season and to recognise the correct timing for price risk management by means of hedging. However, a producer has to be satisfied with the reality that hedging decisions for any crop planted and to be harvested are taken on the basis of information available at the time. The objective of the futures market is, however, to discount the impact of future price expectations or uncertainty to a large extent. However, it does not make hedging decisions any easier due to future uncertainties, which will reflect accordingly in the futures market price as information changes.
Hedging on the JSE Agricultural Commodities Market (SAFEX) remains the only means of managing the different alternatives and to mitigate counter-party risk. Senwes Market Access can, through their producer grain marketers and Senwes Grain Brokerage, assist with various pre-season marketing contracts and hedging alternatives which will fit the risk profiles of the individual producers. The risk profile of a producer is certainly one of the most important aspects to be taken into account before a hedging decision is taken. It is also important for producers to understand the implications of implementing a hedging strategy in order to avoid any future misunderstandings.
Against this background and with the information at our disposal (Table 1), four hedging alternatives are reflected in Table 2, with the advantages and disadvantages of a proposed risk profile fit. It is evident from Table 1 that national stock levels are high enough and that exports and consumption at the current rate will not decrease the surplus. Weather predictions for the coming season are favourable and planting intentions indicate that stock levels will probably remain at high levels. USA prices are trading in a sideways band, but the rand has the potential to increase current export parity price levels. There is a risk that prices will remain under pressure and that it could even decrease to below export parity. Export parity in itself could, however, increase depending on the weakening of the rand, which could support prices. The four hedging proposals contained in Table 2, were made against the background of the above information.
For more information, please contact your nearest grain marketing advisor (procurer). Alternatively Frans Dreyer - Grain Brokerage (018 464 7786), Hansie Swanepoel - Market Information (018 464 7575) or Hennie du Plooy – Producer Marketing (083 388 4968), can be contacted for more information regarding available marketing alternatives.
Table 1: Fundamental factors and potential price drivers for the coming season
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Price driver
National stock
  • Record 2016-17 harvest realised high stock levels with the expectation that carry-over stock will at least be 3,5 times the required pipeline stock levels.
  • Current marketing year - export rate not high enough to address surplus scenario.
  • Yellow maize was exported to Japan, South Korea and Taiwan. These exports are expected to continue sporadically for the rest of the marketing year.
  • White maize was mainly exported to the traditional BNLS countries with Kenya having taken some of the GM-free white maize. Significant white maize exports are not expected due to the fact that the other major consumer of white maize, Mexico, has sufficient stock. Mexico will also have to do away with the $22/mt import levy which applies in respect of countries other than the USA or the price of South African white maize will have to decrease in order for exports to materialise.
National consumption
  • Local processing of white maize for human consumption and particularly for animal feed purposes is cumulatively above average for the marketing year.
  • This high rate can be ascribed to the decrease in maize prices since harvest time and the fact that the white and yellow maize price difference offered the necessary value for animal feed processors to change from yellow to white maize.
Import and export parity
  • Local yellow maize exported from the Durban port was significantly more expensive than maize exported from a port in the USA Gulf, Brazil, Argentina and the Ukraine.
  • The main reason is the high cost of road and rail transport, which relate to the poor condition of the rail transport infrastructure.
  • The advantage in respect of geographic situation which SA has compared to the USA and South America to Asian countries, means that South African yellow maize was competitively priced for exports for the largest part of the marketing year.
  • Local maize prices trade fairly close export parity, but the cost of transport to the harbour and high global stock levels, hamper export potential.
USA prices and the dollar
  • The USA maize price and the rand will play a bigger role in prices moving closer to export parity.
  • USA closing stock levels are high enough and the current price band expectation is between $3.20 and $3.95 per bushel for the rest of the season.
  • The rand is a problem in itself and the inconsistency of this currency cannot be over-emphasised.
  • Uncertainty regarding the political environment and concomitant economic instability contribute towards the volatility of the rand.
  • The USA dollar is inclined to strengthen and economic indicators reflect a systematic recovery of economic prospects. The expected interest rate increases will probably increase investments in the USA, which will strengthen the dollar against other currencies accordingly.
Weather prospects
  • Longer term weather prospects reflect a good possibility of a normal to weak La-Niña (wetter) season during the early and mid-summer months of November to February.
  • The early summer months (November to January) are expected to be warmer than normal for the larger part of the production season, after which it will normalise for the rest of the growing season.
Implication of intentions to plant
  • Intentions to plant were released at the end of October.
  • Expected hectares to be planted have decreased since the previous year, but are in line with the 10-year average. However, the decrease is not sufficient to address the surplus situation.
  • Intentions to plant usually materialise and could even increase. The only seasons during which hectares planted actually decreased, were when producers could not plant due to drought conditions.
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Table 2: Hedging strategies
Minimum prices / (Put option) - Low risk
Protects against price decreases.
Option costs high - close to export parity.
Important to bear in mind:
Market prices move to more than the option premium every season. Should the price increase and should there be more certainty about the harvest, this option could be resold and a portion of the option premium can be recovered.
Synthetic minimum price (fixed price contract and buy call option) - Medium risk
Protects against price decreases.
Potentially lower option cost than minimum price.
Price increases between the fixed price level and the out the money call option level cannot be utilised.
Important to bear in mind:
Should the market price move to above the call option level, it would be sensible to reconsider the strategy in respect of profit taking by reselling the call option. This option premium profit can then be added to the fixed price level.
Fixed price - High risk
Protects against decreasing prices.
No option cost.
Cannot share in upward price potential.
Important to bear in mind:
A fixed price strategy poses definite delivery or expensive buying-out risks.
The market usually increases in an aggressive manner when a fundamental movement takes place, such as a mid-summer drought in a critical phase of the growing season.
The required production levels may not materialise in order to deliver against the lower fixed price.
Senwes Collective Price contract (CPC) - Low risk
Protects against decreasing price movements.
Tonnes of producers forming part of the product, are hedged by means of one or more fixed hedging strategies through the course of the production season.
Option costs can be high should the market move in a lower or sideways direction throughout the season.
Important to bear in mind:
Utilise upward price potential actively and objectively by means of fixed strategy principles.