1 Agri-trading and Hedging: Opportunities for Farmers Ann Berg Futures and Commodity Markets Specialist 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?

Hedging is the transfer of risk from one party to another by buying or selling futures contracts These risks include: Price risks Price risks Counterparty risks Counterparty risks

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

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

Value of futures contracts Price transparency Price transparency Price discovery Price discovery Markets integrator Markets integrator Liquidity Liquidity Infrastructure booster Infrastructure booster Forward price indicator Forward price indicator

Forward price signals Closing CBOT wheat prices Sept

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

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

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

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

Short hedging by warehouse Cash transactions buy 1200 quintals 800/q Sell 1200 quintals Rs.500/q Loss Rs. 300/q Futures transactions Sell 4 Rs. 850/q (30MT each) Buy 4 Rs.500/q Profit Rs. 350/q Net profit = Rs.50/q

The HAFED Experience: Textbook case of wheat hedging HAFED began using futures soon after launch of wheat contract in July 2004 HAFED began using futures soon after launch of wheat contract in July 2004 Strictly a short hedger – sold futures against cash purchases Strictly a short hedger – sold futures against cash purchases Quickly increased its use of the NCDEX wheat futures Quickly increased its use of the NCDEX wheat futures Quickly increased its use of the delivery mechanism Quickly increased its use of the delivery mechanism

HAFED’s hedging program Year Qty purchased MT (physical wheat) (physical wheat) Qty hedged MT Qty hedged MT (short futures sales) (short futures sales) Qty delivered MT Qty delivered MT (against futures short)

HAFED took advantage of large carrying charge between harvest and mid-year prices and placed short hedge in December contract to maximize returns

HAFED’S hedge executions MSP + Bonus of Wheat (April 2006) Mandi, VAT & Transportation Charges Interest & Storage Charges (for 8 months - i.e., up to Dec Cost of MSP Wheat in Dec Selling Rate of Wheat in Dec 2006 on NCDEX (Rs – Rs. 27 expenses) Net Profits per Quintal

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

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

Aggregation can optimize results for farmers Avoid margin calls Avoid margin calls Reduce distressed selling Reduce distressed selling Benefit from quality production Benefit from quality production Reduce exploitation Reduce exploitation Increase credit availability Increase credit availability Increase income Increase income Profit share in aggregation Profit share in aggregation

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