How farmers benefit from futures markets?

Transcription

1 How farmers benefit from futures markets? by Jean Cordier, Professor UMR SMART INRA - Agrocampus Ouest OECD Workshop, novembre 2010

2 How farmers benefit from Futures Markets? 1. The issue of farming? done 2. The «traditional» and «new» benefits of FMs for farmers 3. Issues on FMs. A need for regulation? Conclusion

3 The farmer s issue Objective = Bottom line profit Production decisions acreage choice seed choice and agronomic methods purchasing farm inputs (seeds, fertilizers, crop protection) marketing farm outputs Investment decisions Targeting return on investments Minimizing the cost of capital under risk contraints

4 Production decisions : buying and selling under risk contraints => a core tool = the futures market

5 What is a future market? a universal and a-geographical tool = alike in Asia-America-Europe a prosperous business based upon product innovation (commodities => bonds => index => rights => climatic =>? ) a 150 years constant subject of debate (controversial) on economical utility and efficiency price too low for producers and too high for users? role of speculators. Destabilizing the physical market? a benefit or loss to farmers?

6 What is a future market? A Board of Exchange where standardized futures contracts and options are publicly traded => a market place a centralized, transparent and regulated market as opposed to cash and OTC markets a mean for eliciting futures prices in coordinating supply/demand expectations when trading futures contracts a mean for eliciting price implicit volatility in coordinating exogenous but also endogenous shocks when trading call and put options

7 What are farmer s traditional benefits? (1) Traditional direct benefits a market signal : which production to choose, which acreage to plan? a mean for output marketing strategy to cope with price volatility (grains, oilseeds, livestock) a mean for input purchasing strategy to cope with price volatility (mainly fertilizers and energy for machinery, building heating/cooling) How?

8 Pre-requisite concepts Unitary hedging technique is reducing the portfolio risk from flat price volatility (30%) to basis volatility (5%) Hedging efficiency measure E and basis risk Various basis risks : - a corn producer in Illinois, USA - a cotton producer in Ouagadougou, Burkina Faso - a dairy producer in Brittany, France Mainly forward rather than futures contracts Very few farmers are using directly futures markets. Data available? They manage risk using forward contracts with local traders

9 A mean for «traditional» ag price risk management A mean for diversifying market risk at no cost except for transaction costs in allowing a self market price average when selling A mean for selling price risks against option premium payment (costly) Finally, a pre-income risk management when dealing with input and output prices

10 What are farmer s traditional benefits? (2) Traditional direct benefits A market signal A mean to cope with product price volatility A mean to cope with input price volatility Traditional indirect benefits FMs allow an efficient private storage market credit availability for operating costs formula pricing within marketing contracts LT price stabilization (historical academics findings against populist view up to now)

11 What are farmer s «improved» benefits? (1) Improved direct benefits reference for an expanding derivative market (OTC market) basis contract (to offset basis risk) participative option swaps constant innovation => improved price risk management from formula pricing to value chain contractualisation chain swaps -coops to share implicit volatility (partial chain) chain captain management (full chain) => improved price risk management

12 What are farmer s «improved» benefits? (2) Improved indirect benefits FMs are allowing the expansion of climatic insurance contracts (crop insurance, revenue and margin insurance contracts). F 0 is part of insurance contracts new strategies of income risk management combining futures-forward contracts with crop insurance (with different deductible strategies) income target strategy (with futures contracts) income floor strategy (with option contracts) improved finance strategies (including during catastrophic periods) => improved income risk management

13 FM outputs = F and σr t OTC market - forward contracts - customized options - swaps Insurance system - crop insurance - revenue and margin Credit market Price risk management Income risk management - reducing income coef. of variation - improving income VaR (5%) improving income VaR (5%) So what? Two questions about futures markets behavior

14 Issues on FM A need for regulation? Question 1 : FMs are incomplete markets? range of futures contracts horizon of futures contracts Question 2 : Quality of futures prices and implicit volatility? : speculation as gambling, hedging as risk transfer => numerous FM bans throughout the world : portfolio management => no investment, no risk premium => F 0 (t) = E 0 (S t ) + «natural» exogenous risk : «excess» speculation with hedge funds (long on OTC) investing in commodity index funds (short on OTC) run by swap dealers (long on futures markets) => «excessive» endogenous risk

15 Incomplete markets? Range of futures contracts?

16 Range of futures contracts : Commodities = 12 % Futures Industry Association, Sept 2010

17 Futures Industry Association, Sept 2010

18 Asia North America Futures Industry Association, Sept 2010

19 Incomplete markets? Range of futures contracts? So what? Incomplete markets for sure but complete enough? Very efficient cross hedging practices do exist

20 Incomplete markets? Horizon of futures contracts? Why FMs are limited to two years? (feasibility of more distant futures, potential for O.I. on more distant futures) éch Nov 99 éch Nov 00 éch Nov 01 éch Nov 02 éch Nov 03 éch Nov 04 éch Nov 05 éch Nov 06 éch Nov 07 éch Nov 08 éch Nov 09 Moyenne 5 ans O.I. Nov 0 sept oct nov déc janv févr mars avril mai juin juillet août sept oct Wheat EURONEXT

21 Excessive speculation? Excessive volatility? - Hedge funds are looking for portfolio diversification and defence against inflation - $15 billion in 2003 to $ 200 billion in mid-2008 (CFTC 2008) - Financial instruments based upon two popular commodity indices (Dow Jones AIG/UBS 28%, S&P SGCI 14%) and many «pure» agricultural indices - Swaps on FMs since Various investment strategies from passive rolling futures contrats to active % adjustments (stable % or adapted %) within the instrument

22 Index return «enhancement» using momentum, i.e. - bullish 140 % - standard 100 % - bearish 60 %

23 Two extreme point of views on CIF - Commodity Index Funds (CIF) and swap dealers are inducing «excessive» volatility through massive agricultural market entries and exits (Gilbert 2009, Tang and Xiong 2010) => bubbles and excessive endogenous risk => a need for specific market regulation - Correlation does not mean causality (Irwin and Sanders, 2009 and 2010) => commodity volatility is just market volatility => lead-lag relationships are much more complex => no need for additional market regulation.

24 /t base juillet Cotations Soft du Wheat, blé tendre FOB rendu Rouen Rouen (Source : La Dépêche - Le Petit Meunier)

25 Dry Baltic Index

26

27 Two extreme point of views on Investment Funds - Index funds and swap dealers are inducing «excessive» volatility through massive agricultural market entry and exit (Gilbert 2009, Tang and Xiong 2010) => a need for specific market regulation - Correlation does not mean causality (Irwin and Sanders, 2009 and 2010) => no need for additional market regulation - So what = truth in between black and white

28 Historical regulation and futures market surveillance against manipulation in the US - segregation of traders = commercials and non commercials (speculators) - large trader reporting (relative O.I. calculations, dynamic O.I.) - margin deposits in conjunction with price limits - speculator position limits and targeted spot month position limits => CFTC Round of Dodd-Frank Act Rulemakings (Fall 2010) Where is the European Union on FMs surveillance?

29 So what? Idea 1 : Complete regulation is required regulation throughout the world and not country specific futures market regulation in accordance with OTC regulation Idea 2 : Improved historical market surveillance is required improved segregation of traders (i.e. X types of funds) adapted rules to trader activities and trading practices

30 So what : Commodity Markets Surveillance and Regulation 1. Worldwide and complete regulation 2. Improved historical market surveillance 3. Offsetting the grey mass effect - innovative «viscosity» measures to be implemented rather than physical measures (i.e. public storage or incentives) - A world «Commodity Central Bank» - monitoring the agricultural commodity «mean reverting process» (economics) - monitoring trader practices and investment models (finance) - monitoring country policies and practices (i.e. export bans) (politics) - adjusting the «viscosity» measures (hands in dirty grease)

31 Conclusion FMs are a central issue for farmers FMs do not bring a dream : a stable and profitable price From price risk management to farm income risk management Future of futures more on income risk management (OTC + insurance) more on investment decisions => LT And market regulation for FMs quality? a worldwide issue : Asia America - Europe connected with OTC market ( a very difficult task) managing the grey area => targeting financial fine touch measures rather than physical market adjustments Thank you for your attention