WHY AND HOW TO MANAGE THE RISK OF VOLATILITY May 2016 Charlie Hyland Commodity Risk Manager INTL FCStone Ltd.
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The Role of a Futures Market 1. Price Discovery 2. Risk Transfer What can a Futures Market potentially do for Irish Farmers Provide the ability to voluntarily hedge/fix the price of milk going forward Enable Farmers Secure Margins Futures Markets also exist for Grains, Energy, and more are in development
Hedge Example Decreasing Markets Physical Futures SELL 2 22c/lt 26c/lt 1 BUY 22c/lt 2 Gain/Loss 22c/lt + 4c/lt Regardless of volatility net milk price remains at the initial hedged price 26c/lt
Hedge Example - Increasing Markets Physical Futures SELL 2 30c/lt 26c/lt 1 BUY 30c/lt 2 Gain/Loss 30c/lt - 4c/lt Regardless of volatility net milk price remains at the initial hedged price 26c/lt
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Potential Options for Farmers Securing Forward Prices Farmers Hedge Directly No Specific Milk Futures Contract Link to commodities (Butter/SMP) difficult to manage Hedging via Processor (Forward Contracting) Processor Manage Milk-commodities relationship Hedge by fixing commodity prices with customers Hedging via Processor (Futures Hedging) Processor Manage Milk-Commodities Relationship Hedge via the Futures Market
Goals of a Forward Contracting Programme Enable Farmers manage price volatility by locking in milk prices and/or margins when profitable opportunities arise (i.e. when milk prices are relatively profitable) Enable Processor/Co-op secure supply of milk and customers for its production. Add value to the farmer members. Processors also aim to maintain profitability and avoid taking on price exposures outside of its existing business model Enable Customers have full flexibility to hedge (fix/unfix) milk prices at short notice for extended periods of time independent of the farmers desire to fix/unfix.
Non Independent Risk Management is Difficult Producers Want to Hedge When Prices are High (or expected to fall) Source: LTO Netherlands End Users Want to Hedge When Prices are Low (or expected to rise)
Forward Contracting with Futures Can attract buyers who are not necessarily in your existing supply chain Counterparty risk reduced Offer More Flexibility Flexible terms for example can fix for 3/6/9/12 or 18 months in the future Ability to remove hedge Can be used in a portfolio with physical forward contracting
Conclusion Increased volatility calls for more methods to protect farmers profitability Hedging via Futures is not intended to be the full solution but in other markets is a key part of the solution Milk Price Hedging is Currently Possible for Farmers but Challenging Hedging via Processors is likely the best solution for farmers who want the ability to lock in future prices Any initiative should be voluntary and fair to all members of the supply chain
Thank you! Charlie Hyland Commodity Risk Manager charlie.hyland@intlfcstone.com Tel: +353 1 6349140 Mob: +353 86 3112381