Grain traders grapple with rise of Russian exports

17.11.2017

Companies continue to rely on US markets for hedging despite diversifying trade flows

Global food import bill to hit second highest ever

The $20m loss by US agricultural trader Archer Daniels Midland on hedge positions in Black Sea grain has raised questions about traders’ commitment to traditional North American derivative benchmarks as Russia takes a bigger slice of the global grains market.

The company said two weeks ago that its loss stemmed from a “lack of correlation” between its hedges in North America and the underlying movement in the prices of grains in the Black Sea region, representing Russia, Ukraine, and Kazakhstan.

The loss shone a spotlight on how agricultural companies have continued to rely almost entirely on North American benchmarks for their hedging and trading even as the global grains market has undergone a fundamental shift east.

Rising productivity in Russia made the country the world’s largest grain exporter for the first time last year, vying for top position with the US — which has seen its share of grain exports fall from 45 per cent three decades ago to just 15 per cent today.

But while trade flows have shifted dramatically the derivative market has been far more stable.

The dominant contract has remained the soft red winter (SRW) wheat future traded in Chicago, which debuted 140 years ago, which has at least 70 per cent of the market.

“Liquidity is king,” says Scott Irwin, agricultural economist at the University of Illinois, referring to traders’ attraction to contracts with high volumes that can help smooth out price movements.

Once a commodity futures contract achieves a certain level of demand and liquidity position, it is difficult for a competing contract to attract trading away, says Prof Irwin, adding that traders may choose market depth over a derivatives contract traded in the same timezone as the physical trade or one that closely matches the physical specifications.

Fred Seamon, executive director of CME’s agricultural research and product development, says that there was no reason for the benchmark contract to move from Chicago, even as the exchange has experimented with launching wheat derivatives more closely tied to the Black Sea.

“There is nothing that forces benchmark status from Chicago,” said Mr Seamon. “It may happen but there’s nothing that would necessitate [that].”

The CME tried to launch a Black Sea wheat derivatives contract earlier this year after a first attempt in 2012 failed, suggesting that there is little appetite from traders.

Mr Seamon said SRW’s price correlation to international markets had already improved through the introduction of electronic day trading a decade ago.

There has, however, been some signs of a small shift eastward this decade.

Economists at the US Department of Agriculture and Montana State University said in a new study that Paris — where the wheat contract is more closely linked to the Black Sea — had roughly doubled its influence over global prices in recent years.

They said that though SRW in Chicago remains dominant, their research suggests Europe is becoming more important for “price discovery” as Black Sea grains take a bigger part of the market.

Since 2010, when a ban on grain exports by Russia after a serious drought wreaked havoc on the wheat markets, the importance of the Euronext milling wheat contract in Paris has been rising, they said, having studied price data and how it responds in various markets to major news events.

In 2013, Paris accounted for about 20 per cent of the share of price discovery, the academics said, as the market that moved first in response to news that affected wheat prices in all locations. That was up from about 10 per cent at the start of 2008, according to their research.

“There has been a long-term shift in the centre of gravity and area of influence,” says Olivier Raevel, head of commodities at Euronext in Paris, referring to the growth in influence of Black Sea grains.

Volumes of Euronext’s milling wheat contract have jumped more than ninefold in the decade to 2016, while open interest — the number of outstanding contracts held by buyers or sellers — has almost quintupled, even as its share of the market versus Chicago has been steady.

While traders have been slow to adopt contracts specifically tied to Black Sea grains, some believe that hedging has always been a skill, and that companies simply need to find what works best for them.

One Geneva based grain traders says he is mostly hedging his physical positions in Black Sea wheat this year with physical trades.

He says: “The best hedge for Russian wheat is Russian wheat.”


ft

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