Rising Prices, Higher Volatility and Greater Risk in Agribusiness

Growing Farmers / Grain Elevator issues worldwide, if we summarize they come down to following for easy understanding–

1. Risk hedging tools (Future and Options) on the derivatives market are getting more expensive (more margin) and less reliable (volatility).
These tools have long provided a way to lock in the price of a crop as it is planted, eliminating the risk that prices will drop before it is harvested. With these hedging tools, grain elevators could afford to buy crops from farmers in advance, sometimes a year or more before the harvest.
But that was yesterday. It simply is not working that way today.

2. Crops prices are soaring on the updraft of growing worldwide demand, and a weak dollar is making the crops more competitive in global markets.


3. Crop prices are not just much higher; they also are much more volatile. For example, a widely used measure of volatility showed that traders in March expected wheat prices to swing up or down by more than 72 percent in the coming year, three times the average volatility for that month and the highest level since at least 1980.


4. Those wild swings in expected prices are damaging the mechanisms — like futures contracts and options — that in the past have cushioned the jolts of farming, turning already-busy farmers into reluctant day traders and part-time lobbyists.
Farmers used to leave the market-watching to traders who work for big grain elevator companies. But with some of those companies now refusing to buy crops in advance because hedging has become so expensive and uncertain, farmers have to follow and trade in those markets themselves.

5. Higher volatility in grain prices means higher crop insurance premiums to be paid. This is not just a problem for farmers. Eventually, those costs are going to come out of the pockets of the consumers.

6. Grain elevators are coping with the volatility and hedging problems by refusing to buy crops in advance, foreclosing the most common way farmers lock in prices.
Frustrated over the flawed futures contract, Mr. Fletcher (A grain elevator guy) is voting with his feet. Last year, he entered into a contract with A.I.G. Financial Products, a leading sponsor of commodity index funds, which allows him and the index fund to hedge their risks without using the C.B.O.T.

Instead of using futures or options, A.I.G. simply buys the commodity directly from Mr. Fletcher, who stores it for a fee and buys it back six months later. His storage fee is lower than the one built into the C.B.O.T. contract, so A.I.G. pays less for its stake in the market. And he has a hedge he can rely on.
“I did a deal with them for corn a year ago, and this year I’m doing a deal on soybeans,” he said.

But private deals like these do not provide pricing data to other farmers and to the rest of the food industry, which has long relied on the Chicago Board of Trade as the best measure of supply and demand. If such bilateral contracts become more common, it will be harder for everyone in the industry to anticipate costs and potential profits — which could also push prices up.
This growing uncertainty about prices and hedging “just makes the market less efficient,” said Jeffrey Hainline, president of Advance Trading. “And anything that makes these markets less efficient increases the cost of food.”

7. Higher volatility means putting more cash as margin.
When the margin call arrives, a farmer sometimes has to rely on his bank to advance him the margin he needs to keep those hedges in place — a worrisome requirement even for a successful farmer in an economy already struggling with a credit squeeze.
“The nightmare scenario is when you have to make margin and you’re looking out your back door and seeing, maybe, a crop problem,” he said. “Everybody has a story about a guy they know getting blown out of his hedge” by unmet margin calls.

8. On dozens of occasions since early 2006, the futures contracts for corn, wheat and soybeans have expired at a price that was much higher than that day’s cash price for those grains.

For example, soybean futures contracts expired in July at a price of $9.13 a bushel, which was 80 cents higher than the cash price that day, Professor Irwin said. In August, the futures expired at $8.62, or 68 cents above the cash price, and in September, the expiration price was $9.43, or 78 cents above the cash price.
Futures, for example, are less reliable. They work as a hedge only if they fall due at a price that roughly matches prices in the cash market, where the grain is actually sold. Increasingly — for disputed reasons — grain futures are expiring at prices well above the cash-market price.




When that happens, farmers or elevator owners wind up owing more on their futures hedge than the crops are worth in the cash market. When that happens, no one can be exactly sure which is the accurate price in these crucial commodity markets, an uncertainty that can influence food prices and production decisions around the world.

These disparities also raise the question of whether farmers, who rely almost exclusively on the cash market, are being shortchanged by cash prices that are lower than they should be.

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