Boortmalt-organised meetings have been explaining to growers the principles behind the agreed pricing options available for malting barley. The meetings explained the forward selling options that hinged around the price agreement.
Previous attempts to explain how these options worked became embroiled in a debate over the price mechanism and this cost growers a lot of money because they did not lock into prices in the falling market last year.
I attended the meeting in Carlow last week where Paul Sommerville of Sommerville Advisory Markets explained to growers the marketing principles behind the arrangements. Paul put it very simply when he said that forward pricing options swopped the risk associated with not knowing where prices would end up with the certainty of knowing a price for the amount of tonnes that one might sell in advance on each deal.
When product is committed in advance, the grower knows the price that each specific tonnage will receive. That amount of business is then done, whether it is at a fixed price or a hedge.
Paul explained the difference between the fixed price and a hedge from the grower’s perspective. But whether a grower chooses to sell at the fixed price or takes a hedge, the action swops the price risk for price certainty.
After a deal, the buyer takes on the risk – ie, the risk associated with price movement in the market does not go away, it is merely taken on by someone else. And, just like the grower, they could win or lose but these people have access to much more information and risk-abatement tools than a grower so they are in a better position to minimise their net risk.
Price components
There are a number of different features in this year’s price agreement. These include:
Four options to sell forward at a fixed price on designated dates.Six rather than four opportunities to hedge during the growing season.The final end of season price is to be based on the average of three different dates on the MATIF market post-harvest in September, rather than just one.A safeguard mechanism has been introduced to reduce the fall in the grower’s price if the MATIF price falls below €180/t.Growers also have an option to defer selling at the harvest price and take a later price, but this intention must be stated in August.All of these work in the grower’s favour, especially in a lower-price scenario. However, in a static low market, the price may still not be attractive enough for growers to consider forward selling. Paul commented that buyers also need to minimise their price risk and so they too need to reduce price uncertainty to their business.
Fixed price
A fixed price deal removes all price uncertainty for the grower and transfers it to the buyer, Boortmalt in this case. They, in turn, will most likely lay off their new risk to the markets. From the day the price is struck, the grower knows the exact price that will be paid for that specific quantity of grain.
The risk from a price fall is taken from the grower but someone else takes it on and for that reason the fixed price tends to be somewhat lower than the offer available for hedging.
Paul indicated that the fixed price option was about 10% lower than the hedging option over the past few years.
For feed grains, a forward sale at a fixed price and payment date requires that the agreed quantity and spec is actually delivered. However, this obligation does not arise in the case of malting barley and there is no obligation to deliver. This is because grain could fail on one of the many different quality specifications, whether forward sold or not. However, the grower will deliver if possible because the agreed price will normally be higher than what would be available from other markets later in the season.
The fact that there is no obligation to deliver or supply the agreed quantity and spec is a very useful safeguard for the grower. In this arrangement the fixed price on offer is derived from a formula based on the MATIF price, as are all the price offers used.
Hedging
Hedging is somewhat more complex in that it requires price adjustment or settlement post harvest. Hedging transfers price risk to the market, rather than the end user or buyer. While a hedge price is agreed, the process requires adjustment for where the actual price ends up at harvest. Because of this the grain must actually be delivered at harvest to establish its final price.
“There is no gain or loss in a hedging deal,” Paul stated. Hedging involves forgoing potential profit or loss, but from the day the deal is struck there will be no loss relative to the price agreed. Hedging does involve an opportunity cost because price can move subsequently but you don’t know in which direction.
A hedged deal involves a price settlement at the end and this can result in money being transferred in either direction. This has been difficult for growers to comprehend as they see a payout of a settlement, if price rises after the deal is struck, as income lost. However, it is important to remember that this is the price the grower agreed for the hedge on the day. The same settlement process is used to pay additional money to growers in the event that the price falls after a hedge is agreed. Hedging just fixes the price.
Where a grower hedges a quantity of the crop, at say €165/t, and the value of the crop at harvest is €180/t the grower will receive €180/t for that quantity of malting barley providing it meets malting spec. In this case the grower will receive the €180/t but the difference of €15/t (€180-€165) must be paid to the market to settle the hedge so the net price will be the initial hedging price of €165/t. Settlement is done at the end but the deal is done at the time of the hedge.
Examples
Some simple examples help. If a deal is done in May 2015 for 50t at €165/t and the harvest value of this malting barley ends up at €155/t, the grower will only receive €155 x 50 or €7,750 for this 50t.
However, as the agreed hedge was at €165/t a top-up payment of €10/t will be paid from the hedge so the grower will then get an additional €500, bringing the net receipts up to €8,250 for the 50t. This is the same as the deal agreed initially at €165/t for the 50t (€8,250). This type of example applied last season when prices fell towards harvest.
The situation would reverse in a year like 2012 when what looked like good prices during the season subsequently increased further into harvest. In this example, we will take a grower with 50t selling to a hedge for €165/t in May (same as above and the sale is worth €8,250). If the world suffers a bad weather event and global grain production is badly hit, it is inevitable that prices would strengthen to secure supplies in the face of reduced availability.
In this scenario, let’s say that the price mechanism resulted in a price of €200/t at harvest. So the grower would receive €10,000 for the 50t sold originally at €165/t. In this instance the difference in price is €35/t, which the grower will receive for the grain but this must effectively be paid to the hedge owner as the agreed price was €165/t. So the grower receives €10,000, but he must refund €35/t or €1,750 to the hedge. So the net price is €10,000 minus €1,750, which comes to €8,250, or the original agreed sale value.
So, as Paul stated, hedging does not result in profit or loss – you get the price agreed on the day regardless of price movement in the interim.
Must deliver a hedge
“Hedging is not speculation,” Paul stated. A grower makes a decision to hedge, or not, based on perception of the likely market movement. A hedge puts certainty in the price at the point of delivery, providing the grain passes the quality specifications. But one should only hedge the quantity that one can reasonably expect to deliver at harvest.
The amount that one should consider hedging must relate to the proportion of the crop that one can be confident in delivering at the required spec. But as feeding and malting barley prices move in tandem, their relative price difference is expected to be similar at different price levels.
Paul commented that “because feeding barley and malting barley trade in tandem, a hedge would be equally valid whether one delivers feeding barley or malting barley – the hedge itself will still do its job to shield the grower from market volatility and provide certainty”.
It is important to remember that a hedge relates to the price, not the product, so settlement is about adjusting for any price difference.
In the event of the barley being rejected for malting, it will only receive feed price even though the initial deal was done for the malting price. But if the malting price increased by €20/t between when the deal was struck and harvest, it is expected that the feed barley price will have risen by the same amount. So while a grower might end up with feed rather than malting price, the grower should only be at the loss of the malting premium relative to the initial hedge.
Deflation concerns
Many factors impact on market prices, not just supply and demand. Currency is currently an additional risk because if the euro strengthens, euro prices will drop to equate with international prices. Hedging removes the financial markets element of this price risk.
Paul warned that deflation is key to price uncertainty in the years ahead and growers should act to minimise this risk to their businesses. There is too much abnormal activity in the financial markets to allow grain or other commodity markets to behave normally in the years ahead, Paul warned.
Fixed price
The agreed price is the final price with no settlement required.There is no obligation to deliver if the fixed quantity fails to meet the quality specs.Hedged price
The quantity hedged must be delivered. Hedged prices tend to be roughly 10% higher than a fixed price on the day. Hedging requires a price settlement which relates to the price at which a hedge was agreed and the actual price received at harvest.A fixed price deal sets the final price but there is no penalty for non-delivery.A hedge generally enables a higher price but this must be adjusted by means of a final settlement if price rises or falls at harvest.One should only hedge the proportion that is likely to be delivered for malting.Forward selling transfers the price risk to the buyer and does not lead to loss or gain because it only acts to fix the price at the time of the deal.
Boortmalt-organised meetings have been explaining to growers the principles behind the agreed pricing options available for malting barley. The meetings explained the forward selling options that hinged around the price agreement.
Previous attempts to explain how these options worked became embroiled in a debate over the price mechanism and this cost growers a lot of money because they did not lock into prices in the falling market last year.
I attended the meeting in Carlow last week where Paul Sommerville of Sommerville Advisory Markets explained to growers the marketing principles behind the arrangements. Paul put it very simply when he said that forward pricing options swopped the risk associated with not knowing where prices would end up with the certainty of knowing a price for the amount of tonnes that one might sell in advance on each deal.
When product is committed in advance, the grower knows the price that each specific tonnage will receive. That amount of business is then done, whether it is at a fixed price or a hedge.
Paul explained the difference between the fixed price and a hedge from the grower’s perspective. But whether a grower chooses to sell at the fixed price or takes a hedge, the action swops the price risk for price certainty.
After a deal, the buyer takes on the risk – ie, the risk associated with price movement in the market does not go away, it is merely taken on by someone else. And, just like the grower, they could win or lose but these people have access to much more information and risk-abatement tools than a grower so they are in a better position to minimise their net risk.
Price components
There are a number of different features in this year’s price agreement. These include:
Four options to sell forward at a fixed price on designated dates.Six rather than four opportunities to hedge during the growing season.The final end of season price is to be based on the average of three different dates on the MATIF market post-harvest in September, rather than just one.A safeguard mechanism has been introduced to reduce the fall in the grower’s price if the MATIF price falls below €180/t.Growers also have an option to defer selling at the harvest price and take a later price, but this intention must be stated in August.All of these work in the grower’s favour, especially in a lower-price scenario. However, in a static low market, the price may still not be attractive enough for growers to consider forward selling. Paul commented that buyers also need to minimise their price risk and so they too need to reduce price uncertainty to their business.
Fixed price
A fixed price deal removes all price uncertainty for the grower and transfers it to the buyer, Boortmalt in this case. They, in turn, will most likely lay off their new risk to the markets. From the day the price is struck, the grower knows the exact price that will be paid for that specific quantity of grain.
The risk from a price fall is taken from the grower but someone else takes it on and for that reason the fixed price tends to be somewhat lower than the offer available for hedging.
Paul indicated that the fixed price option was about 10% lower than the hedging option over the past few years.
For feed grains, a forward sale at a fixed price and payment date requires that the agreed quantity and spec is actually delivered. However, this obligation does not arise in the case of malting barley and there is no obligation to deliver. This is because grain could fail on one of the many different quality specifications, whether forward sold or not. However, the grower will deliver if possible because the agreed price will normally be higher than what would be available from other markets later in the season.
The fact that there is no obligation to deliver or supply the agreed quantity and spec is a very useful safeguard for the grower. In this arrangement the fixed price on offer is derived from a formula based on the MATIF price, as are all the price offers used.
Hedging
Hedging is somewhat more complex in that it requires price adjustment or settlement post harvest. Hedging transfers price risk to the market, rather than the end user or buyer. While a hedge price is agreed, the process requires adjustment for where the actual price ends up at harvest. Because of this the grain must actually be delivered at harvest to establish its final price.
“There is no gain or loss in a hedging deal,” Paul stated. Hedging involves forgoing potential profit or loss, but from the day the deal is struck there will be no loss relative to the price agreed. Hedging does involve an opportunity cost because price can move subsequently but you don’t know in which direction.
A hedged deal involves a price settlement at the end and this can result in money being transferred in either direction. This has been difficult for growers to comprehend as they see a payout of a settlement, if price rises after the deal is struck, as income lost. However, it is important to remember that this is the price the grower agreed for the hedge on the day. The same settlement process is used to pay additional money to growers in the event that the price falls after a hedge is agreed. Hedging just fixes the price.
Where a grower hedges a quantity of the crop, at say €165/t, and the value of the crop at harvest is €180/t the grower will receive €180/t for that quantity of malting barley providing it meets malting spec. In this case the grower will receive the €180/t but the difference of €15/t (€180-€165) must be paid to the market to settle the hedge so the net price will be the initial hedging price of €165/t. Settlement is done at the end but the deal is done at the time of the hedge.
Examples
Some simple examples help. If a deal is done in May 2015 for 50t at €165/t and the harvest value of this malting barley ends up at €155/t, the grower will only receive €155 x 50 or €7,750 for this 50t.
However, as the agreed hedge was at €165/t a top-up payment of €10/t will be paid from the hedge so the grower will then get an additional €500, bringing the net receipts up to €8,250 for the 50t. This is the same as the deal agreed initially at €165/t for the 50t (€8,250). This type of example applied last season when prices fell towards harvest.
The situation would reverse in a year like 2012 when what looked like good prices during the season subsequently increased further into harvest. In this example, we will take a grower with 50t selling to a hedge for €165/t in May (same as above and the sale is worth €8,250). If the world suffers a bad weather event and global grain production is badly hit, it is inevitable that prices would strengthen to secure supplies in the face of reduced availability.
In this scenario, let’s say that the price mechanism resulted in a price of €200/t at harvest. So the grower would receive €10,000 for the 50t sold originally at €165/t. In this instance the difference in price is €35/t, which the grower will receive for the grain but this must effectively be paid to the hedge owner as the agreed price was €165/t. So the grower receives €10,000, but he must refund €35/t or €1,750 to the hedge. So the net price is €10,000 minus €1,750, which comes to €8,250, or the original agreed sale value.
So, as Paul stated, hedging does not result in profit or loss – you get the price agreed on the day regardless of price movement in the interim.
Must deliver a hedge
“Hedging is not speculation,” Paul stated. A grower makes a decision to hedge, or not, based on perception of the likely market movement. A hedge puts certainty in the price at the point of delivery, providing the grain passes the quality specifications. But one should only hedge the quantity that one can reasonably expect to deliver at harvest.
The amount that one should consider hedging must relate to the proportion of the crop that one can be confident in delivering at the required spec. But as feeding and malting barley prices move in tandem, their relative price difference is expected to be similar at different price levels.
Paul commented that “because feeding barley and malting barley trade in tandem, a hedge would be equally valid whether one delivers feeding barley or malting barley – the hedge itself will still do its job to shield the grower from market volatility and provide certainty”.
It is important to remember that a hedge relates to the price, not the product, so settlement is about adjusting for any price difference.
In the event of the barley being rejected for malting, it will only receive feed price even though the initial deal was done for the malting price. But if the malting price increased by €20/t between when the deal was struck and harvest, it is expected that the feed barley price will have risen by the same amount. So while a grower might end up with feed rather than malting price, the grower should only be at the loss of the malting premium relative to the initial hedge.
Deflation concerns
Many factors impact on market prices, not just supply and demand. Currency is currently an additional risk because if the euro strengthens, euro prices will drop to equate with international prices. Hedging removes the financial markets element of this price risk.
Paul warned that deflation is key to price uncertainty in the years ahead and growers should act to minimise this risk to their businesses. There is too much abnormal activity in the financial markets to allow grain or other commodity markets to behave normally in the years ahead, Paul warned.
Fixed price
The agreed price is the final price with no settlement required.There is no obligation to deliver if the fixed quantity fails to meet the quality specs.Hedged price
The quantity hedged must be delivered. Hedged prices tend to be roughly 10% higher than a fixed price on the day. Hedging requires a price settlement which relates to the price at which a hedge was agreed and the actual price received at harvest.A fixed price deal sets the final price but there is no penalty for non-delivery.A hedge generally enables a higher price but this must be adjusted by means of a final settlement if price rises or falls at harvest.One should only hedge the proportion that is likely to be delivered for malting.Forward selling transfers the price risk to the buyer and does not lead to loss or gain because it only acts to fix the price at the time of the deal. 
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