By Rob Wolter and Ramon Paxton

 In our most recent article about the Risk Management Puzzle, we outlined what you need to develop a solid risk management strategy. We noted that whether you are a producer or consumer, exposure in hogs and other meats can be challenging. That’s where Cargill Risk Management can help by offering an over-the-counter (OTC) marketplace for meats.

In addition to the OTC opportunity, which you could take advantage of right now, the CME is expected to launch a new pork belly contract in 2020 that is based on the price risk that buyers and sellers face.

Quick history lesson about the pork belly contract

1961: Pork bellies started trading on the Chicago Mercantile Exchange in 1961. The unit of the commodity was 20 tons of frozen, trimmed bellies. They were flash frozen and could be held for an extended time in storage.

2011: Even with a little star power – the contract was depicted in the 1983 film Trading Spaces, starring Eddie Murphy – the contract was delisted in 2011. Food companies had started purchasing chilled pork bellies versus frozen, which reduced open interest to almost nothing.

 2019: A revised version of the pork belly contract is back. A weekly bacon price will be set each Monday, and the index will “reflect the value of one load, or 40,000 pounds (18 metric tons), of fresh skinless pork bellies in cents per pound.”*

What is a pork belly and why should you care?

What is a pork belly, you may ask? A pork belly is the cut used to make bacon. Your second question may be – why should I care about the pork belly contract? It’s a fair question. Here’s why: there has been an increase in wholesale prices due to volatility caused by consumer demand,  African Swine Fever (ASF) decimating hog herds in China and the U.S.-China trade war. See the chart below for a look at prices and read our first article in this series to learn more about ASF.

Source: Reuters

Here are few other reasons that bacon may be a good addition to the menu:

• 40 million pounds = the amount of excess, uneaten bacon the U.S. is sitting on – a 48-year high – according to data released by the U.S. Department of Agriculture*
• 99% = the amount pork belly growth is expected to outperform other food and beverage ingredients in the next four years
• 84% = the amount bacon growth is expected to outperform other food and beverage ingredients in the next four years
• 70% = the percentage of menus where bacon is found
• 42% = the percentage of consumer who claim to eat bacon multiple times per month*

All of this means is that there’s a potential new market for you to explore in this space, as niche contracts like this can offer interesting opportunities for producers and consumers. The majority of the volatility has been in this area versus other pork contracts, which may help increase margins. Here’s another interesting fact: according to June United States Department of Agriculture (USDA) data, the U.S. exported twice as many pork products this year as in the previous year. If you are a producer or consumer of pork, that’s a stat you should keep an eye on, since you don’t want to be caught six to 12 months down the road without a plan.

The pork belly contract will not be in place for a few months, but Cargill Risk Management is here to help now and in the future. We provide a variety of over-the-counter (OTC) hedging solutions that can be tailored to your specific needs – whether it’s in pork bellies, live cattle or corn.

 

*Sources: Bloomberg, https://www.bloomberg.com/news/articles/2019-05-13/cme-to-publish-bacon-index-after-2011-pork-belly-futures-demise;

USA Today, https://www.usatoday.com/story/money/2019/10/28/america-has-40-million-pounds-uneaten-bacon-highest-48-years/2484500001/;

CME Group, file:///C:/Users/k799156/AppData/Local/Microsoft/Windows/INetCache/Content.Outlook/DX89S3NP/2019%20Bacon%20Stakeholder%20Meeting%20(002).pdf

 

By Francisco Gomes and Ramon Paxton

Last year, we started the year by suggesting that those looking at the Brazilian sugar market may want to fasten their seat belts because the volatility came back into the market due to a number of factors including elections and fluctuations in the real’s value against the dollar, among others. As we look at the outlook for 2020, some of the same factors are at play – along with some new nuances just to keep you on your toes.

There are several reasons to expect that volatility will continue in 2020.

#1: Politics matter. The elections in Brazil are over, but political instability, paired with currency fluctuation and a continued weak real against the dollar, has a big impact on the economy. In another part of the world, elections in India were important in 2019 due to the subsidies provided to cane growers and the impact that has on the world sugar supply. Additionally, global trade wars and events like the drone attack in Saudi Arabia have macro impacts on the market – primarily on the crude oil prices – which in turn affects millers.

#2: The weather. Weather is always a factor and will play a large role in the world’s production of sugar cane and sugar beets. We expect the 2020/2021 crushed sugar cane to remain roughly unchanged, but the weather could impact that. For example, Thailand production was recently impacted by a weather event.

#3: Ethanol mix. High prices enabled a record mix of ethanol in Brazil – around 10 million tons less sugar was available for export. As discussed last year, high ethanol demand and weather-driven supply limitations could push prices up. This could also go the other way if global oil prices go down, which could incentive some mills to switch production back to sugar. Additionally, ethanol is denominated in reais, while sugar is done in dollars – meaning the foreign exchange rate will continue to have an impact.

As always there are many variables that could affect the sugar market to either side. With that in mind, now is the time for mills to look at the things they have control over – which could include implementing a risk management strategy that helps protect margins.

Uncertainty is still in the air

Price is king, and the futures prices for sugar are rising. Brazil is at the epicenter of sugar, so we will continue to learn more as we approach the key season in the Center-South. At this point, sugar mix estimates in Brazil are starting to rise, but as we already noted, politics and weather could have an impact. Another point to consider, a recent survey by Platts said 35% (10 million metric tons) of the 2020/2021 Brazilian sugar crop was fixed in November, allowing producers to lock in margins for export. This also means they will need a mix of at least 35% to meet their volume obligations.

Producers always want to lock in the best price possible. One key to success will be producers’ ability to lock in margin in the futures market or buy flexibility to allow them to shift strategies based on what happens in the market. There have been significant fund position and swings from record short positions.

With the uncertainty in front of the market, a conservative hedging approach may be best to preserve a floor price and protect margins. This would help ensure vital cash flow needed to run operations.

Debt levels – and their currency denomination – will play a role in your strategy, too. For instance, mills with debt or operating costs in reals could benefit from certain structured products that hedge against both the price of crude oil and the foreign exchange rate with the dollar.

No matter your situation – including your allocation of production between ethanol and sugar –2020 is likely to throw more volatility and unpredictable variables your way.

Hopefully, you had your seat belts securely fastened in 2019, and you keep it buckled for 2020. Just like the seat belt that protects you in a car, you need a risk management strategy that can support your business when the outlook is uncertain.

 

 

By Rob Wolter & Ramon Paxton

If you are in the commodities space right now, you know the pressures facing producers and consumers. From the trade war and African Swine Fever to the decline in protein supplies, trying to manage your risk in the commodities space can feel like a putting together a puzzle with a missing piece. In addition, the emphasis on Alternative Marketing Agreements makes finding the perfect hedge a challenge for producers.

What are the puzzle pieces you need to put together for a solid risk management strategy?

 #1: Understand your exposure and what’s driving current prices 

What puzzle pieces do you need to pay attention to in order to meet your objectives? Here are a few examples of commodities that might be on your list along with some of the factors that could be affecting them.

#2: Understand how to protect your margin

Producers are forced to manage price risk by accepting an imperfect correlation and utilize a variety of futures and options strategies to protect margins.

 #3: Know your cost of goods

For end users, hedge accounting rules can often limit a company’s ability to protect itself, unless it finds a perfect connection to the specific meat cuts they buy. This approach can be extremely expensive if it’s done in the physical supply agreement, or there may not be risk management solutions that address the specific needs that company has.

 #4: The missing piece – managing the risk on the first three points

Whether you are a producer or consumer, exposure in hogs and other meats can be challenging, but like any other commodity space, the key to putting the pieces of the puzzle together is having a good risk management strategy in the first place.

Learn more about how to develop an effective hedging and risk management program in our 8-Step Checklist. When you understand the pieces, you have more ability to objectively assess your business needs and apply strategies that will help you effectively manage your risk.

Once you have a program in place, think about how you can apply the DDC approach. (This is a quick overview of a longer article – find more details on the DDC approach here.)

1. Diversification – use a variety of strategies to help you benefit from the variety of paths the market may take.
2. Discipline – execute your plan rather than waiting and hoping your target will eventually come into sight. This means you have to stay focused on your objectives and make decisions based on the current market versus past positions. Set your plan and stick to it!
3. Controls – put a series of controls in place to ensure deliverables are executed. This might include reporting, stress testing, oversight and regular dashboards.

When it comes to your exposure in hogs or other meats, Cargill Risk Management can be part of the solution:

• Offering an over-the-counter (OTC) marketplace for meats
• Supporting new contracts, like the pork belly contract that is reemerging (more to come in a future article)
• Creating liquidity for buyers and sellers

Cargill Risk Management is at the cutting edge when it comes to finding specialized solutions for customers. With our ability to work through the physical side of the business within Cargill, we can help you find a comprehensive solution to manage your risk.