Agriculture Archives - Commodity Price Risk

Risk Management Check-up – Considerations Before Harvest

September 13, 2018

Summer flew by. The kids are back in school, late-season scouting is complete and crop tours are in full swing. It’s hard to read the news these days without hearing about ‘bigger than ever’ yield estimates from across the U.S. We’re now just a few weeks away from my favorite time of year, harvest. Many have been focused on production all summer long, surveying several key crop reports. But I’m wondering, how many people have updated their hedging strategy to align will all the information that’s been shared this year? With very accurate estimates of final cost of production, now is the perfect time to re-evaluate marketing and hedging strategies.

I usually recommend that both producers and end-users of commodities use this month as a bench-marking session. It’s a great time to pull out the spreadsheets from January (around the time we were preparing for final yields of the 2017 crop) and compare estimates with where we are today. This is also a good time to ask some questions:

Are you on track with the revenue or purchasing goals you set back in the winter?
With updated yield estimates, have you marketed or secured enough grain?
Do you feel confident in your marketing, purchasing or storage plan for your grain?
Are you positioned to capture market opportunities?

We recently wrote an article about ‘do nothing strategies’. At Cargill Risk Management, we believe doing nothing at all, is in fact doing something. If you don’t plan and prepare for the year, what will happen to your end-of-year financials if the unexpected occurs? You’d be surprised to see how planning ahead can impact your financial performance for the end of the year.

For producers, adding market participation to those ‘must-sell’ bushels at harvest can be a strategy that can provide opportunity for price movements as well as limiting downside risk. Implementing this can take many forms, including OTC options allowing customization for price risk management.

If you are an end-user of commodities, have you taken advantage of pricing opportunities? If large crops are realized, do you have your needs for the next 6-12 months covered? Revisiting your risk management plan now can pay dividends into the future.

Securing a price through customized risk management products can be a cost-effective way to gain market participation. These tools allow you to participate in future market moves that benefit your position while limiting moves that do not.

Last, it’s important not forget about the 2019 crop, As the harvest begins, you should be thinking about crop plans and pricing strategies to help ensure 2019 is another year filled with success.

Is a hedge always a hedge?

August 16, 2018

By: Keith Milne and Christian Tylinski

If you are a coffee roaster or a consumer-facing brand, it could be easy to assume that a futures hedge gives you all the protection you need. After all, prices and volatility are currently very low. Hedging on the futures market provides comprehensive coverage for your value chain, right?

The reality is that the particulars of the current environment may have us primed for a rapid return of volatility. If that happens, futures hedging alone may leave critical gaps in your risk management strategy and allow your competitors to secure a better margin – enabling them to undercut you on price and gain share with your customers.

Examining the particulars of this market, it becomes clear that some flexibility can be a good thing. Structured solutions may be able to help you hedge in ways that futures positions cannot.

Today’s market: volatility brewing?

As we know, prices and volatility in the coffee market have been at historic lows for some time. Meanwhile, money managers or funds have built up very large short positions.¹ These substantial positions could amplify price moves. An uptick could cause funds to begin buying back contracts, which could create a feedback loop of even faster increases and buybacks.

What could trigger that first step up in prices? With mixed performance from global equities so far in 2018, money managers may sooner or later begin to seek returns in new venues. Expect commodities to be on their short list of targets. Every few years, institutional investors, banks and others are drawn into commodities markets looking for yields.¹ Even now, we are seeing that happen in hard commodities, and agricultural could well be next. When they start to move money into new asset classes, especially commodities with smaller global supplies like coffee, it might have a sizable impact on prices.

Weather also could light the fuse. Frosts or drought in key growing regions can quickly reverse sentiment and cause prices to skyrocket. The September timeframe will be a key window for weather news that could rattle markets.

Spotting gaps in your risk management strategy

It is understandable why coffee roasters and consumer brands seek to mitigate the risk in their value chains through futures hedging. If you are long in physical supply, going short in futures is a time-honored hedge. And in normal markets, it can work well to protect against the majority of the risk you face.

But as we have seen above, we are not necessarily in a normal market.

Given the potential for a rapid return of volatility and a run-up in price, rigidly locking in your margins at the wrong time – with no flexibility – may leave you at a disadvantage. Minutes can make a big difference, never mind days or weeks.

If your competitors secure even slightly better margins, they will have more options as they seek to market their products, discount price points, and grab the attention of the consumer who is making a purchasing decision in the supermarket aisle or the shopping center.

Margins are great, and you need to make your budget. But getting locked in too tightly can leave a gap that others can employ to outflank you, potentially using a few cents to cripple your growth.

Structured solutions for greater flexibility

Before volatility arrives, a sound risk management strategy will assess all options and determine what alternative solutions may work best for you. This takes the guesswork out of hedging at just the right moment, which can be hard for anyone to do when volatility is high.

Structured risk management products can protect you from downside movements and help keep you competitive, so you have more optionality than a traditional futures hedge provides regardless of exactly when you need to buy or sell.

Although predictability is a mainstay for many end users of coffee, and futures markets are a good means to achieve that, a little flexibility may give you that last boost you need while protecting you against blind spots.

_{S. Commodity Future Trading Commission’s Commitments of Traders report}

Low coffee prices still call for disciplined risk management

July 24, 2018

By Matthew Dunbar

During a period of low prices like the one we are currently facing in the global coffee market, producers and trading houses are confronted with a conundrum. How do you strike a balance between over-committing your volume at the first sign of higher prices and missing out on a rally by waiting too long?

This challenge is complicated by structural changes in the coffee supply chain that are emerging even as we speak. Buyers are pushing longer credit terms back up the supply chain, leaving growers and trade houses worried about cash flow during the upcoming year. Credit terms for 270 days – or even 365 days – are becoming common.

Meanwhile, outside managed money (including funds) are maintaining record short positions in this market. For better or worse, funds act as a multiplying force in the market, meaning their very high level of shorts could amplify any move in prices.

With a growing consensus that global equities may be overvalued, commodities markets could very well see a strong influx of managed money as investors seek returns. This is already happening in metals and petroleum. Agricultural commodities – including coffee – may be the next destination for managed money, precipitating a rise in prices.

And of course, there is always the unknown of weather and its impact on production. Low prices put a check on production anyway. As this decreased production meets an expected two to three percent annual rise in consumption, now the fourth year in the current down cycle, it likely will cause a rise in prices.

In the midst of this uncertainty, it is important to define your coffee price risk management strategy before the market reaches a tipping point and prices go up. Then, when the change arrives – and it can arrive quickly, as we know – it is critical to maintain discipline and resist letting emotion throw you off course.

Because low prices cannot last forever, here are a few linked scenarios that producers and trade houses should consider and plan for in advance.

A cash influx

With global equities on an uneven footing during the first part of 2018, it would be no surprise to see money managers begin to look elsewhere for a return. This is an inevitable cycle that we in commodities see every few years. But just because we’ve seen it before doesn’t mean we should underestimate the impact.

Even a 1 or 2 percent move of managed money could mean hundreds of millions of dollars pouring into commodities like coffee. Unless there are offsetting fundamental signals – like an uptick in production or projections of sluggish demand growth – the entrance of this kind of money into the coffee market would almost certainly push prices upward.

A fund run

In this context, it is worth taking a closer look at fund positions. Because managed money as a group are exceptionally short right now, the first sign of a price rise could jar them out of their current position and cause them to buy back their contracts. The point at which this might happen is hard to predict, but when the market passes a certain threshold within the funds’ technical analyses, things could snowball quickly.

An even bigger credit crunch

If the market begins to run up and you are holding short positions, suddenly those positions could be working against you. You might face margin calls that significantly raise your cost of capital. Maintaining your hedges could cripple your cash flow.

Now imagine that this happens all up and down the coffee supply chain. Facing the same cash flow concerns, roasters and end-users of the commodity could push for even longer credit terms, putting producers and trade houses in a tough spot.

The solution: A disciplined strategy

Although the above scenarios may be worrisome, they can be overcome. The key is to define a strategy and stick to it. Do not let emotions drive your decisions, even in the face of extreme circumstances.

If you are upstream in the supply chain, this may be difficult. With prices having been low for so long, any increase of just a few cents may make it very tempting to lock in a price. But this may not be the level you want to sell all your volume at; acting too soon could cause you to miss significant additional upside. Cargill Risk Management offers structured products to help you get to the objective level you are seeking, so you are not watching the market every day and feeling jittery about every bump or dip in the chart.

Worries about credit and cash flow can also cloud decision-making. It is understandable after all, because you do not want market investors negatively impacting your ability to run your business. Here, again, a comprehensive plan is key. We work with individual clients to establish credit thresholds, which may provide a cushion against margin calls when the market moves.

At the end of the day, a well-defined risk management plan can give you assurance, no matter market conditions, and protection from letting emotions ruin your day.

Putting together the supply puzzle for better risk management

June 18, 2018

By: Jeremy Barron

We all know the USDA monthly crop production report is the single most important data set in the agriculture business. But for the full picture, we rely on three major USDA reports throughout the year:

Planting Intentions (March)
Final Planted Acreage (June)
Final Production (January)

Putting the pieces together with the data shared in these reports can be tricky. These three individual reports are the puzzle pieces to a full picture. Understanding each can help you better align and prepare your commodity price risk management strategy.

The USDA’s Planting Intentions report in March is the first confirmed estimate the market receives on the upcoming crop year. Until this point, traders look at historical data and projections to estimate a crop size. Since there are so many unknowns, there tends to be opportunity for market moves. And depending on the side of the market you are on, going into spring without a plan can be dangerous.

The USDA’s Final Planted Acreage report in June provides clarity on the season’s planted acres. By this time, we have experienced a planting season in North American corn and soybeans. Most acres have been planted (or were prevented from being planted) and now the market can focus on the yield piece of the puzzle. Due to many unknown factors between the March and June reports, a solid risk management plan is critical.

Let’s say you are a corn and soybean farmer in North America, its early June and you’ve just finished planting your crop. There is a lot of speculation about how many acres were planted this spring. You’ve been busy and watching the markets hasn’t been your top priority. However, you suddenly see your crop emerging and thriving. Immediately you begin to think about commodity prices and start to run various “what if” scenarios. But wait, before you know it, corn and soybeans have dropped 30 cents in a matter of days. Do you wait to see if it comes back? Or, do you act on hopes that yields will be strong, knowing the June 29 crop report will be out in a couple weeks?

*Graph compiled by Cargill Risk Management using historical prices from Reuters

This dilemma is all too common at the farm gate. By asking yourself – How do I manage price risk? What tools are available to me? If I could get “X” price, what percentage of my crop would I be willing to market? – You develop a deep understanding of your goals and can begin to formulate your “in-season” marketing plan.

A similar dilemma exists for the commercial commodity consumer. A sudden drop in prices can be a great opportunity to review your risk management plan. By understanding your consumption needs and risk tolerance, you can start to formulate your plan for how you protect prices further out on the curve. A methodology we use is the “DDC” approach to commodity risk management. This approach encourages you to find the right balance of discipline, diversification and control and is the first step to building a framework to managing commodity risk.

If as a producer, you find yourself getting stuck on pricing ‘what if’s’, or if you’re trying to find balance in your commodity risk plan as a consumer, OTCs could be a good option for you. From both perspectives, OTC products can help you obtain desired pricing, giving ultimate control over your plan so that you’re prepared when the unexpected happens.

Then, on June 29th, the USDA Final Planted Acreage report is out. Traders will focus on crop size. The USDA monthly crop production report will once again, take center stage until the final production report is released in January.

Understanding these three, critical pieces to the supply side of the puzzle, combined with a solid commodity risk management plan, can help you set course on another productive, and hopefully profitable year.