1239286220863 Craig Baker Commodity Price Risk Management (1)
Transcript of 1239286220863 Craig Baker Commodity Price Risk Management (1)
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Market-Based Solutions for
Commodity
Price Risk Management
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-Craig Baker
Commodity Risk Management Group,
World Bank
EUROPEANCOMMISSION
ALL ACP AGRICULTURAL COMMODITIES PROGRAMME
ACP GROUPOFSTATES
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What Creates Price Risk?
Impacts of Price Risk;
Can Risk Management Tools Help? Overview of Risk Management Tools;
Application of Risk Management Tools;
Risk Assessment;
Lessons Learned;
Not Covered (due to time)Actual examples of
successful implementations
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Agenda
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Impacts of Price Risk
Example:producer prices fixed at the beginning of the season;
If prices risebetween purchase and sale, farmers groups / ginnersare profitable and:
Profits are returned to farmer in the form of 2ndpayment;
Balance sheets remain in tact, loans are repaid and finance isavailable for the following season
If prices fallbetween purchase and sale, farmer groups/ ginners:
May avoid making sales in order to avoid losses;
May be forced to lower the purchase price to farmers; May default on sales because can not procure enough product;
May make sales and book losses;
May not have cash to continue paying farmers;
May go out of business
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Some Examples
African Food Aid $800m in 2006
Burkina Faso -2005/6 - $110m in Cotton Debt
El Salvador2001/2 - $250m Coffee Debt
Senegal2006 - $20m Cotton Debt
What or who is Next?
African Food Aid $900m in 2007
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Impact on Financial Institutions
Existing challenges in agri-lending include: low collateral,infrastructure, knowledge, price volatility, market access
(phones), weather (climate) risk, agri technology;
Banks have experienced adverse consequences of volatility
and this affects willingness to supply competitively priced creditto the agricultural sector;
Credit supplied is therefore often based on conservative
collateralised schemes and very little innovation exists in terms
of lending products;
High cost of finance erodes margins for all;
Objective:improve risk management to assure continued
engagement of banking sector in agricultural financing
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Can Risk Management Tools Help?
toreplace costly, inefficient, disruptive ex postresponseswith cheaper, more efficient, targeted ex anteresponses
that stimulate private sector agricultural lending
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Overview of Price Risk Management (Hedging)
Tools
Derivatives are financial weapons of mass destruction
Warren Buffet
It is not the plain vanilla contracts that Buffet was
referring to when making these statements but rather
the overall lack of understanding of exposures arising
from exotic contracts that are impossible to price andbring about long terms obligations.
We need to demystify risk management and separate it
from speculation!
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Overview of Price Risk Management (Hedging)
Tools
Two main products: Futures Contract;
Option Contract:
A financial agreementbetween two parties that gives the buyer
the right but not the obligationto buy or sell a futures contract
within a specific period of time at a specific price level;
Has an upfront costAkin to insurance;
Standardised contracts that specify:
Price;
Quantity;
Delivery date;
Settlement Date
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Option Contracts..
PUT Option
Contingent Export
CALL Option
Contingent Import
Definition
PUTS = purchase the
right but not the obligation
to SELLa specific futurescontract at a specified price
within a specified time
CALLS = purchase the
right but not the obligation
to BUYspecific futurescontract at a specified price
within a specified time
Offers Protection against prices moving down against prices moving up
What You Get
If market moves down, you
receive the difference
between price protected
and the prevailing market
price
If market moves up, you
receive the difference
between price protected
and the prevailing market
price
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Application of Risk Management Tools.
Governments Risk- managing food supplies / reserves; reducing the need for and cost of
policy interventions
Assist Governments with the:
Need to build confidence in commercial solutions;
Need improved planning
Producers
Riskmanaging sale prices to cover cost of inputs
Assists Producers with the:: Need to understand how the global market moves & affects local prices;
Need for confidence that producer price is competitive in the market;
BUTgenerally very difficult to access risk management marketsdirectly so best approach is to access price risk mgmt solutions
through market intermediaries
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Application of Risk Management Tools
Market Intermediaries (Cooperatives / Buyers / Traders / Processors) Riskmanaging price volatility in between time of purchase & sale; avoiding trading
losses caused by intra-seasonal price volatility; maintaining own credit-worthiness andability to pay back loans; managing farmer credit risk when extending loans for inputs& production
Assists Market Intermediaries with the:
Need to understand & be able to quantify risk throughout the season;
Need to offer competitive prices to farmers and be confident of ability to pay that price;
Need to improve management of intra-seasonal price and credit exposures;
Need to understand global markets & improve negotiating power
Banks / Financiers
Risk- managing credit risk for financing farmers& market intermediaries
Assists Banks / Financiers with the:
Need to improve risk assessment capabilities & monitoring throughout the season;
Need to offer risk management solutions to borrowers;
Need to balance extending / increasing credit without increasing risks;
Can play a critical role in helping a country gain access to financial markets
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Risk Assessment is the First Step!
Risk comes from not knowing what you're doingWarren Buffet
Every participant in a commodity chain has risk that is determinedby its business practices:
Price Fixing;
Purchases and Sales Patterns;
Volumes of Purchases and Sales;
Types of Contracts;
Levels of Credit
Risk Assessment = understanding how purchase & sales patternsinfluence risk;
Banks / Financiers should be using these tools and assist
Market Intermediaries with the adoption of these practices!
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Three Risk Assessment Tools
Position Analysis:
What is your (clients) position relative to the market?
In which direction is your (clients) exposure?
If you: BUY before you SELL (long position); or
SELL before you BUY (short position)
...you (your clients) are at risk and have taken a position
LONG positions = risk of prices moving down;
SHORT positions = risk of prices moving up
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Three Risk Assessment Tools
Breakeven Analysis:
Breaking even = covering costs;
Costs change over time depending on changes in:
Fixed costsTransport, Ginning, Milling, Roasting;
Variable costsPurchase price
Asses costs in terms of unit costsUsh/Kg;
What is the price level at which you (your clients) are
breaking even?
Mark to Market Analysis:
Compares breakeven level vs. current market level;
What is the current exposure quantified in $ terms?
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The Alternative Approach....
We should be managing risks instead of managing crises
Dr. Abera Deressa
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Lesson Learned
Price risk tools if carefully applied may yield:
Reduced cost of borrowing from banks;
Increase access to creditas confidence of repaymentincreases;
Stability of earnings & secure minimum operatingmargin;
Assurance of price to be offered farmers;
Capacity building for improved risk management alsostrengthens marketing / financial knowledge;
Ensure that it is not just another cost in the value
chain...
Capacity building on these issues takes time