Commodity Risk Management - Irish Co-Operative ... · Commodity Risk Management •Education...

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Commodity Risk Management

Dairy Risk Management Overview

CIT September, 2012


International Assets Holding Corporation | www.intlassets.com | www.fcstone.com | www.downesoneill.com

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Agenda • Introduction Liam Fenton

• Brief overview of INTL FCStone

• How the market has developed in the US

• How it is developing in Europe

• Issue’s with Development in Europe

• Basic Theory of hedging

• How companies are utilising it today

• How Farmers can benefit from this market’s development

• Does the Dairy Industry need hedging

• Approximate Cost’s

• Next Steps

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Liam Fenton • Born and raised on a dairy Farm in Co

Limerick

• Bank of Ireland

• Set up my own company

• Traded on futures markets in NY/

Chicago/London/Dublin

• Established FCStone Europe office in 2008

Charlie Hyland

John Lancaster

• Still milk Cows on Family Farm!

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Global Presence

30 offices | 1000+ employees | 20,000 customers in more than 100 countries

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INTL FCStone Dairy • NASDAQ Listed/Fortune 500 Company

• Began as Co-op in Risk Management

• Purchased the No1 Dairy Risk manager in US – in 2007

• Involved in US Dairy markets since their inception 20 years ago

• Leading International Dairy Economists on staff

- Bill Brooks

• Participant in much of the CME product development

• First clearing member of the NZX

• Leading futures/option brokerage firm in Milk/Butter/Powders/Whey Product

• Establishment of the Cash Settled butter market

• Research and Development of European Dairy risk management tools part

financed by the IDA

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Volatility

Causes

Solution

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How The Market Developed in US

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Volatility-What causes it at the

moment?

• Not Speculators – Too small

Cause

• Decreasing Intervention levels and Quota

changes

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Speculators in the US Market Disaggregated Commitments of Traders- Options and Futures Combined Positions as of January 24, 2012 : Reportable Positions : :------------------------------------------------------------------------------------------------------------- : : Producer/Merchant : : : : : Processor/User : Swap Dealers : Managed Money : Other Reportables : : Long : Short : Long : Short :Spreading: Long : Short :Spreading: Long : Short :Spreading : ---------------------------------------------------------------------------------------------------------------- MILK, Class III - CHICAGO MERCANTILE EXCHANGE (CONTRACTS OF 200,000 POUNDS) : CFTC Code #052641 Open Interest is 51,939 : : Positions : : 27,965 23,648 0 1,797 41 1,497 41 31 5,232 3,323 11,349 : : : : Changes from: January 17, 2012 : : 1,396 405 0 78 -3 -968 -136 -6 167 -250 311 : : : : Percent of Open Interest Represented by Each Category of Trader : : 53.8 45.5 0.0 3.5 0.1 2.9 0.1 0.1 10.1 6.4 21.9 : : : : Number of Traders in Each Category Total Traders: 77 : : 35 32 0 . . . . . 10 17 18

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Class III Milk Price

$8.00

$9.00

$10.00

$11.00

$12.00

$13.00

$14.00

$15.00

$16.00

$17.00

$18.00

$19.00

$20.00

$21.00

$22.00

1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

$/c

wt.

Class III Support

Reduction of price supports in the US market resulted in increased

volatility

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Example of one Companies

solution we have in the US

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$6

$7

$8

$9

$10

$11

$12

$13

$14

$15

$16

$17

$18

$19

$20

$21

$22

$23

$24

Jan-

00A

pr-0

0Ju

l-00

Oct

-00

Jan-

01A

pr-0

1Ju

l-01

Oct

-01

Jan-

02A

pr-0

2Ju

l-02

Oct

-02

Jan-

03A

pr-0

3Ju

l-03

Oct

-03

Jan-

04A

pr-0

4Ju

l-04

Oct

-04

Jan-

05A

pr-0

5Ju

l-05

Oct

-05

Jan-

06A

pr-0

6Ju

l-06

Oct

-06

Jan-

07A

pr-0

7Ju

l-07

Oct

-07

Jan-

08A

pr-0

8Ju

l-08

Oct

-08

Jan-

09A

pr-0

9Ju

l-09

Oct

-09

Jan-

10A

pr-1

0Ju

l-10

Oct

-10

Jan-

11A

pr-1

1Ju

l-11

Oct

-11

Dol

lars

per

cw

t.

Weighted Average Contract Prices vs. Announced Class III PricesJanuary 2000 through December 2011 - Contract Ranges Reflected

Weighted Average Value - $13.73 vs. Class III Average - $13.80

Weighted Average Contract Price Announced Class III Price Contract Range (High & Low)

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How Does this program work? Farmer phones Co-op

Asks for a price on future production

Co-op contacts FCStone (FCS)

FCS refer to market & return price to Co-op

Farmer then decides if he wishes to sell

forward

Co-op relays order or otherwise to FCS

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Advantages

• Farmer has certainty as to price of future

production or percentage of production

• Farmers Bank is happier/Easier to raise

finance

• Co-Op secures future supply of milk

• Co-Op does not have risk of fixing its price

• Co-Op can then offer fixed pricing to

Customers and ensure margin

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But its not about best Price its

MARGIN!!!

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How is it developing in Europe?

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Futures Markets (In alphabetical order)

• Eurex – EU Butter (Financially Settled)

– EU SMP (Financially Settled)

• NYSE Liffe – EU SMP (Physically Settled)

– Butter and Whey to Follow

• NZX (New Zealand) – WMP

– AMF

– SMP

• CME (US Market) – Non-Fat Dry Contract

– Class III / Butter / Cheese etc.

OTC Markets

• Flexible Contracts

Markets and Contracts

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What’s been hedged last year?

• 20,000 Tonnes of Product

Butter/SMP/Cheese

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Main Participants

• Consumers

• Traders

Less Involved

• Producers

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Issues with Development in Europe?

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• Education

• Education

• Education

• Independent/Reliable Data

• Still industry dependency mentality on

European Intervention

• Farmer Access/Natural sell side

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Basic Theory of hedging

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• Hedging is used to manage the effects of price

volatility on businesses

• Hedging typically utilises financial markets to offset

risks faced in your physical purchases and/or sales

Hedging Theory

Cash Market Losses (Gains)

=

Futures Contract Gains (Losses)

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€ € € €

Very basic theory – simple scenario

You buy inventory….at a cost

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€ € € € € €

Very basic theory – industry business model

The market rises – you gain

Profit

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€ €

The market falls– you loose

Loss

Very basic theory – industry business model

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€ €

Using futures - its an offset To protect against this particular risk you would sell a futures

Buy inventory Sell

futures

€ €

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€ €

Very basic theory – its an offset To protect against this particular risk you would sell a futures

Inventory value loss

Futures

value

gain

€ € € €

Margin

locked in

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€ € € €

Very basic theory – its an offset To protect against this particular risk you would sell a futures

Inventory value gain

Futures

value

loss

€ €

Margin

locked in

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Manufacturer Fixing price of Raw Materials when making

sales contracts

SELL

BUY

Gain/Loss

Net Gain / Loss

Cash/Physical

Futures

1 2

2 1

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Hedge Example - Increasing Markets

SELL

BUY

Gain/Loss

- 300 Eur

+ 300 Eur

Cash/Physical

Futures

1 3200 Eur

2 3500 Eur

1 3200 Eur

2 3500 Eur

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Hedge Example - Decreasing Markets

SELL

BUY

Gain/Loss

+ 300 Eur

- 300 Eur

Cash/Physical

Futures

1

1 2

2 1 3200 Eur

2 2900 Eur

1 3200 Eur

2 2900 Eur

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How are companies ultilising it today?

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• Do new/trades for longer period of time

and improving margin

• Protect Co-op producers from time lag risk

• Protection of Inventory

• Stability of pricing

• Gain new Customers

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How Farmers can benefit from these

market developments?

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Benefits for Farmers

• Allows Certainty

• Allows financial planning

• Allows him to sleep at night!

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Does Dairy Industry Need it?

• Intervention & Quotas return NO

• Intervention Goes YES

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Does Dairy Industry Need it?

Growth of demand for product

• Dairy is in competition with other products

who have these tools

• One Commodity by 2050 that supply is an

issue

• Industry to make most of Capital

Investment

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Approximate Cost

Commission

.1% (1/10 of a Percentage) of the value of

milk at current prices

Cost of Capital

2%-5% of the Nominal value of product

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• Not Enough Liquidity

– Liquidity is improving and will likely continue to do so as market

volatility increases

• Quotations not a Good Reflection of Physical Market

– Basis does have to be actively managed

– Correlations are strong with most physical markets

• Futures Will Attract Speculators to the Dairy Market

– Unlikely in the medium term – not big influence in the US

– Speculators would bring liquidity

Common Dairy Risk Management Criticisms

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Idea on an Action Plan

• Dairy Industry take charge of its self again

• Move away from Brussels

• No more stagnant industry of 80’s and

90’s

• Take advantage of our natural resource

• Work together

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What Europe/Government can provide

• Education

Co-op producers ICOS/Third Level Colleges

Farmers TEAGASC

• Risk Management Costs

Leverage European money for margin ICOS/IFA Lobby

Subsidise/Support margin hedges Mexican Govt program-

AIB/BOI/Rabobank

• Marketing

Irish product as price manageable Bord Bia

Ireland as a location for Consumers Enterprise Ireland

• Data Provide Industry Data/Indices Department of Agriculture

• Form working group today and meet next week!

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What INTLFC Stone Can Provide

Monthly FORWARD CONTRACTING PROGRAM for Co-Op

• Educate Cooperatives/Producers

– Risk Management

– Establish Forward Contracting Program

• Provide Software for recording forward contracting

• Provide daily real time reporting of net position

• Legal and regulated access to exchange traded products and

OTCs

• Design of Indices and market pricing

• Provide Industry market forecasts and analysis ie Econometric

models etc

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What INTLFC Stone Can Provide

Monthly FORWARD CONTRACTING PROGRAM for Co-Op

• We can work with Individual companies/Group of companies or the

Industry

• Paid

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Thank You!

Charlie Hyland /Liam Fenton/John Lancaster

Commodity Risk Managers

FCStone Commodity Services (Europe) Ltd

[email protected]

Tel: +353 1 6349140

Mob: +353 872888571

www.intlfcstone.com

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Transcript of Commodity Risk Management - Irish Co-Operative ... · Commodity Risk Management •Education...