If all goes as planned, the Canadian Wheat Board’s (CWB) monopoly on marketing western Canadian wheat and barley will come to an end in August. While there are still legal challenges to the Marketing Freedom for Grain Farmers Act, it’s been approved by both houses of Canadian parliament and seeks to abolish the board’s control, opening up new markets to western Canadian farmers.
Since 1935, western Canada’s farmers have operated under a single-desk system where the wheat board is the sole entity to take delivery, market and establish prices for wheat. Up to now, all farmers had to do was deliver their wheat, and the wheat board did the rest.
This is mixed news for wheat producers, merchandisers, millers, food processors and other commercial users in that region who will now need to manage their own price risk. For some, grain marketing will be a very new experience. Many others though have been using futures markets to manage price risk around the CWB pricing scheme for some time, and will now get the ability to fully control the marketing of their grains.
Just a few years ago the Australian grain industry went through a similar transition. I was managing the OTC desk of an Australian bank at the beginning of the process. The Australian Wheat Board was the monopoly exporter of wheat and did all marketing on behalf of the producer. Like in Canada, a segment of producers had already been hedging around the AWB pricing using futures and swaps linked to Chicago Board of Trade (CBOT) wheat futures. In Australia, unlike in Canada, a robust bank swaps market also existed. Also unlike Canada, a local futures market existed.
Trading a Benchmark
As the market opened up, there was a strong demand to learn more about grain marketing. More customers were exposed to both bank swaps and futures as hedging tools. Without the dominance of the AWB, the cash marketing alternatives offered by grain merchants expanded as well. While the local wheat futures contract grew in volume – and in fact a new contract reflecting Western Australian export wheat was put in place – producers and commercial users continued to trade the global benchmark contract in greater volumes than before. With a local alternative, why didn’t that local contract become more dominate? I believe there were two reasons.
First – liquidity. Hedgers want to ensure that they can enter and exit a hedge position when they want, in the quantities they want with as little slippage as possible. As I recently shared at the Grain World Conference in Winnipeg, a benchmark future like CBOT wheat allows this (and in fact, liquidity in the contract continues to grow). With the local contract, producers had issues executing significant volume and the bid/ask spreads were wider than those on the CME products.
The second reason is the ability to use options. A producer who doesn’t want exposure to margin call can buy a put option where their financial outlay is limited to the premium paid. Many of the most successful producer marketers and marketing advisors use options- only strategies. CME Group has created several options-based tools to serve this population, including MGEX-CBOT wheat spread options, which we’ll be launching this spring.
Like their Australian counterparts, the challenge to Canadian producers will be to understand the new marketing environment they will be operating in. I would encourage wheat producers there – and anyone else new to hedging – to read our Study Guide to Hedging Grains and Oilseeds, and watch this webinar on how to begin hedging grains. These and other resources we offer discuss everything from opening futures accounts to different hedging strategies, and will help newcomers to the market understand the many benefits of managing risk on a futures exchange.
The disbanding of the CWB represents an important opportunity for increased global participation in our CBOT wheat contracts. But it is also an opportunity for the many Canadian farmers who will be entering the market in 2012, to hedge their product in the world’s most liquid pool of buyers and sellers.
A version of this post first appeared in World Grain magazine.