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1
Commodity Risk Management
Dairy Risk Management Overview
CIT September, 2012
Commodity Risk Management
International Assets Holding Corporation | www.intlassets.com | www.fcstone.com | www.downesoneill.com
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Commodity Risk Management
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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Commodity Risk Management
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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Commodity Risk Management
Global Presence
30 offices | 1000+ employees | 20,000 customers in more than 100 countries
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Commodity Risk Management
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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Commodity Risk Management
Volatility
Causes
Solution
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Commodity Risk Management
How The Market Developed in US
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Commodity Risk Management
Volatility-What causes it at the
moment?
• Not Speculators – Too small
Cause
• Decreasing Intervention levels and Quota
changes
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Commodity Risk Management
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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Commodity Risk Management
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
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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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Commodity Risk Management
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Commodity Risk Management
Example of one Companies
solution we have in the US
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Commodity Risk Management
$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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Commodity Risk Management
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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Commodity Risk Management
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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Commodity Risk Management
But its not about best Price its
MARGIN!!!
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Commodity Risk Management
How is it developing in Europe?
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Commodity Risk Management
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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Commodity Risk Management
What’s been hedged last year?
• 20,000 Tonnes of Product
Butter/SMP/Cheese
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Commodity Risk Management
Main Participants
• Consumers
• Traders
Less Involved
• Producers
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Commodity Risk Management
Issues with Development in Europe?
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Commodity Risk Management
• Education
• Education
• Education
• Independent/Reliable Data
• Still industry dependency mentality on
European Intervention
• Farmer Access/Natural sell side
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Commodity Risk Management
Basic Theory of hedging
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Commodity Risk Management
• 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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Commodity Risk Management
€ € € €
Very basic theory – simple scenario
You buy inventory….at a cost
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Commodity Risk Management
€ € € € € €
Very basic theory – industry business model
The market rises – you gain
Profit
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Commodity Risk Management
€ €
The market falls– you loose
Loss
Very basic theory – industry business model
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Commodity Risk Management
€ €
Using futures - its an offset To protect against this particular risk you would sell a futures
Buy inventory Sell
futures
€ €
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Commodity Risk Management
€ €
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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Commodity Risk Management
€ € € €
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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Commodity Risk Management
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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Commodity Risk Management
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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Commodity Risk Management
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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Commodity Risk Management
How are companies ultilising it today?
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Commodity Risk Management
• 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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Commodity Risk Management
How Farmers can benefit from these
market developments?
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Commodity Risk Management
Benefits for Farmers
• Allows Certainty
• Allows financial planning
• Allows him to sleep at night!
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Commodity Risk Management
Does Dairy Industry Need it?
• Intervention & Quotas return NO
• Intervention Goes YES
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Commodity Risk Management
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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Commodity Risk Management
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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Commodity Risk Management
• 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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Commodity Risk Management
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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Commodity Risk Management
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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Commodity Risk Management
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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Commodity Risk Management
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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Commodity Risk Management
Thank You!
Charlie Hyland /Liam Fenton/John Lancaster
Commodity Risk Managers
FCStone Commodity Services (Europe) Ltd
liam.fenton@intlfcstone.com
Tel: +353 1 6349140
Mob: +353 872888571
www.intlfcstone.com
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