Deliverable versus cash settled commodities and price quote

5.4. 11.5.4. Deliverable versus cash settled commodities and price quote

Two classes of agricultural commodities typically referred to in trading agricultural commodities are deliverable and cash settled commodities. Deliverable commodities refer to those commodities that the short position (seller) has the right, but not the obligation, to make delivery to a pre-specified location for which the long position (buyer) has the obligation to take delivery. For instance, corn is a deliverable commodity. A seller (short) could make delivery at one of the specified delivery locations and the buyer (long) would have to take delivery of the corn at that location. Other deliverable commodities include wheat, soybeans, live cattle, and pork bellies.

Cash settled commodities are those commodities for which a cash settlement can be made at the end of the trading period. For instance, feeder cattle are a cash traded commodity. If Joe Bob held his short position until expiration, he would not have the right to make delivery. Instead, Joe Bob would cash settle his short position, much like offsetting his contract by buying. You should be aware of the settlement terms of the commodity you are trading.

Table 2 shows a typical futures price quote page for the Chicago Mercantile Exchange Feeder Cattle Futures Contract. The table is explained by moving left to right across columns. Contract represents the month and year of the feeder cattle futures contract for which price quote are given. For instance, Jan-99 refers to the futures contract due to expire in January 1999. Open represents the opening futures price for the day. High represents the high bid for the day. Low represents the low bid for the day. Last represents the most recent bid of the day. For example, at 10:30 a.m. the last value would be the most recent bid and the high and low would represent the high and low of the day up until 10:30 a.m. Volume represents the number of contracts traded up until that time of the day. Settle price represents the final bid price for the most recently concluded trading day.

Table 3 shows a typical options price quote page for the Chicago Mercantile Exchange Feeder Cattle Futures Contract. The table is explained by moving left to right across columns. The month, year, and whether the table is a Call or Put option is described at the top of each portion of the table. Strike represents the price for which the Call or Put option contract is currently traded. Open represents the opening options price for the day. For instance, the USD1.65/cwt. open price for a 7 000 Call is the price that was bid at the beginning of the day for a USD70/cwt. Chicago Mercantile Exchange Feeder Cattle Call option. High represents the high bid for the day. Low represents the low bid for the day. Last represents the most recent bid of the day. For example, at 10:30 a.m. the last value would be the most recent bid and the high and low would represent the high and low of the day up until 10:30 a.m. Change represents the change in bid value from the previous day close. Volume represents the number of contracts traded up until that time of the day (Parcell and Pierce, 2013).

5.5. 11.5.5. What is commodity basis?

Commodity basis provides a significant amount of information to producers and agribusinesses for making production, forward pricing, hedging, and storage decisions. Many producers believe that understanding basis patterns is the most fundamental means of evaluating marketing decisions. That is, basis tends to follow historical seasonal patterns and by understanding these patterns a producer or agribusiness person can make better management decisions and reduce risks involved in those decisions.

Commodity basis is the difference between a local cash price and the relevant futures contract price for a specific time period. For a specific commodity basis is defined as:

where cash price is the cash price for a specific commodity at a given location and futures price is the relevant futures price for that commodity. An example illustrates:

Assume Clover B. Cattle raises corn and feeder cattle in Fayette, Missouri. On November 4 the local elevator is buying corn for USD2.83/bushel and the local livestock auction is selling 7-8 cwt. feeder cattle for USD72.36/cwt. On this same day, the closing price of the December corn futures price at the Chicago Board of Trade is USD2.96/bushel and the closing price of the November feeder cattle futures price at the Chicago Mercantile Exchange is USD70.98/cwt. Now, if Clover B. Cattle wants to know her basis, she would simply take the cash price and subtract the futures price for each commodity (Parcell and Pierce, 2013).

		Corn	Feeder Cattle
	Local Cash Price	$2.83	$72.36
Less	Futures Market Price	$2.96	$70.98
	----------------	-------	-------
	Basis	-$0.13	$1.38

A negative value represents a cash price “under” the futures price and a positive value represents a cash price “over” the futures price. A basis that becomes more positive or less negative over time is said to narrow or strengthen. A basis that become less positive or more negative over time is said to widen or weaken.

Basis describes two separate relationships for grain and livestock. Therefore, these enterprises are separated in the discussion below. For grain, basis is typically used as an indication of current local demand. Weak basis indicates that the market doesn’t want grain now, but the market may or may not want it later. Strong basis indicates the market wants the grain. Basis is best used in deciding how to sell. For instance, assume you are a corn producer who believes the corn price is high and basis is strong relative to historical patterns. What should you do? Sell in the cash market as there is little opportunity to better the current market price through storage and/or taking a futures position. For livestock, basis refers to the difference between supply and demand in a local location and supply and demand for the aggregate market. Like grains, basis contracts can be formulated for livestock. Thus, understanding the basis can help farmers and agribusiness personnel in evaluating forward contracting and hedging decisions (Parcell and Pierce, 2013).

Basis is a crucial factor in hedging using the futures. Table 4 is used to describe a gain or loss to either a short or long hedger when basis strengthens or weakens. For the long hedger, the hedger prefers for the basis to weaken. That is, the hedger pays less in the cash market relative to the futures market and may gain more from their position in the futures market. For the short hedger, the hedger gains from a strengthening basis. That is, the hedger realizes a cash price increase relative to the futures price and may gain more from their position taken in the futures market.

11.4. táblázat - Table 4: How a grain producer should use basis in marketing strategies

5.6. 11.5.6. Speculation on the futures market

Even though the evidence on the impacts of increased speculative activities on prices is inconclusive, the risks of the formation of price bubbles and the exclusion of commercial actors, because of higher costs of participation in a deregulated commodity futures market, are well documented. This implies that tighter regulation is warranted, at least as a precautionary measure. Increasing transparency, by requiring exchange trading and clearing of most agricultural commodity contracts, and setting lower limits for non-commercial actors could be the first set of measures taken by the countries that house major commodity exchanges. Action regarding transparency in futures markets and tighter regulation of speculation is necessary (Sanders and Irwin, 2010).

6. 11.6. Demand for food products in the future

It appears increasingly clear that the unlimited demand of rich consumers for food products generates negative pecuniary externalities for the poorest consumers. Demand tends to be presented as an exogenous variable (like the weather) that cannot be negotiated. This is not true. Indeed, we know that the consumption levels of the world‘s richest countries cannot be extended to everyone in a world that looks set to grow to include 9 billion people by 2050. Demand is significantly affected by public policy choices and can be reduced. The significant expansion in the production of animal products also raises questions as a number of associated costs are not internalized in prices, and because industrial meat production places significant demands on cereal stocks and freshwater reserves. Moreover, the livestock industry makes a significant contribution to greenhouse gas emissions.

By generating a new demand for food commodities that can outbid poor countries and food-insecure populations, industrial biofuels highlight the tension between a potentially unlimited demand (in this case for energy) and the constraints of a world with finite resources. Several proposals ulinked to changes in existing mandates could reduce the likelihood of biofuel production contributing to price spikes. Given the major roles played by biofuels in diverting food to energy use, governments should abolish or reduce targets on biofuels and remove subsidies and tariffs on biofuel production and processing. Governments should explore incentives for the reduction of waste in the food system including addressing post harvest losses.

6.1. 11.6.1. Investing in agriculture

Farmers and prospective farmers will invest in agriculture only if their investments are profitable. Private sector investment also needs to be encouraged at all stages in the value chain – upstream of the farm, in seed and fertilizer production and distribution, and downstream in processing, marketing and distribution. Underlying competition problems that have led to the development of cartels or of monopsonistic/monopolistic market structure should also be tackled (FAO, 2009).

Increasing public investment in transport and productive infrastructure, as well as in human capital, is central in stimulating productivity and reducing post-harvest wastage. Improving infrastructure, in particular rural roads and market facilities such as warehouses, storage facilities and market-information systems are important in reducing transport costs and integrating smallholders to markets. Investing in, and improving irrigation facilities, and market institutions and mechanisms will result in increased quantities of food produced, better quality and more stable prices. Improving extension, education and health, targeting small producers but also other value chain actors, are key elements of a sound policy approach to increase productivity and enhance food security and the well-being of farmers.

Investments in infrastructure, extension services, education, as well as in research and development, can increase food supply in developing countries and improve the functioning of local agricultural markets, resulting in less volatile prices. In this way, markets can work for the poor people who bear the burden of food price volatility. Most of the investment, both in primary agriculture and downstream sectors, will have to come from private sources, primarily farmers themselves purchasing implements and machinery, improving soil fertility, etc.

However, investing in agriculture with a long-term view is necessary to prevent a repetition of the food crisis. It is also necessary to guarantee a transition from food and agricultural systems that deplete natural resources to sustainable food and agricultural systems that reduce the use of fossil energy and pollution. Preservation of agrobiodiversity and the creation of new varieties should be promoted by international and national agronomic research centres, as should research aimed at maximizing biomass on diversified agricultural production systems. Agro-ecology offers an important and complementary base of experience and perspectives for such a transition that is particularly suited for producers with limited access to chemical inputs.

6.2. 11.6.2. Food waste

Waste has been identified as an important issue which affects the underlying supply-demand balance for food. In developing countries, post-harvest and post production losses due to inadequate infrastructure, poor storage facilities, inadequate technical capacity and under-developed markets are the main causes of waste. In developed countries and increasingly in emerging economies waste occurs in the distribution system, in the restaurant sector and at home, including parts of food products which are not economical to use; food that does not meet cosmetic standards, plate waste; food that is discarded because it spoiled, and inefficient use of food , contributing to obesity.

Most losses are avoidable to some degree and some types of waste could be almost entirely eliminated. Reducing waste could be an important part of a strategy to improve food security while reducing environmental and resource pressures. If food waste can be reduced, the increase in production estimated to be needed to meet the increase in demand over the next 40 years would be smaller. Reducing waste would also help to reduce the pressure on land, water stress, soil degradation, and greenhouse gas emissions.

In developing countries the improvement of the overall resilience and productivity of agriculture should address much of the problem of waste from post-harvest losses. In developed countries, possible avenues for policy action could include engaging with the private sector, to increase awareness and develop voluntary agreements, reviewing regulations that may inadvertently generate avoidable waste, supporting research to improve storage, prolong shelf life and better detect deterioration, implementing public education campaigns, and investment in better assessment and monitoring.

6.3. 11.6.3. Biofuels

At the international level, crop prices are increasingly related to oil prices in a discrete manner determined by the level of biofuel production costs. Increases in the price of oil enhance ethanol’s competitiveness relative to petrol and strengthen its demand. Since both energy and food/feed utilise the same input, for example grain or sugarcane, increases in the production of ethanol reduce the supply of food and result in increases in its price. This relationship between the prices of oil, biofuels and crops arises due to the fact that, in the short run, the supply of crops cannot be expanded to meet the demand by both food and energy consumers.

If oil prices are high and a crop’s value in the energy market exceeds that in the food market, crops will be diverted to the production of biofuels which will increase the price of food (up to the limit determined by the capacity of conventional cars to use biofuels – in the absence of flex fuel cars and a suitable distribution network). Changes in the price of oil can be abrupt and may cause increased food price volatility. Support to the biofuel industry also plays a role. Subsidies to first-generation biofuel production lower biofuel production costs and, therefore, increase the dependence of crop prices on the price of oil.

6.4. 11.6.4. GHG-emission

The agricultural sector is very green-house-gas (GHG) intensive: it accounts for about 13-33% of global GHG-emissions, but only for about 4% of global output. Agriculture will therefore be called upon to contribute significantly to mitigation. At the same time, agriculture will be affected in ways that are not fully understood or fully predictable, but there is little doubt that some regions, principally arid and semi-arid zones, will come under increasing pressure.

Climate change will lead to more frequent extreme events such as droughts, heat waves and floods. These incidents will affect not just production and the volatility of production, they may also create new difficulties related to water quality, storage and related food safety issues. Complex demands for mitigation and adaption will therefore be made on the sector during a period when significantly increased production is needed in response to projected needs. There is need to improve agricultural technologies specific for, and well targeted to small-scale agriculture and for appropriate production policies and practices aimed at increasing smallholder productivity in a sustainable manner.

6.5. 11.6.5. Promoting food security strategy programmes

Food security is a complex and multidimensional issue and a national responsibility. Therefore countries need a national comprehensive food security strategy in line with the specificities and special characteristics of each country. Such strategies should include policies to reduce, manage and cope with price volatility. These strategies should be developed and managed in an inclusive manner with civil society, Farmers‘ Organisations and in partnership with the private sector.

A key element in any long term solution is investment in increasing the productivity and resilience of developing country agriculture. This can contribute to improving food security in two ways. It can reduce food price volatility, for example through increased productivity and improved technical management of production and of risk, and it can help farmers and households to cope better with the effects of volatility, once it occurs.

7. Questions

1. Impact of the financial crisis on the food chain?

2. Drivers of food price volatility?

3. Food expenditure shares in terms of per capita income?

4. What are the territorial supply constraints?

5. Hedging agricultural commodity with futures and options?

6. Demand for food products in the future?

8. References

FAO (2009): Investment. High level expert forum on how to feed the world, 12-13 October 2009, Rome.

FAO, IFAD, IMF, OECD, UNCTAD, WFP, the World Bank, the WTO, IFPRI and the UN HLTF (2011): Price volatility in food and agricultural markets: policy responses. Rome, FAO.

Headey, D. and Fan, S. (2010): Global food crisis: How did it happen? How has it hurt? And how can we prevent the next one? Washington, IFPRI: 122.

Headey, D. (2011a): Rethinking the global food crisis: The role of trade shocks. Food Policy 36: 136-146.

Headey, D. (2011b). Was the global food crisis really a crisis? IFPRI, Washington: 66.

HLPE (2011): Price volatility and food security. A report by the High Level Panel of Experts on Food Security and Nutrition of the Committee on World Food Security, Rome 2011. http://www.fao.org/fileadmin/user_upload/hlpe/hlpe_documents/HLPE-price-volatility-and-food-security-report-July-2011.pdf

OECD (2008): Biofuel support policies – an economic assessment, OECD, Paris.

Prakash, A. (2011): Why volatility matters, in Prakash. A. (ed.) Safeguarding food security in volatile markets, FAO, Rome

Prakash, A. and Stigler, M. (2011): The economics of information and behaviour in explaining excess volatility, in A. Prakash (ed.), Safeguarding food security in volatile markets, FAO, Rome.

Sanders, D.R. and Irwin, S. (2010): A speculative bubble in commodity futures prices? Cross sectional evidence, Agricultural Economics, Vol. 41, pp. 25-32.

World Bank (2011): Commodity prices (Pink Sheet), http://go.worldbank.org/4ROCCIEQ50l

Parcell, J. and Pierce, V. (2013): An introduction to hedging agricultural commodities with futures. http://agebb.missouri.edu/mgt/risk/introfut.htm