Gearing up | New futures contracts based on Canadian dollars, multiple delivery points
Brad Vannan knew there was widespread interest in a durum futures contract when a major Italian buyer came to see him as soon as the ICE Canada Futures exchange announced its plans.
“I never expected that,” he said.
His phone has been ringing with calls from around the world ever since ICE Canada verified that it was going to launch spring wheat, durum and barley futures contracts now that the Canadian Wheat Board is about to lose its monopoly.
The three contracts began trading Jan. 23, and hopes have been raised that the world will finally have a durum futures contract, that a world-price-relevant Canadian spring wheat contract can be maintained and that barley futures will provide a true world price for the crop.
Many think that the federal government has removed the greatest impediment to working contracts by eliminating the CWB monopoly.
However, few new futures contract launches are successful.
Vannan has a formidable task convincing farmers, grain companies and grain buyers that ICE’s new contracts are viable and better than existing alternatives.
He has two key selling points:
- the success of the existing canola futures contract, which is doing booming business
- the customized relevance of the three new contracts’ specifications and delivery points to provide a truly representative price of grain crops.
He said the new contracts are not a duplication of the three North American wheat futures contracts.
“You don’t want to be another one of the same. You want some differentiation.”
Vannan said the new contracts are based on the Canadian dollar and use multiple prairie grain elevator delivery points.
The U.S. wheat contracts in Chicago, Kansas City and Minne-apolis are based on the U.S. dollar and have few delivery points, mostly at export port facilities.
Vannan said it wasn’t a hard decision to go with Canadian dollars, even though it might be harder for foreign speculators and Canadian grain companies to use.
“It’s better for the price to be in Canadian dollars because it’s better for the farmers,” said Vannan.
“Exporters are very adept at hedging currencies. Speculators do this all the time. But it’d be a wrinkle some farmers might not want to deal with.”
He was surprised to find that most speculators also prefer a contract in Canadian dollars because it allows them to play on their commodity outlooks and the currency market. With most contracts in U.S. dollars, a Canadian contract could move differently when there is currency volatility.
The delivery points are at locations across the Prairies, with the par point generally being in central Saskatchewan, and discount and premium zones to the east and west, depending on the crop and the location of the main market.
This echoes the structure of the canola contract, which means it should be familiar to farmers.
However, it is radically different from most contracts, which are based on port delivery.
The different direction for ICE Canada comes from the unique challenges the prairie grain industry faces with rail transportation to port.
If a rail line or mountain pass to Vancouver is blocked, the price spread between prairie elevators and Vancouver terminals can greatly expand and become divorced from the cash market.
This would destroy confidence in the use of the contracts as surrogates of the world price.
“You could put your delivery point at the tip of the funnel, if it’s all passing through the funnel, but Canada’s rail transportation system is extraordinarily vulnerable to disruption,” said Vannan.
The delivery point structure could become a great advantage for the new ICE contracts because U.S. traders are concerned with the delivery points for the Chicago winter wheat contract and the Minneapolis spring wheat contract.
If the Winnipeg contract more accurately reflects world wheat prices, it could attract users who want a world price rather than a central North American price.
The Minneapolis contract uses a Duluth, Minn., delivery point, even though most spring wheat flows west and south.
Spreads can open up between the cash and futures market when delivery points aren’t representative of where grain actually flows. This can undermine the contract because it doesn’t provide a true hedge against risk.
Previous attempts to develop durum contracts failed, but Vannan said that proves there is a desire for a contract, but it wasn’t viable as long as the wheat board monopoly was in place.
The situation has now changed.
With the entire prairie and northern U.S. durum crop now available for pricing and hedging through Winnipeg futures, Vannan said it’s possible ICE Canada could quickly set the world price of durum.
“Our canola contract has grown to represent canola values for the world. Durum has that same potential, because our region is so dominant to world trade.”
Vannan said he is confident commercial demand will become the foundation of three thriving contracts because the grain industry insists that it wants futures contracts for all three grains. Right now, grain companies see too much risk without a viable mechanism for pricing and hedging grains.
A futures contract will allow them to focus on their grain handling businesses and not force them to take on major risks with price.
“They don’t want to take the price risk,” said Vannan. “They’re willing to take the execution risk, and that’s where the futures market comes in.”
Farmers might be surprised to see the new contracts using a 100 tonne size basis, which is much more than the 20 tonne size for each canola contract. The new size is based on American wheat futures contracts, which are all 5,000 bushels, or about 136 tonnes. European contracts are for 50 tonnes.
Vannan knows that the opening weeks of the new contracts will be keenly watched but not likely enthusiastically embraced by farmers, grain companies or speculators until they prove themselves.
That’s a worry, but he’s confident the commercial superiority of the new contract will eventually attract traders.