Grain World Presentation

[craig]

I just came across a report as I was deleting e-mails that basically said that at the Grain World presentation the Canadian Wheat Board was projecting quite a bit lower prices for most cereal crops for the 2004-2005 crop year. In light of the current rally in all grain markets it begs a few questions. If the CWB is correct in their projections, then producers should be aggressively pricing into this rally. If the CWB was wrong, how could they be so far off the mark in such a short period of time? Weather for North American crops other than possibly winter wheat is not an issue so it is obvious demand is driving the market. When I can currently lock in CPS wheat at projected values equal to or above HRS 13.5 PRO's something doesn't make sense. I suspect the board has a reason for being conservative with there opening Pro's but in light of current trends it will be interesting to see where the next Pro's come out at.

[charliep]

A question I had asked me at Grain World is whether the Pool Return Outlooks are even relevant anymore. The producer pricing option prices provide a signal of where new crop business can be transacted and to me this is a more relevant signal than a forecast. The responsibility of forecasting/risk management should be the farm managers based on their own analysis/the advice they get from outside sources.

What are others thoughts?

[TOM4CWB]

Charlie;

The CWB throws in the percentage of the pool priced @ a hedged futures price, to create the CWB "Adjustment Factor" according to a CWB power point I saw a week ago.

This factor either lowers the FPC if the futures are higher than the pool hedged value, or reduces the Adjustment factor, if the hedges in the Pool for that crop year are higher than the FPC being locked in.

CEO Measner wrote and told me last year that the hedges done on the PPO contracts are combined into the pool hedges, after the FPC is priced...

They are not managed to be pulled off when the specific FPC tonnes are delivered by the farmer. Is this still the case today?

How can the CWB say the FPC/BPC have no connection to the Pool or the PRO?

[rain]

Craig forecasting gets tougher and tougher depending on how complicated the model being used is. Straight supply demand is easy. Once you throw in macroeconomics currencies, politics thing get much more complicated. Then you have to take into account, who is paying for the study and what is there political agenda. Is the author mandated to be extremely conservative?

I have always trusted independent report more then government reports. But I still read the relevant government reports to round out the information gathering process.

[charliep]

Tom4cwb

Both the FPC and the basis contracts relate directly to the pool and this is a risk (particularly if you get feed wheat. Neither are a forecast price but rather a forecast hedgeable relationship with the overall pool returns as determined by the CWB.

[timm]

email from cwb re their so called basis contracts.
The basis reflects the difference between the futures and CWB sales made
throughout the crop year. The relationship between the CWB Pool Return
Outlook (PRO) for the reference grade and the forecasted futures component
of the PRO calculation is the starting point in determining the basis. The
calculation is further adjusted for a discount covering basis risk, time
value of money, administration and the percentage of the pool sold.
Through this basis calculation the basis offered pulls out the pooled basis
or the value of the CWB basis on sales made throughout the crop year. The
basis calculation is done monthly when the PRO is released. If there is
substantial changes in the market the CWB will issue a mid-month PRO to
reflect the market situation or adjust the basis to reflect these changes.
This crop year with the extension of the sign-up deadline into the
beginning of the crop year, the basis will be adjusted to reflect the
percentage of the pool sold and basis risk. The CWB hedges the fixed price
and basis payment contracts by selling futures when farmers price the
futures component of their basis contract or lock in the flat price on a
fixed price contract and by buying futures as the CWB makes sales during
the crop year. At the end of the pool year the short and long positions
offset. This can be thought of as the CWB buying BPC/FPC farmers out of
the pool account.

Each basis month has an expiry date by which you must either lock in the
futures or roll the contract to a forward futures month. The furthest out
you can roll the contract is to the July futures since the program
positions are offset by the end of the crop year. July basis payment
contracts were locked in on June 30, 2003 since this was the basis month
expiry date and the CWB locks in the futures value on this expiry date as
per the terms and conditions of the contract.

For 2004-05 the CWB will apply the adjustment factor to the basis when
sales are made. The factor could be positive or negative depending on the
current market versus the average futures level on sales made to date. If
the current futures are trending upward as compared to the average futures
the CWB bought the basis will decrease (become less favorable) and if the
current futures values are trending downward the basis will increase
(become more favorable).

The fixed price is determined by adding the basis to the relevant futures
daily. The fixed price is the value used in the buy out and pricing
damages formula. The fixed price on the day the buy out is initiated is
compared to the basis you locked in and the futures value on that day. The
futures on the day of the buy out are added to your basis to compare the
value of your contract to the current CWB fixed price. If the basis widens
i.e. for CWRS the basis becomes a greater value over the futures, the
difference is charged on the buy out. If the basis narrows i.e. for CWRS
the basis becomes a lesser value over the futures, there is no arbitrage
opportunity thus no charge, you would only be subject to the administration
fee (currently $15.00 per transaction).

Buying out the basis contract is considered locking in the futures on the
day of the buyout for the measurement of the basis change.

Formula:

Current FPC - (Contracted Basis Futures on the day of the Buyout) if
negative equals zero $15.00 per transaction administration fee

After the deadline date for the sign-up period, the relationship between
sales made and the current futures are measured to determine if the basis
has widened or narrowed. Farmers who make a BPC commitment are pricing
their production outside the pool accounts and this tonnage is segregated
outside the pool for both hedging purposes and determining pool payments.
As the crop progresses and more sales are made the pool return becomes more
fixed. If the futures are below the PRO the basis will widen out to
reflect the difference between the pool return for the year and current
futures levels. If you are buying out of the basis contract this is the
opportunity cost of switching back to the pool account.

What I have described is the same as John indicated, current basis less
your contracted basis, but it is important to think of the calculation this
manner because when the futures on a basis contract are locked in the BPC
becomes a fixed price. When the futures are locked in on the BPC a second
measurement is calculated in the buy out or pricing damage formula, the
loss in futures component. The CWB will sell futures on the day you lock
in the futures component of the basis payment contract. To determine the
buy out or pricing damages the futures on the day are compared since the
CWB will have to buy these futures back. If the futures increase the
change is a loss and this cost is charged.

Current Formula:

Greater of:

Current FPC - Contracted FPC if negative zero

or

Current futures - Contracted futures if negative zero

plus $15 administration fee per transaction

The greater of the basis change or the loss in futures was implemented in
the 2002-03 crop year with the $2.50/tonne administration fee dropped due
to drought conditions faced by farmers that year. Using this calculation
only futures losses are charged or the arbitrage back to the pool account.
In the 2003-04 crop year the $15 administration fee per transaction was
implemented to cover our cost of processing the buy out or pricing damages.

I have broken out the components of your 2002-03 pricing damages to show
you how they where determined as August 1, 2003 when the positions were
closed. They are as follows:

The current FPC on August 31, 2003 $249.73/tonne

Contracted Basis (July) rolled on February 27, 2003 $ 18.58/tonne

Contracted Futures (July) locked in June 30, 2003
$173.73/tonne

Lock-in value of BPC $192.31/tonne

Current FPC - Contracted FPC (change in basis/arbitrage) $ 57.42/tonne

OR

September futures on August 1, 2003 $190.10/tonne

July futures converted to September locked -in on June 30, 2003
$164.56/tonne

Loss in futures $25.54/tonne

The CWB closes out the positions at the end of the crop year, so after the
July futures expiry date the positions are rolled to September until
close-out.

You were charged the greater value of $57.42/tonne on your 175 tonne
contract for a total of $10,048.50 pricing damages. The contingency fund
would have been attributed this amount to cover the loss in futures and
payments to the pool account.

I hope this addresses your concerns
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[craig]

How complicated can this process get. It would seem that there should be some simpler methodology for doing fix price contracts. The present system does nothing more than confirm what is suspected and that is that fix price contracts are tied to pool accounts. If the Board does a true hedge seperate from the sales program then there should be no risk to the pool account. At the end of the day producers should have the same risk management opportunities of the open market and the board should still end up with all the grain. Doesn't seem like that is happening.

[Incognito]

Timm:

Your are looking for feedback. I'm interested in yours as well in this scenario.

Regards