How the Canadian Wheat Board ran Minneapolis futures to $25 a bushel
If and when the next amendments are made to the Canadian Wheat Board Act, they should include a provision that its annual report may not exceed 10 pages. That would have saved western wheat and barley farmers the hundreds of thousands of dollars it took to create, translate, print and publish the 2007-08 annual report which came out last week. The slick, Madison-
Avenue production runs to 100 pages, including a dozen pages that have little else on them except gigantic headlines. Over half the five-color bulk is self-promotion of the monopoly and self-praise for directors and management. Viterra’s annual report
was 24 pages.
It is doubly ironic that this Enron-styled annual report included the briefest disclosure that the Board managed to lose $89 million in futures market trading. Nothing is said about this massive, unprecedented loss until page 61. It is casually mentioned
that losses in alternative off-pool pricing and payment programs for wheat “generated a net loss of $89.5 million” because of “net hedging results”, especially “the cost of rolling hedges in an inverse market, never significant in the past.” Spring wheat futures on the Minneapolis Grain Exchange exploded to an unbelievable $25 a bushel exactly a year ago. The
March contract spiralled higher as expiry approached. Between Feb. 4 and 25 2008 the future price zoomed from $14.33 a bushel to $24 and an intra-day high of $25, the record for any wheat contract in the world. On Feb 25 alone it gained $4.75 a bushel as daily limits were lifted. As quickly as it went up it came down, going off the board at $16. Wheat prices were all historically high at the time, but the Minneapolis spot contract was in a class by itself. On the day March hit $25, September closed at $12.15 and December at $11.98. The March Chicago future was $12.55.
Somebody was trapped holding big short positions as the contract was expiring. At that time there were rumors that it was the Wheat Board. Long holders were refusing to let it buy back its shorts at any realistic price. Now the scanty information in
the annual report is enough to put two and two together.
When a real grain company buys wheat from farmers, it simultaneously sells futures contracts of the same amount at the same or a very similar price. Someone has to be on the buy side and it is usually a speculator, which is the function of speculative participation. This is hedging and it is a principal economic purpose of futures markets. If the cash price falls before the grain company sells the wheat, the gain on the futures trade (by buying back the contract at a discount) offsets the cash loss,
and vice versa. A known price is locked in. If necessary, a real grain company can deliver physical wheat to satisfy its short position and this threat of delivery is largely what secures the integrity of trading.
The Wheat Board is not a real grain company and no one knows that better than Minneapolis traders. The Board could not make or threaten delivery to cover shorts, so had to pay whatever it took when it ended up holding the shorts too long. The management of the Grain Exchange did not step in during this out-of-control time, as any exchange can do if markets malfunction and prices get out of realistic ranges. Trading can be stopped in such situations and short and long holders directed to negotiate a settlement.
Trading was not stopped by the exchange, nor did the Commodity Futures Trading Commission ever express any interest. One wonders if they would have been as passive had the trapped short been an American, but the Board was made the donkey with
no tail.
The Board was in the futures market because of its non-pool alternative con- tracts, which attempt to offer
cash prices related to openly-known market prices. The Board tried to act like a real grain company, but instead ended up as an amateur speculator in the most volatile market in history and the laughing stock of the Minneapolis trader community. The $89 million represents a transfer of
wealth from western Canadian wheat growers to Minneapolis wheat speculators. It is value lost which cannot be recovered by any future action.
The Board has been running alternative contracting programs (Fixed Price Contract, Basis Price Contract, Daily Price Contract) since 2001 and they have become quite popular; almost all commercial-sized growers now use them and volume rose 32% in 2007-08 to 4.5 million tonnes, almost 25% of its non-durum wheat business. The Board said it received $1.64 billion from sales attributed to these programs (a modest $364 a tonne) but returned only $1.26 billion ($280 a tonne) after deducting
trading losses of $89.5 million ($20 a tonne) and other expenses. It has since apparently stopped most or all futures trading, probably the cause of the 60% drop in trading volume and open interest on the Minneapolis Grain Exchange in January compared to the year-ago month.
For bookkeeping purposes the loss had to come from somewhere, and some of it apparently came out of the conventional
pools. This seems contrary to specific wording of the Wheat Board Act, which directs that all proceeds minus expenses are to be paid to farmers from the various pools. Pools are mandated by the legislation, and a strict interpretation could prohibit
these off-pool activities entirely.
In anticipation that there could be losses in these new and untried plans, the Board set up a contingency fund for them in 2000. At first there were small surpluses, but as the alternative plans grew the funds had to be bulked up. As much as $20
million may have been moved from conventional pools over several years, decreasing cash available for distribution or requiring larger borrowings, or both. In 2006-07 there was a loss of $37 million in these programs, which drained the contingency
fund to about $60 million. The $89.5-million futures haircut in 2007-08 ran the fund $28.9 million in the hole.
The Board also for the first time has established a cash trading category. It arose from sales of 900,000 tonnes of barley by private grain companies and others in the few weeks before the start of the 2007-08 crop year when an open market was to have been created for barley. The move was cancelled when the Board won a lawsuit against the government. The Board in the next 12 months of the crop year sold only 455,000 tonnes of feed barley.
In releasing the annual report the Board emphasized that it posted record revenues of $8.41 billion compared to $4.95 billion in 2006-07 and $3.49 billion the year before that. The leap in world prices, none of the Board’s doing, accounted for the boost, and the fading of prices in 2008-09 will have the opposite effect. Gather ye rosebuds while ye may.
To account
Will the minister need to explain these disturbing things?
The waste of $89 million in the Wheat Board’s trading losses infuriated some farm groups, but it does not appear that this shocking development will change the dynamics of monopoly politics. The parliamentary opposition’s view is that
the Board can do no wrong because it is “controlled by western farmers” and so whatever happens must be acceptable
to them. The opposition did not attack agriminister Ritz or demand that he explain why he allowed this to happen, as it would in any comparable situation with any other government department or agency.
Some organizations, including the Western Canadian Wheat Growers, demanded a review of the Board’s risk management practices, which seemed to finally resonate with Ritz. That brought a retort from the Board in the form of a news release which revealed that in 2007 the Board obtained the advice of Gibson Capital Inc. of Calgary. Two of its three principals are former Board employees. No report was ever made public. The group has carried out various assignments
of no particular sophistication for the Alberta government, one or two grain companies and others. The
Board’s position is that by involving this firm it has done its homework and discharged its responsibility.
The news release blamed the rest on the volatility of markets, and noted that it offered futures-linked pricing plans when private companies suspended them.
Agriminister Ritz hinted at an outside review, which Board chairman Hill said it would welcome. The Board knows
it is in a stronger position politically than the minister or his government. This should be a turning-point incident, but it could also blow over in a few weeks without consequences for Board management or any corrective action.
If and when the next amendments are made to the Canadian Wheat Board Act, they should include a provision that its annual report may not exceed 10 pages. That would have saved western wheat and barley farmers the hundreds of thousands of dollars it took to create, translate, print and publish the 2007-08 annual report which came out last week. The slick, Madison-
Avenue production runs to 100 pages, including a dozen pages that have little else on them except gigantic headlines. Over half the five-color bulk is self-promotion of the monopoly and self-praise for directors and management. Viterra’s annual report
was 24 pages.
It is doubly ironic that this Enron-styled annual report included the briefest disclosure that the Board managed to lose $89 million in futures market trading. Nothing is said about this massive, unprecedented loss until page 61. It is casually mentioned
that losses in alternative off-pool pricing and payment programs for wheat “generated a net loss of $89.5 million” because of “net hedging results”, especially “the cost of rolling hedges in an inverse market, never significant in the past.” Spring wheat futures on the Minneapolis Grain Exchange exploded to an unbelievable $25 a bushel exactly a year ago. The
March contract spiralled higher as expiry approached. Between Feb. 4 and 25 2008 the future price zoomed from $14.33 a bushel to $24 and an intra-day high of $25, the record for any wheat contract in the world. On Feb 25 alone it gained $4.75 a bushel as daily limits were lifted. As quickly as it went up it came down, going off the board at $16. Wheat prices were all historically high at the time, but the Minneapolis spot contract was in a class by itself. On the day March hit $25, September closed at $12.15 and December at $11.98. The March Chicago future was $12.55.
Somebody was trapped holding big short positions as the contract was expiring. At that time there were rumors that it was the Wheat Board. Long holders were refusing to let it buy back its shorts at any realistic price. Now the scanty information in
the annual report is enough to put two and two together.
When a real grain company buys wheat from farmers, it simultaneously sells futures contracts of the same amount at the same or a very similar price. Someone has to be on the buy side and it is usually a speculator, which is the function of speculative participation. This is hedging and it is a principal economic purpose of futures markets. If the cash price falls before the grain company sells the wheat, the gain on the futures trade (by buying back the contract at a discount) offsets the cash loss,
and vice versa. A known price is locked in. If necessary, a real grain company can deliver physical wheat to satisfy its short position and this threat of delivery is largely what secures the integrity of trading.
The Wheat Board is not a real grain company and no one knows that better than Minneapolis traders. The Board could not make or threaten delivery to cover shorts, so had to pay whatever it took when it ended up holding the shorts too long. The management of the Grain Exchange did not step in during this out-of-control time, as any exchange can do if markets malfunction and prices get out of realistic ranges. Trading can be stopped in such situations and short and long holders directed to negotiate a settlement.
Trading was not stopped by the exchange, nor did the Commodity Futures Trading Commission ever express any interest. One wonders if they would have been as passive had the trapped short been an American, but the Board was made the donkey with
no tail.
The Board was in the futures market because of its non-pool alternative con- tracts, which attempt to offer
cash prices related to openly-known market prices. The Board tried to act like a real grain company, but instead ended up as an amateur speculator in the most volatile market in history and the laughing stock of the Minneapolis trader community. The $89 million represents a transfer of
wealth from western Canadian wheat growers to Minneapolis wheat speculators. It is value lost which cannot be recovered by any future action.
The Board has been running alternative contracting programs (Fixed Price Contract, Basis Price Contract, Daily Price Contract) since 2001 and they have become quite popular; almost all commercial-sized growers now use them and volume rose 32% in 2007-08 to 4.5 million tonnes, almost 25% of its non-durum wheat business. The Board said it received $1.64 billion from sales attributed to these programs (a modest $364 a tonne) but returned only $1.26 billion ($280 a tonne) after deducting
trading losses of $89.5 million ($20 a tonne) and other expenses. It has since apparently stopped most or all futures trading, probably the cause of the 60% drop in trading volume and open interest on the Minneapolis Grain Exchange in January compared to the year-ago month.
For bookkeeping purposes the loss had to come from somewhere, and some of it apparently came out of the conventional
pools. This seems contrary to specific wording of the Wheat Board Act, which directs that all proceeds minus expenses are to be paid to farmers from the various pools. Pools are mandated by the legislation, and a strict interpretation could prohibit
these off-pool activities entirely.
In anticipation that there could be losses in these new and untried plans, the Board set up a contingency fund for them in 2000. At first there were small surpluses, but as the alternative plans grew the funds had to be bulked up. As much as $20
million may have been moved from conventional pools over several years, decreasing cash available for distribution or requiring larger borrowings, or both. In 2006-07 there was a loss of $37 million in these programs, which drained the contingency
fund to about $60 million. The $89.5-million futures haircut in 2007-08 ran the fund $28.9 million in the hole.
The Board also for the first time has established a cash trading category. It arose from sales of 900,000 tonnes of barley by private grain companies and others in the few weeks before the start of the 2007-08 crop year when an open market was to have been created for barley. The move was cancelled when the Board won a lawsuit against the government. The Board in the next 12 months of the crop year sold only 455,000 tonnes of feed barley.
In releasing the annual report the Board emphasized that it posted record revenues of $8.41 billion compared to $4.95 billion in 2006-07 and $3.49 billion the year before that. The leap in world prices, none of the Board’s doing, accounted for the boost, and the fading of prices in 2008-09 will have the opposite effect. Gather ye rosebuds while ye may.
To account
Will the minister need to explain these disturbing things?
The waste of $89 million in the Wheat Board’s trading losses infuriated some farm groups, but it does not appear that this shocking development will change the dynamics of monopoly politics. The parliamentary opposition’s view is that
the Board can do no wrong because it is “controlled by western farmers” and so whatever happens must be acceptable
to them. The opposition did not attack agriminister Ritz or demand that he explain why he allowed this to happen, as it would in any comparable situation with any other government department or agency.
Some organizations, including the Western Canadian Wheat Growers, demanded a review of the Board’s risk management practices, which seemed to finally resonate with Ritz. That brought a retort from the Board in the form of a news release which revealed that in 2007 the Board obtained the advice of Gibson Capital Inc. of Calgary. Two of its three principals are former Board employees. No report was ever made public. The group has carried out various assignments
of no particular sophistication for the Alberta government, one or two grain companies and others. The
Board’s position is that by involving this firm it has done its homework and discharged its responsibility.
The news release blamed the rest on the volatility of markets, and noted that it offered futures-linked pricing plans when private companies suspended them.
Agriminister Ritz hinted at an outside review, which Board chairman Hill said it would welcome. The Board knows
it is in a stronger position politically than the minister or his government. This should be a turning-point incident, but it could also blow over in a few weeks without consequences for Board management or any corrective action.
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