Price discovery and price protection for oilseed flax
Trade determines price, and visible markets such as the Winnipeg Commodity Exchange (WCE), which is the premium market for canola/oilseed rape and oilseed flax, make that price broadly available to buyers and sellers. The WCE, as with other such exchanges like the CBOT (Chicago Board of Trade – the premium soybean and soyoil market), provide the means for sellers and buyers to conclude transactions for physical grain, and also provide a public forum to determine the value of that grain. The Exchanges provide a meeting place for sellers and buyers to cover risk through “hedging” in a future trading month. This is done for a series of trading months throughout the year, such that transactions may take place today for settlement in the future. This means that price risk may be off-set to a large degree by hedging, a process whereby a position can be taken in the market in the future which can be liquidated nearer to the time of its maturity. This provides someone holding physical stocks of grain (a farmer or a grain company) with a mechanism to off-set that same amount of grain in a future month. When the physical grain is actually sold, the market may have changed – moved up or down in value. This price movement will be reflected in the futures month which was used as a hedge. Liquidating the position in the futures month should off-set any price swing in the cash transaction, thereby protecting the value of the grain. To take a position without such off-setting protection is called speculation. Price risk management is important because of market volatility, and because there is often a significant delay between production and supply, and the physical transaction.
Hedging – an example
A seller may take a position in the market to protect an acceptable price by taking an opposite position in a futures month until physical delivery of the commodity. The off-set to cover gains or losses in value is not necessarily exact, but generally the future months will reflect the current (cash) value with the addition of carrying charges.
An example of a “hedge” for a flaxseed seller (e.g. a Canadian exporter) is given in Table “The effect of futures on the return on the effective selling price of flaxseed”, based on an example for soybean oil published by the Chicago Board of Trade (Chicago Board of Trade, 1996).
In the examples in Table “The effect of futures on the return on the effective selling price of flaxseed”, when the November futures price went up between June and September, the futures price was 50 cents per tonne less than the selling price of the physical flaxseed. When the futures hedge was bought back, it actually yielded a small profit by making the effective selling price 50 cents more. So the hedge yielded an additional 50 cents per tonne once both transactions were completed. The original target price of $250 was met and the futures transaction provided a 50 cent bonus. Of course, if the November futures had been more than $260, then the target of $250 would not have been met. However, any loss would likely have been minimal. One objection to the use of the futures hedge at all in this scenario would be that since the actual sale realized $260, by using the futures an opportunity for an additional $10 on the target price was lost. However, this is a speculative approach as the market could have gone the other way, resulting in a loss. This is shown in the second example when the futures market dropped to $240. The hedge in the futures market provided a gain of $10, which brought the total return to $250, so meeting the target price. Without the hedge it would have been $240.
Basis
The value of oilseed flax to the farmer selling his seed to a grain company in western Canada (at a price referred to as the “street” price) is determined as a “basis” to the nearby futures month. The basis reflects costs, such as handling, storage, insurance, etc of the grain and hopefully a reasonable margin. The demand for that grain in the short term also affects the basis. Thus, a wider basis will reflect less real and anticipated demand, while a tighter basis will mean stronger demand. As with any market, changes to the supply and demand situation will affect the value of the futures price and thus the street price.
In the case of oilseed flax, there are two main types of market – the global export market reflected by the Winnipeg Commodity Exchange (WCE), and local domestic/regional markets. Domestic/regional markets include traditional markets, which may be significantly affected by traditional customs and government protection (such as in Russia, China and India); and larger markets within major trading blocs such as the European Union.
The most transparent market for oilseed flax is the WCE futures market. Farmers, grain companies, processors, exporters and importers all participate in this market. Production and export demand are the key contributors to the WCE price of Canadian oilseed flax (which is quoted as “basis Thunder Bay” – the main eastbound grain port on Lake Superior). In Europe, prices are generally more or less in line with the Winnipeg Commodity Exchange (WCE), but from time to time may diverge, depending on short-term conditions and specific demand at various times of the year. Thus, if the WCE and European prices are in line, the price in Europe will reflect the Thunder Bay price in Canada, plus the cost of handling and unloading at the port, ocean freight to NW Europe, insurance, etc. The prices of oilseed flax and linseed oil for Europe are usually quoted as cif NW Europe (cif stands for “cost of goods, insurance, freight”) for seed, or ex-tank Rotterdam for oil. The reason for choosing NW Europe or Rotterdam as a reference is because Rotterdam is the largest port in the world where huge quantities of oilseeds are trans-shipped, or off-loaded for crushing in Dutch plants. Similarly, other NW European ports such as Antwerp in Belgium, and Hamburg in Germany, are major centers for oilseed processing. This pricing basis therefore refers to the physical point at which the product value is quoted – delivered to a port unloading facility for seed, or unloaded from a storage tank in Rotterdam for oil. The price for seed or oil at other locations in Europe will reflect the NW Europe (seed) or Rotterdam (oil) price, plus a freight adjustment.
Similarly, the price to other export destinations from Canada (such as Japan) will reflect the cost of shipping from the west coast of Canada (Vancouver) rather than through Thunder Bay. The price of oilseed flax may be quoted fob (“free on board”) at Vancouver port facility, or c&f (“cost of goods and freight”) Japan port, depending on which party is looking after the freight. There are other arrangements but the above discussion covers the most common methods for pricing.