How hedging grain crops on world markets will add value post-harvest in 2021
As we approach the final hurdles of what has been a favourable year for winter crops so far, attention is turning to grain marketing and the plan of attack going into harvest and beyond.
Wheat prices across the country are healthy on face value, bringing an added bonus to those looking to harvest an above-average crop.
APW1 port prices are in the vicinity of $300-320 per tonne depending on which state you’re in, which is getting most growers $250-260+ at their local depot. Many growers will be eager sellers at these prices, but it’s important to the see the forest for the trees.
Why relative value is important
When looking at prices, we must always consider their relative strength or weakness – which is to say, how does the $300 local port price stack up versus global wheat prices.
If it’s significantly higher, we are more inclined to sell domestically given the risk this premium may not be around for long.
If the opposite is true and the local market only offers a small premium (or even a discount) – then just selling into a domestic bid in order to take risk off the table is typically not the best approach to maximising our returns.
How do current Australian wheat prices stack up relative to the rest of the world and when we look at world prices, what are we comparing against?
Firstly, we’re generally comparing ourselves against the US futures market (both CBOT and Kansas exchanges), which the world’s growers, exporters and traders still use as a proxy for global wheat prices.
Secondly, and more importantly, we need to compare ourselves against our exporting rivals selling into South East Asia (SEA – our biggest wheat customer).
This second metric is the most important given Australia exports most of its wheat and our ability to make sales into offshore markets is paramount to supporting prices.
The good news is that we are currently cheap compared to our exporting rivals.
If you convert current Australian wheat prices from port to delivered SEA, we are cheaper than Russian milling wheat (our main competitor), plus our quality and moisture is better.
In fact, the only country who can come in cheaper is Argentina, but given the higher quality of our wheat and the tough season they’ve endured, it’s likely we’ll still be the origin of choice in 2021.
Being the cheapest wheat into our export markets tells us that, outside of some short-term potential harvest pressure, our prices don’t have much downside relative to the rest of the world. That is, our prices can’t sustainably fall from current levels without the rest of the world prices also falling.
Therefore, the high absolute prices today are more a reflection of an elevated global market than buyers paying a big premium for our wheat versus the rest of the world (like they have in the past two drought years).
The risk therefore lies not in our prices falling independent of the world prices, but in offshore prices falling.
When we look at our prices relative to the US wheat futures markets (or the European MATIF market), we are equally as cheap – with our prices relative to CBOT/Kansas near enough to multi-year lows – giving us even more confidence that in relative terms our prices are supported at current levels.
The chart to the right is converted into AUD and illustrates the 20/21 Melbourne APW1 price vs the Dec-20 CBOT (basis being the difference between the two). Although we’ve had a recent increase in our basis level, if we look back at the last 10-12 years, rarely have we been this cheap vs CBOT.
Our prices versus Kansas (the other US exchange) are not as weak historically speaking, given the wide discount to Kansas but our prices are still very much at the lower end of the historical range.
Managing downside price risk
The risk we face in our prices domestically is more a case of the risk that global wheat prices fall from here, rather than our prices falling independent of the rest of the world.
When our relative value is this weak compared to the US wheat exchanges and we’re cheaper than Russia milling wheat into our export destinations, it can pay to focus on selling offshore to protect against a fall in global prices, rather than hitting domestic bids.
It’s also worth noting that our current cheap relativity is the driving force behind why buyers in the domestic new crop market have been so eager to get their hands on supply, given they see current prices as a great relative buying opportunity.
By hedging (i.e. instead of selling domestically, selling a Kansas, CBOT or MATIF contract for next year expiry) we can expose ourselves to an improvement in our relative value in the post-harvest market.
This improvement might come from world prices falling and our prices not falling as much, or our prices rising by more than world prices – either option will result in an improved return compared to selling domestically now.
If we look back at history (see chart above) we see that as the main harvest window closes and the selling pressure from growers starts to dwindle, we typically see an improvement in our relative value (i.e. we start to price in a bigger premium over world prices).
As it becomes harder to accumulate grain against pre-existing sales – this in turn gives us an opportunity to capitalise on this and sell into a higher relative market.
Adding value post-harvest
It is always important not to take prices simply at face value, as even what looks like a good price might be a distraction from a better opportunity to maximise our grain marketing returns.
By evaluating the relative strength or weakness of our domestic prices, we can more accurately assess the risk/reward of focusing our sales on the offshore market (i.e. hedging), which over time has been able to offer both improved returns and a safer avenue to taking price risk off the table.
Market Check’s Strategic Program has been implementing a hedging strategy for Australian growers to participate in relative strength post-harvest since 2012.
The post-harvest hedging strategy, given its compelling historical performance, is a cornerstone of Market Check’s holistic grain marketing strategies, which have been delivering clients consistently strong year-round returns for over 25 years.
To take a closer look at the Market Check strategic managed program, go to www.marketcheck.com.au/strategic-program, or call a specialist adviser in your area: Eastern states 02 9499 4199, South Australia 08 8661 7130, Western Australia 08 6313 7929.
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