Friday, November 12, 2010

Operating a CWB Pool in a voluntary market

Proponents of the single desk often say that the CWB could never succeed as a voluntary option in an open market.  In fact, this is the basis of the argument that a dual market could never work.

The main reason often indicated is that voluntary pooling can’t work.  It’s not pooling that’s the problem, it’s the Initial Payment.  In an uptrending market, the Initial Payment (which if fixed) would become increasingly unattractive.  Even the Pool Return Outlook (PRO) lags behind the market and doesn’t show the current value of the grain.  So, in an uptrending market, the price signals from the pool would fail to attract deliveries as farmers opted for higher open market prices.

The opposite would occur in a down trending market.  As the spot open market price drops, the PRO would become increasingly attractive.  In fact, the Initial Payment might become too high.  In this situation, the CWB argues, it would be swamped with grain deliveries that it would end up selling at a loss.

There are two factors that need to be addressed.  Access to the CWB program in an open market and  pricing.

Let’s start with pricing.  This is how it could work:

All farm contracts with the CWB would begin as a basis contract.  The basis would be guaranteed.  There would be no guaranteed Initial Payment.

I’ve often wondered why the CWB guarantees a flat price with the Initial Payment when it only has control over the basis.  The CWB takes on the risk that the market price will move against the Initial Payment.  For this reason, the CWB sets the Initial at something like 60-65% of the expected final – just in case.

Guaranteeing only the basis would mean less risk to the CWB. A typical basis (on CWB sales) to the appropriate futures market could be identified and the potential range of that basis calculated.  The CWB could advise as early as seeding time what the basis would be for all classes and grades of wheat and barley.  Because the CWB would be guaranteeing only a basis, the risk to the CWB would be greatly reduced.

Just like the current Initial Payment, the Initial Basis would be guaranteed, meaning it would never go down.  And there could be final payments (based solely on the difference in the basis sold when compared to the initial basis).

Farmers would sign up deferred delivery basis contracts with the CWB at the beginning of the year – just like they do with grain companies on canola.  And just like the non-CWB market, the contract would be priced at a time of the producer’s choosing (not at the CWB's discretion).

Beyond offering a competitive and meaningful price in an open market (and one that changes as the underlying market prices change), there are other benefits: 
  • It could be voluntary. 
  • Farmers could get paid on delivery a higher proportion of the final sale value, helping with cash flow considerations.
  • The CWB would have much less risk making it easier for the CWB to manage its risk (therefore it would cost less).  
  • There would be no need for complicated PPOs.
  • The CWB could offer shorter pooling periods.
  • Farmers could opt into the pool at any time.
  • The CWB could offer pricing off the different futures contracts which would allow for better price signals for deliveries.  For example, if there was a price advantage to deliver in the spring instead of the fall, the price would provide that incentive.
  • Farmers that want just a flat price initial could get that from the CWB too.
  • Better price discovery and transparency.
    Why does the CWB want to take on risk that it must then manage?
    Next, I’ll cover how the CWB can manage access to the CWB program in an open market.

    No comments:

    Post a Comment