Sunday, January 1, 2012

To stay or not to stay

The last bump in the road to marketing freedom – or entrepreneurial freedom – is the pending court challenge by the eight farmer-elected directors of the CWB.  

In the original filing, the CWB and its farmer-elected directors took the position that the Act (resulting from Bill C-18) was invalid because the Minister failed to comply with Section 47.1 of the CWB Act and on this basis they were seeking a declaration by the court that the new Act is invalid.  Further, they wanted to immediately stop the implementation of the new open market (via a “stay” or injunction) until the judge rules on the validity of the Act. The judge refused to grant an immediate stay referring to the request as “draconian”, but the case is going forward and is set to be heard on Jan 17-18, 2012 in Winnipeg.  

Since Bill C-18 has been passed and implemented, the remaining eight farmer-elected directors (the Eight, we’ll call them) have been released.  The remaining five directors decided the CWB would drop its case, leaving the Eight – who were named individually on the original filing – to proceed on their own.

Now, instead of an immediate stay, the Eight are asking for a stay that will take effect while the judge is hearing and deliberating on the case.  The reason for the stay, according to court documents, is that the Eight believe that moving to an open market will cause disruptions to the market and “cause irreparable harm”.  

But we’ve already moved to an open market.  The Eight have it quite wrong - going back to the Single Desk while the case is being heard will create disruptions and cause harm.  What if the judge rules the Act is valid?  If a stay is granted, we would then have gone from the Single Desk to the open market (Dec 18th), then back to the Single Desk (Jan 17th), then – once again – to an open market.

Even so, in his affidavit, Bill Toews argues for the stay.  He argues that, much of the trade for wheat, durum and barley occurs on the basis of forward contracting as much as 6 months in advance of the shipment – or up to 12 months ahead in the case of malting barley.  Mr. Toews argues that opening the market now – for transactions for delivery after Aug 1 – will have a depressing effect on the current 2011-12 pool that ends July 31st.  This is not an argument to hold off these changes at this time; it’s an argument to never make changes, since, if correct, this would happen any time the Single Desk is removed.  

But it’s not correct.

Prices in the current 2011-12 crop year represent the supply-demand balance for this crop year.  Once the new crop is harvested, there is additional supply available to the market, creating a new supply-demand balance and hence, different prices.  But buyers still buying for the last half of the 2011-12 crop year (Jan-July 2012) will be subject to prices based on the current supply-demand balance – not the new crop balance.  

Toews argues that with farmers freely selling into the new crop position, prices there will drop.  (The CWB has always argued that farmers selling on their own will push prices lower than if the CWB was selling for them.)  He then suggests that buyers in the old crop position will expect lower prices as well.  

There are two problems with this.  First, an efficient market will feel the effect of all trades, so we should expect the market to “feel” the effect of forward selling. But the amount of forward contracting by farmers in January for new crop deliveries would be insignificant; certainly not enough to push the market lower.

Second, even if the new crop price is more attractive than the nearby price, if you need wheat now, you have to pay the higher nearby price.  A buyer can “expect” lower prices all he likes, but the market is the market and there is little a buyer can do to get around that.

If Toews is concerned that farmers will opt to hold the grain currently in their bins until after Aug 1st (which it seems some may be doing), this will not have the depressing effect he argues; rather it will reduce available supply from the current market which, if anything, will support prices in the current crop year.

Although his argument is a “mighty stretch”, Toews advises in his affidavit that this will have the impact of dropping the pool by only $2 to $5 per tonne.

It would make sense to compare that small downside (if you believe it) to gains made by selling in an open market.  Farmers contracting into the new crop year will be paid full value for their wheat upon delivery, far better than the CWB Initial Payment of about 65% of the crop value.  It’s very tough to argue that farmers are suffering harm when they are getting better prices through forward contracting and they are getting paid in full upon delivery.

Arguing against the use of forward contracts in the open market – with the court ruling pending – Toews states: “... in the event that the Bill is subsequently declared to be invalid, those contracts will also be invalid with the result that both buyer and seller will be forced to “unwind” the hedge positions that they had taken at the then prevailing market prices.  The costs of doing so could be significant.”

In the Continental Barley market from June to Sept 1993, market participants including farmers were free to sell to any buyer in the US without going through the CWB – until that market was shut down by a court ruling.  Those sellers incurred significant losses – not due to the unwinding of hedge positions as the CWB posits; rather it was due to the intransigence of the CWB in how it dealt with those sellers with outstanding contracts.  Whereas the CWB could have facilitated the smooth transition back to the Single Desk environment, it chose to heavily penalize those that were involved in any Continental Barley trades by not allowing those trades to be executed.  The cost was indeed significant, but it didn’t need to be.

When the barley market was open temporarily again – in 2007 – close to a million tonnes of export barley was sold by grain companies.  But since they remembered the pain of Continental Barley, they negotiated with the CWB ahead of time; in the event that the Single Desk was returned (which, of course, it was), the CWB agreed to allow outstanding forward contracts to be executed as if the market was open.  Toews argues that “costs were incurred” but he fails to indicate that the only related cost was the payment of a fee to the CWB – what some called the CWB’s “export tax” – of $4.00/tonne.  This was paid to the CWB by exporters to simply maintain the right to execute their contracts unimpeded by the CWB.  Although it collected this fee, the CWB took no part in executing the transactions.

The CWB can’t argue that going from the Single Desk to an open market (and back again) would cause disruptions and irreparable harm when it would only be disruptive and harmful if the CWB chooses to create disruptions and harm.

The best thing to do is to just allow things to continue as they are as we wait for the court ruling.

Make no mistake: the Eight are the ones causing market uncertainty with the court case.  A stay would just add to the disruption and uncertainty.  If they were really concerned with disruptions, uncertainty and associated costs, they wouldn’t be asking for a stay.  And they would be indicating that regardless of what happens, they will do whatever they can to enable a smooth transition.

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