Tuesday, July 31, 2012

Happy New Year!

Aug 1 is here and we’re finally clear of the debate and acrimony; we can focus on new business.  Or can we?

The other day I was out looking at crops just outside of town.  Standing alongside a wheat field I took a deep breath and said to my friend, “Smell that.”

“Smell what?”

“Take a deep breath; notice that?  No more BS.” 

Taking another focused breath, I added, “No wait, it’s still there – almost so imperceptible you don’t even notice it right away.  But it’s there – it hasn’t gone away completely.”

On the eve of The New Marketing Era in Western Canada, there are still those that are grasping at the shadows of the mandatory CWB – or as a friend called it yesterday, CWB - the “Compulsory Wet Blanket”.  The Canadian Wheat Board Alliance and The Friends of the Canadian Wheat Board (let’s simplify things and call them The Alliance & Friends) continue to try to convince us of that the end of the CWB will create marketing anarchy and poverty in Western Canada.  Fortunately, they couldn’t be further from reality.

At the risk of giving them more attention than they deserve, I want to remind people how off base detractors of the new market are in their arguments.  Here are the Top Ten Myths of the New Market:

10.    The grain industry will become more concentrated and powerful
Time will tell of course, but as many of us had suggested, there are new players – Gavilon Inc., Lansing Olam Canada and CHS, to name just three – becoming increasingly active in Western Canada.  Something tells me there is more to come as things evolve.  Competition is a good thing.

9.       Producer cars will no longer be a viable option
On this one, they may be partly correct, but for the wrong reason.  The Alliance & Friends have argued that without the single desk there will be no one there to support producer cars.  Here they’re missing two points:
            a)    The new CWB has access to terminals and intends to continue to promote producer cars and work with farmers that want to load them. 
b)      Farmers who load producer cars have argued that they are worth about $1200 per car by avoiding primary elevator handling fees.  But, in a competitive market without the CWB single desk, those handling fees will come under pressure, thereby reducing the financial attraction of producer cars.  Will producer car loaders still load producer cars if the perceived advantage is only $200? 

8.       Trucks of Canadian wheat will overwhelm US elevators; US farmers will demand trade sanctions
The Alliance & Friends have suggested that Canadian farmers will fall over each other to sell into the US, driving the US price lower.  And this will lead to US farmers demanding trade sanctions against Canada.
Yet higher US prices have migrated north, taking away the incentive to drive south.  Almost immediately, new crop wheat prices in Canada were very competitive with US prices and continue to be.  Arbitrage is working – just not in the direction the Alliance & Friends would have wanted it.

As for US farmers’ outrage – according to a Reuters news story, Jim Peterson, marketing director of the farmer-run North Dakota Wheat Commission expects US farmers will benefit on the global stage from an end to the CWB's "price-distortion".

Keep in mind, the 14 or so US trade actions were against the CWB – not Canadian wheat.

7.       The quality of Canadian grain products will go down
Bill Gehl, president of the CWB Alliance, said that the quality of Canadian food products will go down without the single desk because the buyers will be free to buy the cheapest grain on the planet – and grain used in Canada will be the radio-active variety from around Chernobyl.  There are two problems with this argument:

            a) Food manufacturers were always free to buy from whomever and from wherever they wanted.  The CWB never had control over Canadian millers or bakers. 
b)      Since Canadian food manufacturers could always buy from wherever they wanted, and since – as Mr. Gehl will tell you – they are profit maximizing enterprises, they already buy the cheapest grain they can, which, as it happens, comes from Canada.

6.       ICE Futures Canada’s new futures contracts have failed
Although I haven’t heard this from the Alliance & Friends, they are critical of all futures markets. 
Yes, the new contracts were launched over six months ago and, yes, there is still only light trade.  But those saying they have failed should be reminded of Mark Twain’s comment “the report of my death was exaggerated”. 

The CME’s new Black Sea wheat futures started trading in early June and so far in the two months to July 30th have a grand total of 9 open contracts – and in only one month.  By comparison, after its first two months of trading, ICE milling wheat had close to 100 open contracts – and in three different months.  Although you may hear the CME speak disparagingly about ICE wheat futures, you’ll never hear them talk that way about their own Black Sea contract.  They know better than to talk a contract down (unless it’s your competitor’s).

The new ICE futures contracts for milling wheat, durum and barley are tools needed in Western Canada, particularly after the end of the single desk.  But these things take time and take effort.  Futures contracts are exceedingly difficult to kick start; everyone says they will trade them when they get liquidity – but how do they get liquidity unless people start in?

Rather than pessimistically talking these contracts down, we need to optimistically talk them up.  Hedgers need to place orders, farmers and end users need to ask for basis contracts based on the new contracts, traders need to spread ICE futures against other contracts like Minneapolis.  Wouldn’t it be great if the new CWB offered basis contracts off ICE futures?

In the long haul, these contracts have the potential to provide better price discovery, more stable basis and better transfer of risk than anything else.  It’s undoubtedly worth a little effort.  And it’s definitely an exaggeration to say they failed.

5.       The new CWB will fail
Apparently, according to the Alliance & Friends, voluntary pooling won’t work.  It seems that those within the new CWB didn’t get that memo because they’re charging ahead with them regardless.  Like anything else, CWB will succeed only if it's supported.  My guess is that if it succeeds with voluntary pools, it will be in spite of core CWB supporters turning their back on it.

Embarrassingly, in true “dog in the manger” fashion, there is nothing the Alliance & Friends would like more than the demise of the new voluntary CWB.

4.       There will be no one to focus the industry or act on behalf of farmers
As many of us have stated previously, there are many models of trade organizations that can be used to design one for wheat in Western Canada.  The Canola Council of Canada is a great example with participation from all corners of the canola world, working toward a common goal – a thriving industry.  It’s no wonder that the canola industry is not only thriving, it is flourishing.

Luckily no one is listening to the Alliance & Friends and they’re just getting on with things, first with a planned Barley Council and also a potential Cereals Council.

3.       Prices will go down as farmers will drive them lower
Canadian farmers selling into a market will not drive the global price of a commodity lower.  If anything, they could drive the basis wider (lower), but total handling (and marketing) costs paid by farmers under the CWB system were the highest in the world. 

Ok, I don’t know that for a fact, but I do know that the handling costs were remarkably high compared to every other market I am aware of, making the theoretical basis extremely weak to begin with.  Add to that the high “marketing costs” borne by farmers because of the way the CWB worked: shipping 1’s against a sale of 3’s; demurrage to the farmers’ account; thinking despatch is a source of revenue (when it is a cost); shipping wheat from southern Alberta through Churchill (because it is the cheapest routing for grain from North East Sask (yes, I know, it doesn’t make any sense to me either); delaying shipment to a customer (for up to a year) at the customer’s request and getting nothing for it; shipping wheat from Montreal to Vancouver; selling only half a crop (durum); etc, etc.  Ka-ching, ka-ching.

I’ll stick my neck out a bit here and say the cost of handling and “marketing” that farmers will pay will go down with the end of the single desk.  (There really is only one way to go here.)  And, ignoring global price movements, that means higher prices for farmers.

2.       Small farms will suffer without the single desk
The trend over the past three decades has been toward larger and larger farms, mostly due to decreasing profitability.  And that’s WITH the CWB single desk.  I’m not about to say that the trend toward larger farms will stop with the end of the single desk, but with increased competition, lower marketing costs, increased marketing options and a more functional marketplace, profit per acre should go up making smaller farms more viable.

1.       The CWB is the only one offering price averaging or pooling.
Well, that’s not entirely correct.  A new, independent company called Farmers Advanced Risk Management Company (FARMCo) is launching a price averaging tool for farmers.
Quite frankly, I got fed up listening to the Alliance & Friends (and a few academics) about how voluntary pooling wouldn’t work (because it didn’t work in the 20’s and 30’s). So I developed a program to show how it could work; the result is FARMCo and the Advanced Grain Pricing Program (AGPP).

FARMCo’s mission statement explains its position:

“FARMCo will play a leading role in changing the grain marketing culture in Western Canada, particularly with farmers, by advancing and broadening sound grain marketing concepts and providing meaningful tools and techniques for both farmers and other grain merchandisers.”

A fixed price Initial Payment – like they used in the 20’s and 30’s – will always struggle in a voluntary situation.  Fundamental to the design of the AGPP is that the price paid to farmers is variable, moving and keeping pace with the market.

Cash flow suffers under conventional pools, with restricted delivery and relatively small Initial Payments.  Waiting for over a year for a Final Payment doesn’t help.   The AGPP does not restrict deliveries, rather it pays a premium for deferring deliveries, giving an incentive to store.  It has an Initial Payment of about 85-90% of the current market and the final payment is made within two to three months of the sale, making it cash flow friendly.

In the AGPP, we use futures and options to provide “better than average” pricing, exploiting carrying charges to the farmer’s benefit.  In addition to getting paid to store, basis is not pooled, so participants get everything their local market has to offer.

FARMCo is focused on providing value to the benefit of farmers – hence the name.  Not only will farmers be among its shareholders, all profits (beyond a fixed management fee) go directly to its farmer clients.  No one else – not even the new CWB – can say that.

The new market is here.  Even Anders Bruun, lawyer for the Friends of the CWB recently stated, “Things may have changed so much that the monopoly couldn’t possibly be restored”.  We have crossed the Rubicon – there is no going back.    

Let's not forget that there's a lot more to this change than unplugging the CWB. Anyone who expected this industry to just slip into the future without a scratch – whether you thought it would be good or bad - would have been misled.  And although there are challenges ahead, I’ll take them over the Compulsory Wet Blanket any day of the week.

Take a deep breath.  It sure smells good.

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