Issue 31
Marketing Guide 2000
 

Prairie Grains is the official publication of the Minnesota Association of Wheat Growers, North Dakota Grain Growers Association, South Dakota Wheat, Inc. and the Minnesota Barley Growers Association.

Copyright
Prairie Grains Marketing Guide
2000

Hedging canola:

The mechanics of using futures markets

By Ray Grabanski and Betsy Jensen

Canola is becoming a more popular crop with farmers in the Northern Plains the past few years, providing excellent returns vs. other crops.  With all the canola grown in ND and MN, every once in a while we get calls regarding hedging canola in the futures market.  Most of these calls involve the mechanics of doing so in the Winnipeg futures exchange, but some include the mechanics of using the soybean futures in Chicago. So which market should you use? Of these two choices, there are pro's and con's to using each market. 

Advantage of using Winnipeg canola futures over Chicago soybean futures includes:
1. It's naturally a better hedge since it's the same commodity. We believe Winnipeg canola futures more closely follow cash U.S. canola prices than the Chicago Bd. Of Trade soybean contract. The fundamentals of the canola market can be different than soybeans, although they are substitutes to a certain extent.   Differences in fundamentals can sometimes lead to unanticipated results if cross-hedging outside the commodity you're selling, in this case, canola.  What happens if the canola crop, for instance, freezes while soybeans remain untouched? All of a sudden, a big difference in price moves could occur.

We expect the correlation coefficient (a measure of how closely related two markets are) of U.S. cash canola prices is higher with Winnipeg Canola futures than with U.S. soybean futures (although we have not calculated this correlation coefficient).  Some quick research could be done to calculate the correlation coefficients, but we'd expect the Winnipeg canola futures to work better as a hedge than Chicago soybeans.  (If a study was conducted, we'd suggest calculating an optimal hedge ratio for canola, too).

Disadvantages of hedging using the Winnipeg market includes:
1. The Winnipeg canola contract is small at only 20 metric tonnes (1 metric tonne = 22.046 cwt)  Even at a small yield of only 1000 lbs/acre yield, one canola contract is only 44 acres of canola.  At 1,500 lbs./acre yield, one canola contract is only about 30 acres of crop.  You'll have more transactions and brokerage fees using the Winnipeg contract vs. Chicago soybeans, where one contract could be used to cover a similar dollar amount to a little over 7 canola contracts.

2. Winnipeg canola is in Canadian dollars. Although the Canadian dollar doesn't fluctuate wildly vs. the U.S. dollar value, it does fluctuate. This can affect a hedge, and will mostly be an unanticipated effect. You could hedge the Canadian currency, too, but now you have an even more complicated hedge (and more transaction fees).

Canola futures do closely follow the U.S. soybean market, since Canadian crushers look to U.S. bean oil and meal futures to determine crush margins, but canola does have its own fundamentals. Volume was once a big problem with Winnipeg, but that has been steadily increasing making it less of a problem.  Volume is up over 20% from last year, and Winnipeg is the only canola exchange in the world. It trades all Canadian, U.S., Australian and European canola, so volume is becoming less of a problem. 

Hedging on the Winnipeg Futures Exchange
Using the Winnipeg canola futures market to hedge canola produced in the U.S. can be a beneficial tool to reducing the risk of price fluctuations.  Keep in mind the Winnipeg futures contract is a 20 metric ton contract, but it typically sold in board lots, which means 100 tons. The quote is based on delivery to a par region in Saskatchewan for #1 Canadian canola and trading hours are the same as soybeans, 9:30 to 1:15.

One of the most difficult parts of using the Canadian exchange is looking at the actual price quote.  How does the quote of $275CD per metric ton relate to your canola, on your farm, in U.S. dollars and hundred weight?   Without going through all the calculations, just use .0308 times the Canadian price to get U.S. dollars per hundred weight. So a $275 quote actually means $8.48, assuming an exchange rate of $.68. You can see all the calculations at the end of the article.

Now keep in mind that $8.48 is based on a delivery point in Saskatchewan, not Velva or Altona, or even Red Wing, MN. Just like the wheat market, canola also has a basis, and you should get an estimate of what your basis will be throughout the year by following your local basis relative to futures.

This year, basis is very weak because of the large expected supplies, and large carryover stocks.  Current Altona new crop basis is $24-27 under the Winnipeg futures, instead of the typical $20 under basis.  Instead of using $275CD, use $250 and your new crop bid in Altona is $7.71. It's up to you to determine your transportation costs to the individual markets. 

Calculations to convert Winnipeg canola to U.S. dollars/cwt

•  To change metric tons to cwt, just multiply by 22.046. 
(1 metric tons) x (22.046) = 22.046 cwt

• To change from Canadian to U.S. dollars, multiply CD by the exchange rate  ($275CD) x (.68) = $187U.S.

• To find the per cwt U.S. value of the contract, divide U.S. dollar value by cwt ($187)/(22.046 cwt) = $8.48 cwt.

Final notes on using soybean futures to hedge canola
Canola growers may also consider using the soybean oil contract for hedging. It is a smaller contract than soybeans, and would imply about 3 contracts of canola for each bean oil (3.2 based on oil lbs, 2.91 based on today's value). That is versus about 7 contracts canola for 1 soybean contract.

The choice of which market to hedge may come down, in the final analysis, to other considerations than those listed. Are the fundamentals of the canola market better or weaker than soybeans?  This year, for example, canola acreage is down while soybean acreage is up.  Therefore, it may be better to be sold in the soybean market. And if prices are below the loan rate, you may wonder why you should hedge at all since the government is providing a free put option via the loan rate. Unless you are doing an LDP play, this may just be speculation on lower prices.

Note LDP calculation change for minor oilseeds
Earlier this summer with little fanfare, the Kansas City office of USDA changed the methodology for calculating minor oilseeds LDPs. They used to calculate weekly LDPs from Friday through Thursday of each week (picking 2 of the 5 days within that span) and posted the result on Friday.  Now they use Wednesday to Tuesday (and use all 5 days) and post the result on Friday.  This change affects canola, sunflower, crambe, and flax as well as some other minor oilseed crops. Keep this in mind when taking your LDP.

Typical Seasonal Price Pattern Also Expected for Canola
Canola Prices at Velva, ND
($/cwt)

A typical seasonal price pattern can be expected this year for canola, says NDSU extension crops economist, George Flaskerud. Similar to sunflower, short-term storage should be profitable, with prices improving after harvest and through the spring.

Grabanski is President and Jensen Research Director of Progressive Ag Marketing, Inc. in Fargo, ND, Ph. 1-800-450-1404, website: www.progressive ag.com. Last year's Prairie Grains Marketing Guide that included a listing of marketing advisors in the region may be found online: www.smallgrains.org/springwh/MGuide99/Pro/pro.htm