“New PLATTS contracts help bring great awareness to the topic of risk management for Black Sea players, but still are not the end all solution to manage price risk. There remains plenty of risks as it relates to credit, execution, foreign exchange, interest rates. The need for cash in a risk management plan remains an important factor to understand to manage margin calls, and this remains a large hurdle for many in the Black Sea as cash is typically wanted to re-investment in the physical business. The market’s involvement is needed to sustain liquidity in these contracts, which are crucial for the health of a trading market.
Commodity Risk Manager
Vice President Eastern Europe/Black Sea Region
INTL FCStone Financial Inc- FCM Division*
The Black Sea region remains a dominant force in today’s grain market, we all know this, but it has not always been like this. For example, it was not until 2001 that Russian wheat exports exceeded that of imports. Currently the Black Sea holds the reign as the world’s largest wheat export, largest sunoil exporter, and 4th largest corn exporter in the world. Over the course of the past several decades, the world looked to U.S., Brazil, Canada and Australia for price direction with the primary emphasis on U.S. As trade flows changed and production increased in the Black Sea, a greater importance relied upon the developments found in the Black Sea, especially that of price. Several factors played into this shift of increased production. Better efficiencies and farming practices on some of the world’s most fertile land, devaluing FX market and ideal geographical location in relation to demand origins have contributed to increased production.
The global wheat market remains a competitive marketplace. Every two to three months somewhere in the world, wheat harvest is occurring. Globally, prior to 2007, global supplies remained stagnant at 700-750 mmt, since 2007 supplies have steadily grown to record levels seen at a near 1,050+ mmt. This a near 40% increase in global supplies! This while global demand increased 27%. During this same time, Black Sea in 2007 remained 18% of global wheat exports, while in 2017/18 and 2019/20 the market share has increased to a near 40%- yes 40%!
As importance increases for Black Sea supplies, so does the need to manage this price risk. Historically speaking, Chicago corn and wheat and Matif wheat have been used as a cross hedge. At times it has been an effective hedge for those wanting to mitigate Black Sea price risk, but as export volumes increased the need for a stand alone hedge remained a legitimate argument. In 2012 the CME launched a Black Sea wheat futures contract that allowed for physical delivery based on a few Black Sea delivery locations spanning from Romania, Ukraine and Russia. Due to the difficulties in operating delivery, origin, and quality differences, the contract never gained momentum that the market was looking for. A few contracts traded but nothing with substantial size or interest. There is a reason why the U.S., for example has three wheat contracts; Soft Red Winter (Chicago wheat), Hard red Winter (Kansas Wheat) and Spring Wheat (Minneapolis wheat).
This brings us to today. Since December 2017, the CME launched a financially settled Black Sea Wheat (BWF) and Corn (BCF) contract. The contract financially settles against the spot physical price published by PLATTS. The spot price per wheat is reflected of loadings 28-42 days out via FOB Novo 12.5 pro wheat, min 25kmt, max 60k mt. This reflects Russian origin; soft wheat 12.5pro, TW min 77 KG/hl, max moisture 14%, min Wet Gluton 25%, min W number of 180, min Hagberg FN of 250 seconds, max Bug Damage 1.5% and max FM of 2%. If a Russian FOB number is unavailable, other Black Sea origins FOB prices would be used to back to a Russian FOB equivalent. The spot price per corn reflects loadings 28-42 days out via FOB Ukraine Panamax port (Odessa, Yuzhny, and Chornomorsk). Min 15k, max 60k mt. This reflects Ukraine origin, Max moisture 14.5 %, max broken kernels 5%, max damage 5%, max FM 2%. Both wheat and corn contracts are 50 mt per contract and are listed out 16 months. Options are also available for market participants (12 months out) to manage price risk.
The growing need for sunoil risk management also remains as the Black Sea remains the world’s largest sunoil exporter. To date, much like corn and wheat, cross hedging was utilized mainly in relation to CME Soybean oil, but given the differences present, a strong correlation was lacking. Even though at times correlations can be strong- a long lasting correlation was not present. More recently, on August 26th, 2019, the CME also introduced a sunflower oil contract (BSF) that references PLATTS spot prices. The mechanics behind the sunoil contract relates very closely to that of wheat and corn. BSF expires financially based on the spot price published from PLATTS. The spot price per PLATTS Sunoil reflects loadings one or two calendar months forward from the month of assessment via FOB Chornomorsk and Nikolaev normalized to FOB Chornomorsk, 3k mt size. Specifications remain raw sunoil, FFA basis 2%, max 3%. Moisture 0.5% Max. Impurities .5% Max, min flash point 121C. hydrocarbons Max 50 mg/kg.
Current trading activity remains spread across the whole value chain, from large vertically integrated firms in the Black Sea to consumers and physical traders of Black Sea cash supplies as well. Speculators are important to liquidity as well, and there are also banks and hedge funds that show trading interests as well. Some market players also spread risk vs Chicago wheat, KC wheat and or Matif wheat. The introduction of these contracts allow anyone in the world to have direct access to Black Sea wheat and corn without touching the physical product for the first time. Prior to these contracts the only way to have direct exposure was to buy or sell physical cargos.
Trading of these PLATTS contracts have proven successful for wheat and corn, but as of late open interest (the total amount of outstanding contracts) have continued to decrease modestly. As you can see from the below chart, total open interest has remained steady among BWF and BCF futures and options, with open interest peaking in July 2019 at 42,649 contracts (2,132,450 mt) while total volume continues to grow to 339,561 (16,978,050) contracts in total as of the first part of September. Sunoil has yet to trade since the contract started in late August.
One area of growth potential remains in the use of BWF, BCF and BSF in cash contracts. Many in the Black Sea are already familiar with corn contracts that reference prices of Chicago corn plus a premium; the same can be applied with BWF, BCF and BSF now as well. This can allow for the use of a more effective pricing reference as it relates to physical cargos.
The use of these PLATTS contracts brings greater transparency for the market as a whole. In the past, it was a bit tough to find forward values 6-9 months in the future, but now a simple view to CME allows anyone in the world to view where current prices remain. A market carry or inverse can be quickly realized, analyzed, and utilized for decision making. This increase in transparency is not welcomed by all though, as sellers typically do not like it due to more visibility, while consumers welcome this to bring better prices.
In conclusion- these new PLATTS contracts help bring great awareness to the topic of risk management for Black Sea players, but still are not the end all solution to manage price risk. There remains plenty of risks as it relates to credit, execution, foreign exchange, interest rates. The need for cash in a risk management plan remains an important factor to understand to manage margin calls, and this remains a large hurdle for many in the Black Sea as cash is typically wanted to re-investment in the physical business. The market’s involvement is needed to sustain liquidity in these contracts, which are crucial for the health of a trading market. We live in an instant gratification world, but we must remember it took centuries for the CME to gain the presence that it currently has in the derivative’s world (Chicago Board of Trade, or CBOT, now Chicago Mercantile Exchange, or CME, started in 1858), and it was just in the 1980’s when options were introduced to the market. BWF/BCF had options introduced a few months after the futures were introduced. Even though OI remains stagnant right now for these contracts- they remain a risk management tool available for the market to manage Black Sea price risk. Other markets can still be used as a cross hedge, but BWF, BCF and BSF are directly tied to cash prices in Russia and Ukraine.
The subject of price risk management can take on different meanings and understanding, it’s the job of INTL FCStone Financial Inc. to help understand your price risk and the best strategies to implement to help manage them. For some this might be a great awareness of what could be driving the marketplace, while for others it might be sophisticated strategies to manage price risk. Whether you are new to the industry or a seasoned trader the goal remains the same; to manage price risk rather than allowing the market to manage you. The most speculative strategy is doing nothing and watching the market dictate if you make or lose money- those proactive in some way are in a better position to grow their business and the use of BWF, BCF and BSF could help with that process.
*INTL FCStone Inc. (NASDAQ: INTL), through its subsidiaries, provides clients with a comprehensive range of customized financial services around the globe. The trading of exchange-traded futures and options as well as swaps and OTC derivatives involves substantial risk of loss, and you should fully understand those risks prior to trading. All references to exchange-traded futures and options are made on behalf of the FCM Division of INTL FCStone Financial Inc., a NFA member and CFTC registered Futures Commission Merchant and Commodity Trading Advisor.