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Understanding the Western Barley Futures Contract -- August, 2006 | |
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Introduction
Alberta is Canada’s largest barley growing province. Alberta produced an average of 44 per cent of Canadian barley production in the 10 years ending in 2004-05. During those years, Saskatchewan produced an average of 35 per cent of the crop and Manitoba produced about 12 per cent.
Some of the Alberta-grown barley is shipped to Eastern Canada and Vancouver and exported to overseas markets. However, the majority of it remains in Alberta and is fed to cattle and hogs.
Most Alberta barley is traded on the cash market. While this is an effective and efficient market, it forces barley growers and users to deal with price fluctuations. Growers are nervous about prices falling. Buyers are worried prices will rise.
By using the futures market to hedge or forward price barley, both sellers and buyers can protect themselves against price fluctuations in the cash market. The Western Barley Futures (WBF) contract, which is traded at the Winnipeg Commodity Exchange (WCE), offers barley growers an opportunity to lock in a price before making a cash sale. It also offers barley users the ability to lock in the price of a major input.
This module discusses the origin, specifications and some uses of the WBF contract.
Background
Barley is the major feed grain in Canada. Between 1995 and 2005, the Canadian barley crop varied between 11.5 and 15.5 million tonnes. Alberta produced between 4.7 and 7.1 million tonnes in those years except for the disastrous 2002 crop when production was only 2.7 million tonnes. About 75 to 80 per cent of the Alberta crop is used as feed, mostly for cattle but some is used for hogs. Alberta produces between 800,000 and one million tonnes of malt barley each year.
In Alberta, barley production is mainly concentrated in the central and north-central portions of the province, although significant amounts are also produced in the Alberta Peace and just south of Calgary. The cattle feeding industry is concentrated in the south with the hog feeding industry mainly in central Alberta. As a result, large amounts of barley are shipped southward in Alberta.
Barley producers have two marketing alternatives for their feed barley:
(1) selling to the Canadian Wheat Board
(2) or selling to the non-board market such as feedmills and livestock operations.
Selling feed barley to the CWB involves two choices. The choices are using the pooling system with two pooling periods per year or using the Board’s Fixed Price Contract. Both choices require committing delivery to the Board through Guaranteed Delivery Contracts
Most feed barley sold to the non-board market is sold using the daily cash price. However, producers and users may lock in prices using forward contracts or hedge the barley price using the WBF contract. See Using Hedging to Protect Farm Product Prices for more details on using hedging with futures contracts to lock in a price.
The WBF contract was initially developed in 1989. A group of Alberta barley users and producers led the push for an effective, efficient barley futures contract that would serve the needs of the western barley industry by reflecting the local supply and demand conditions. After a great deal of discussion and review, the group developed a futures contract that was based on using Lethbridge, in the major barley feeding area of Western Canada, as a price reference point. (See Commodity Futures Markets: How They Work for an explanation of “price reference point”.) They took their proposal to the Winnipeg Commodity Exchange, where it was approved, and trading began. Since that time, a number of substantial changes to the contract have been made to make it function better for both barley growers and users.
Uses of the WBF Contract
The WBF contract was designed specifically to meet the needs of barley growers, livestock feeders, barley merchandisers (grain companies and grain dealers) and feedmills in Western Canada. It serves three key functions:
1. price discovery,
2. a complement to the cash market and
3. a price risk management tool.
Price discovery
The WBF contract is used as a price discovery mechanism for non-board feed barley. In other words, growers and users of feed barley are able to “discover” a fair market value for the crop for some future time period at any time during business trading of WBF contract at the WCE. See Commodity Futures Markets: How They Work for more details on futures and price discovery.
Growers and users are also able to monitor feed barley prices by watching the WBF contract prices. The nearby contract month is the closest month that is trading. For example, in August, the nearby contract is October. A grower may want to watch or track either the nearby or the contract month that is just after the month he/she plans to sell cash barley. For example, if a grower plans to sell some barley into the local cash market in November, he/she would follow the December barley futures. A barley buyer needing supplies in November would do the same.
Complement to the cash market
The futures market is a good tool for monitoring prices as it is designed to complement, but not replace the cash market in Alberta and western Canada. The specifications of the contract parallel as closely as possible the barley-pricing practices of that region, so prices in the futures market reflect feed barley market conditions in the area.
Price risk management
As was stated above, a WBF contract can be used as a way to monitor the barley market, but its most effective use is as a price risk management tool. WBF can be used as a price risk management tool to protect growers and users from feed barley price fluctuations. A grain farmer can protect him- or herself from lower prices by a process called hedging through a Registered Futures Commission Merchant, often called a commodity broker. A barley user can also protect him- or herself from higher prices by using hedging. For more details on hedging, see Using Hedging to Protect Farm Product Prices.
Price risk can also be managed by a producer by forward selling barley through a deferred delivery contract (a guaranteed price for a guaranteed quantity) offered by grain buyer. A barley user can also forward buy barley through a forward contract offered by a grain company of other seller. Grain companies use the WBF as a hedge to protect themselves when they guarantee a price in a deferred delivery contract with either a barley grower or user.
Contract Specifications
Every futures contract must have tight specifications for the market to function properly. WBF specifications are no different. Table 1 shows the most recent WBF specifications.
| Table 1. WCE Western Barley Futures Contract – effective through the end of trading for the July 2007 contract. |
| Price Reference PointFOB on-truck at the buyer’s facility, in Lethbridge |
| CurrencyCanadian dollars per tonne |
| Contract (Delivery) MonthsMarch, May, July, October, December |
Contract Size1 contract = 20 tonnes known as a “Job Lot”
5 contracts = 100 tonnes known as a “Board Lot” |
| Par Contract Quality48 pounds per bu. (300 grams/0.5 litre), 14.8% max moisture, 2% max dockage, other specifications to meet #1 CW Barley |
| Discount ($5.00/t)46 pounds per bushel (288 grams/0.5 litre), 14.8% max moisture, 2% max dockage, other specifications to meet #1 CW Barley |
| Discount ($15.00/t)44 pounds per bu. (276 grams/0.5 litre), 14.8% max moisture, 2% max dockage, other specifications to meet #1 CW Barley |
| Premium ($2.00/t)50 pounds per bu. (305 grams/0.5 litre). 14.8% max moisture, 2% max dockage, other specifications to meet #1 CW Barley. |
Trading Hours – Central TimeOvernight session: 5:30 p.m. to 6:00 a.m.
Daytime session: 9:30 a.m. to 1:15 p.m. Central Time |
| Minimum Price Change10 cents per tonne |
| Daily Price Limit$7.50 per tonne above or below previous close |
| First Notice DayOne trading day prior to the first delivery day |
| First Delivery DayFirst trading day of the delivery month |
| Last Trading DayTrading day preceding the 15th calendar day of the delivery month |
Western Barley Contract Changes
The Winnipeg Commodity Exchange has announced changes to the WBF contract beginning with the start of trade for the October 2007 contract. The major change is a change in the price reference point from FOB on-truck at the buyer’s facility in Lethbridge to FOB in-store any “registered” elevator located within approximately 90 miles from North Saskatoon, Saskatchewan. Table 2 shows the changes to the October 2007 and later WBF contracts.
| Table 2. WCE Western Barley Futures Contract – effective with start of trading of the October 2007 contract. |
| Price Reference PointFOB in-store at a registered elevator in Saskatoon or at a registered facility within a distance of approximately 150 Km (90 miles) from Saskatoon. |
Implications of the change are that, since the price reference point is now around Saskatoon, the October 07 and later futures contracts will very likely trade at much lower prices than the old contract, likely $30 to $35 per tonne lower. The reason for the lower futures price is that the new price will no longer include the costs of shipping barley from Saskatoon to Lethbridge in the price. However, the feed barley cash price could be almost the same because typical basis levels (relative to the October 07 and later futures) for all points on the Prairies will likely strengthen significantly.
Trading Months Beginning and Ending
When futures contracts for one of the WBF trading months, say October 2005, ends or expires, trading of that month in the following year, in this case October 2006, automatically begins.
Margins
Any person or company wanting to buy or sell WBF contracts must deposit cash with their commodity broker. These deposits are called “margins”. See Commodity Futures Markets: How They Work for more details on margins.
What to Do With Futures Contracts
A barley producer who has sold a WBF contract, called a “short” position, has made a legal commitment, and that commitment must be dealt with. A barley user who has bought a WBF contract, called a “long” position, has also made a legal commitment that must be dealt with.
There are several ways a farmer, who holds a “short”, or “sell” Western Barley position, can fulfil his obligations.
(1) The barley grower can sell his barley to any buyer he chooses and buy back his futures position. Buying back the “sell” futures is called an offset.
(2) The grower can deliver his barley against his futures position.
(3) The grower can enter into an “Exchange of Futures for Risk” or “Exchange for Risk” (EFR).
(4) The grower can enter into an “”Exchange of Futures for Physical” or “Exchange for Physical” (EFR).
Choice One, offset, is the most common way of dealing with a “sell” futures position. The farmer arranges to sell the barley privately, perhaps to a neighboring feedlot. Or, he may decide to feed it to his own livestock, sell it to a feedmill or keep it in the bin until market conditions improve. What he decides to do with the cash barley is his own business. However, he must honor his WBF contract contractual obligations even if he feeds the grain to his own livestock.
To offset, the producer can buy his way out of the “sell” or “short” futures contract, by taking an offsetting position in the futures market. In the same way he previously sold the futures contract (to initiate his hedge), he buys back his position. He can offset his “sell” position by phoning his broker and placing a “buy” order. He will pay the prevailing futures market price at that time. Once the buy order is filled, the farmer no longer has the legal obligations of his initial “sell” contract because it has been “offset” by his “buy” futures order. See Commodity Markets: How They Work and Using Hedging to Protect Farm Prices for more details on offsetting or rolling a contract.
For example, let=s say that a barley grower sold four Oct. WBF contracts (80 tonnes), at $140/t. In September, the barley is harvested and sold to a feeder for $90/t (when his local basis is $30/t). The barley grower tells his broker to buy back the four Oct. futures contracts. The four Oct contracts are bought at $120/t. The net selling price to the grower would be $90 for the cash barley plus a $20/t gain on the “sell” futures contract for a total of $110/t not including broker commissions.
If, however, the grower could not find a buyer for the cash barley at an acceptable price in October, there are other alternatives. The grower can store the barley, and roll the “sell” futures to a later month by buying back the Oct. WBF contracts and selling a later futures month, say, December or March. “Rolling” moves the hedge forward by a number of months for cost of one commission of the commodity broker.
Choice Two for dealing with a “sell” futures contract is to deliver his barley against his futures position. Another module will deal with delivery against futures contracts.
Choice Three is known as “Exchange of Futures for Risk” or “Exchange for Risk” (EFR) where the holder of a “sell” position exchanges his futures with a holder of a “buy” or “long” barley futures position. Exchange for Risk is rarely used and requires a thorough understanding of the process.
Choice Four is “Exchange of Futures for Physical” or “Exchange for Physical” (EFP). EFP will also be discussed in another module.
Common WBF Contract Questions
1. What volumes must producers use with the WBF contract?
One WBF contract consists of a 20 tonne unit. However, it may be difficult to get orders for less than five contracts filled - sold or bought. The WCE only quotes prices from bids, offers or trades of a minimum of five contracts.
2. Can the WBF contract be used as a speculative tool?
Yes, speculators can buy and sell WBF contracts depending on which way they think the price will move. Speculative traders do not have to grow or accept delivery of barley.
3. Who is allowed to trade WBF contracts at the Winnipeg Commodity Exchange?
Registered futures commission merchants, more commonly know as commodity brokers, are the only people who are licensed to buy and sell futures on WCE. They do it on behalf of barley growers or users.
Additional Information
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This document is maintained by Magda Beranek.
This information published to the web on August 5, 2006.
Last Reviewed/Revised on August 6, 2008.
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