Traditionally, in the second half of the season, corn is the main export crop in Ukraine. However, 2020/21 MY began with a wave of defaults of forward contracts for supply of corn amid surged prices. Moreover, the mass exports from South America is coming. So, will Ukrainian corn be competitive and will the country have time to fulfil its export potential? At the moment, Ukraine has shipped a little more than half of its export potential, and the demand for Ukrainian corn leaves much to be desired in light of high prices in comparison with other origins...
Trader with Risoil Ukraine, Timur Schischlov told us about the consequences of defaults, what they were based on and who suffered the most, why the forwards for delivery of new-crop corn are signed so actively in Ukraine, the prospects for the second half of the season in Ukraine and the world and many other.
- Timur, share your opinion about the first part of 2020/21 MY. What key features would you highlight? How have they affected the Ukrainian agribusiness?
- One of the main features of this season was a drastic shift of development model of the corn market. In the spring of 2020, a wave of the coronavirus was actively developing in the USA, lockdowns were introduced, there was no demand for fuel and ethanol in the USA, and corn futures on the CBOT were falling down. In addition, most of the reputable analysts and traders predicted significant acreage under corn w
orldwide. This, combined with favorable weather (according to long-term weather forecasts), should have provided the record production and carry-over stocks in Ukraine, the USA and the world. In this regard, the price/stock to use ratio (stocks to consumption) predicted the price of Chicago futures below 3.00 USD and 130-140 USD/t CPT-port in Ukraine during the active phase of the harvesting campaign in the Northern Hemisphere (October-November).
Everyone knows what we have got. World production is down by 50 MMT, the price is almost 2 times higher than expected. The peak price of corn was 260 USD/t CPT-port and it reached 574.25 cents per bushel on CBOT. It is not only about corn. The prices of most of the agricultural products are more than 70% higher year-on-year. Inflation, anticipation of a crisis, reduced crop, mass imports of all crops by China, etc.
- We faced a price surge in Ukraine at the beginning of corn season resulted in a wave of defaults on forward contracts. Share your vision of the situation and its consequences. How has this affected the marginality of traders?
- Every business has its risks in a greater or lesser degree. The list of all possible risks of a trading company is long, but the main ones are:
1) market risk (price change);
2) product quality risks;
3) product safety risks (goods safety);
4) counterparty risk.
This season, the counterparty risk has hurt most of the large traders. Unfavorable weather is the main and non-influenceable risk for an agricultural producer. It may seem that the price is also the main and non-influenceable risk for the farmer, but this is not exactly. The graph shows by the example of the largest crop in terms of volume (corn) that since 2012 the selling price of corn is higher than its cost price. We use the average data for Ukraine and the average annual price, but they can show the general picture quite objectively.
In 2019/20 MY, some farmers faced the weather risk, and some of them decided not to take responsibility, but to shift their problems to trading companies. Thus, they decided not to supply the grain under a forward contract, because "we harvested less than we wanted". There will be only a few producers who will be into the red by the end of the year. Most of the “defaulters” are those who “have not earned enough”. This was the first significant weather problem in many years. The graph below shows the dynamics of corn yields.
I think it is important to explain in brief that any large trading company has its own risk management policy that regulates the volume of an open trading position. The details of this policy are different for each trader, but, in simple terms, the opposite action must be taken against each purchased contract: either the sale of a physical commodity, or the sale of a futures or other financial instrument.
According to the Swiss Trading & Shipping Association (STSA), the margin for commodity traders ranges from 0.5% to 3% (and this is under all risks listed above). The reason is the competition of so-called “big smart money”.
0.5-3% of the price at 152.5 USD/t (this is an indicative average price of a forward contract for corn) is equal to 0.75-4.5 USD/t. It should be noted that not all deals are profitable.
This season, the bulk of forward contracts was signed when prices were varying between 145 and 160 USD/t on CPT-port basis. Approximately 5-6 mln tonnes. At the time of contract execution, the price was 200-260 USD/t CPT-port depending on month.
Thus, a trader who wanted to earn 0.75-4.5 USD/t, in fact loses 55-100 USD/t on default of a supplier.
It is important to emphasize this, as communicating with manufacturers/small trading companies (intermediaries), we often see that people do not understand this. They believe that we earn this 100 USD/t and that we knew this would happen and bought from them in order to deceive them. Firstly, no one was forced to sell. Secondly, we have to buy up each not delivered tonne at the market price and load it according to our sales contracts.
- How has it affected your company’s business and general perception of Ukraine as a reliable exporter? For how long will we see the consequences of this situation? How will this affect the future of forward contracts?
- TOP-15 traders (including Risoil) provide/cover 94% of corn exports from Ukraine. These are large international and Ukrainian companies who cannot, due to their size, systematic approach and reputation, tell their buyers that they will not deliver a product because their Ukrainian supplier has not delivered this product.
How will this affect the activity of our company and the market as a whole? A number of companies with access to the forward market will be significantly reduced. I mean not only financing, but also the opportunity to sell. In general, the company that "defaults" receives a one-time benefit, but bears losses in long-term prospect. The example is simple: the fewer buyers a supplier has, the lower price he will get. Premium prices will be available only to reliable suppliers. Let us take as an example an enterprise that sells 500 thsd tonnes of corn per year. The lesser access to the market of buyers will result in short received 2 USD/t, meaning 1 mln USD per year.
We do not work with those with whom we had problems, and also with those with whom there were problems on the market according to confirmed information. This is the only way to protect yourself.
- According to Your observations, how active is forward contracting for delivery of 2021-crop now? Did the form of the contract agreement change at all, considering the risks of the current year?
- In fact, forward market is active for those, who despite everything fulfilled their obligations this year. From what we can see, the form of the contract did not change. Market has tightened «compliance» and reduced limits for each supplier. As of today, we estimate that nearly 2.5-3 mln tonnes of new crop corn has been forward contracted. It is even more than last year. Besides, the same volume of sales has been reached approximately in June last year. The producers like the price 200+ USD, but they don’t want to lose the moment of sale.
- This season has demonstrated the necessity to use instruments of risk hedging. How much has the interest to them from Ukrainian agribusiness increased, or market is still mainly skeptical about them? Have You used hedging tools? If You have, which one and how much are they effective in terms of high price volatility?
- In our trade we of course use various financial instruments for hedging. In terms of corn, they are mainly futures and options for Black Sea and US corn at CBOT, wheat - futures at MATIF for European wheat and futures at CBOT for Black Sea wheat. This is an integral part of a trade. For our suppliers we offer the contracts with options (or option strategies) and basis contacts for corn. But the demand for them remains rather low.
Unfortunately, the market education level in the use of financial instruments is quite low, but there is a positive tendency - every year there are more demand. The main problem is that a producer doesn’t understand the reason for these instruments, and even if the business is successful, why make everything difficult.
This is like a car insurance. Thank God every one of us doesn’t use it every year, and paying for it one thinks is it worth doing. But, for example, one big car crash, steal or price rally by up 100 USD/t, is able to recoup the cost of all previously paid insurance.
- Corn, being one of the most price stable crop became turbulent. How do You manage to work in such conditions?
- Volatility is good, if You can manage it. No one knows, what will happen tomorrow. What is the difference between the professional and layman - a professional knows what to do if the market develops differently from expectations. And if we take for example current year, last spring and summer no-one could not even imagine the prices for corn to be 200+ USD/t CPT-port. Everything looked as if in Ukraine and on the global market there will be so much corn that it would cost 130 USD/t CPT-port and we would not know what to do with it. That’s why, of course, when you bought all these forward contracts last summer, the market was hedging according to one or another company risk-management policy. This, again, is an issue of super-profit of traders
In general, I can say that despite significantly increased volatility, it is not difficult to trade on long upward price trend. Experienced American traders has a saying: «Don’t confuse bull trend with your own genius»
- 2020/21 MY will be remembered for its high prices, which is mainly caused by general upward price tendency on the global market, even if the balances in Ukraine, and in the world are difficult to call intense. What would you call the key factors of support on domestic and global markets?
- Among everything I would separate two main issues:
1) Inflation of USD and expectation of even higher inflation. Due to COVID-crisis the Federal Reserve of the USA keeps discount rate at 0.00-0.25% and prints dollars (Stimulus Package), which provokes inflation, commodities are considered the best anti-inflation hedge + expectation of financial crisis which will cause the necessity to look for «save heaven» for capital.
2) Demand from China and expectation of its rise.
These two factors apply not only to corn, but to almost all crops.
- Despite the new price maximums, the selling of agriproducts is not very active from the season beginning, and even during upcoming planting campaign there were limited offers. As a result, export of corn is much lower year-on-year. How would You characterize the current condition of Ukrainian corn market in terms of its competitiveness and demand on the global market?
- According to our estimates at the end of February there was a largest share of non-exported corn for the season since 2014 - 46% out of memorandum number of 24 mln tonnes. First of all, this is caused by constant price rise. Secondly, because nearly all grains and oilseeds are 70+% more expansive and in order to cover your financial needs for planting/harvesting campaign etc, farmers should sell less products and keep the rest, hoping for further price rise or just because at this stage there is nowhere to spend. Since the beginning of the season, this is a working strategy which bring the farmer extra money.
Current prices for Ukrainian corn compared to other origins (including the USA and Argentina) show that we would need to «buy the demand». At this stage (as of date of interview) Ukraine is competitive only for traditional buyer - the EU, whereas in other destinations we lose to the US and Argentina. Mysterious question is how large will China’s demand be (particularly the demand for non-GM Ukrainian corn, despite cheaper US GM corn).
- As of our estimates, by the end of February around 56% of export potential was realized (13.2 and 23.5 mln tonnes) and there is little time left before South America enters the market. In Your opinion, will Ukraine have time to sell in the SH of the season?
- It will. In April Argentina will be actively competing, but we intersect in fact only in Egypt, this happens every year and does not prevent us from exporting the already traditional 2.5-3 mln tonnes. In the current season in October-February Ukraine exported to Egypt 1.2 mln tonnes. Traditionally in most cases in October-February we ship nearly 50%, and the rest in March-June, so we are going according to plan. Brazil starts to export actively only in July.
- In Your opinion, how long will support of these factors last and when do we expect the slump?
- There are opinions on the market, that we can enter new cycle of high prices. Thus, if crisis really happens, inflation will continue and China will remain active importer of agricommodities, the current prices can become new reality for some period of time.
Current cycle of low prices lasted since 2014.
- In conclusion, I want to thank You for informative conversation and I’d like You to share Your expectations concerning the SH of 2020/21 MY. To what should market participants pay special attention?
- If shortly, in terms of corn, I would recommend to look at:
- Policy of the Federal Reserve of the USA.
- Inflation in the world.
- Weather in South America.
- Import of agriproducts by China.
- Import of corn by the EU.
- New crop planting in Northern hemisphere.
Interviewed by Anna Tanskaya