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“Futures markets are not pretending to replace European Union subsidies”
Interview with Jean-Loïc Bégué Turon,
Head of Derivatives Markets, InVivo Group
With 283 member cooperatives, InVivo Group is the number-one French cooperative group for agricultural trade and services. The Group operates in four main strategic businesses: plant seeds and supplies, grain trading and storage, animal nutrition and health as well as distribution and services. InVivo is one of the charter members of momagri.
Jean-Loïc Bégué-Turon is head of derivatives markets at InVivo. His division provides comprehensive services to cooperatives wanting to use of futures markets to cover their physical operations, and supplies consultancy and training support to assist them in managing price risks and market launch.
In the interview he granted us, the executive summarizes the pros and cons of futures markets, while insisting on the fact that they do not enable to stabilize agricultural commodity prices on international exchanges, nor do they fight low prices over the long term. So contrary to some opinions, futures markets cannot replace compensatory public policies.
by Paul Montfort, Analyst, momagri
1/ What do futures markets contribute to French farming operations?
Agricultural large-scale crops have been experiencing a true Copernican revolution for the past three years. For years, prices paid to producers showed relative stability thanks to the CAP; they rarely fluctuated by more than €20/ton for a single crop (with the exception of the 2003 harvest that was noted by a severe drought and a €60/ton variation) and generally went between €100 and €140/ton. The 2007 crop was a turning point in the evolution of agricultural commodity prices, which were subjected to a significant volatility surge and an extensive scope of fluctuations. As of now, prices can swing by more than €150/ton during a single crop and it is not unusual to observe variations of €10/ton in a single trading day, an occurrence that was unthinkable only three years ago! This new trading environment caught the whole agricultural sector unprepared.
The recent transformation of market environment is disrupting the agricultural world. In addition to their countless concerns (such as production, search for new markets, environmental preservation…), farmers must now include price risk management and price volatility. Indeed, price volatility turns out to be crucial considering the price variations that can occur during a crop year and thus alter profit margins. In addition, the variations observed during the past three years in the European wheat market have not been unusual, compared to what has been happening on American markets during the past 50 years.
Theoretically, futures markets are enabling the whole agricultural community to rise to the challenge of mastering volatility by independently managing the flow of goods and price fixing. As a result, the agricultural sector became “financialized” in the sense that price fixing is not longer concomitant to preparing physical contracts. The commitment to trade goods is made far in advance, and each party retains the possibility to handle price fixing independently of the other by trading on futures markets.
Reforms generated by the CAP health check will increase the need to resort to the tools provided by futures markets. Along with the progressive suppression of intervention prices, farmers will face markets without the security of a guaranteed minimum price. Futures markets can let them reconcile their crop rotation before seedtime, and cover their cost price as it gradually takes shape along with farmers’ investment (production inputs, etc…) during the crop year. Tools such as futures and options contracts can be taken out directly by farmers, but they require an investment in training, data research and market analysis time.
Thus, futures market development goes hand in hand with greater price openness since we all know the value of the base index, and with making market launches more complex in a soaring volatility environment. If all tomorrow’s farmers are not “agri- managers” with futures market expertise, they will nevertheless be better informed and better trained. Their proficiency and standards levels represent a true challenge, and thus opportunities for cooperative groups knowledgeable in professionalizing their price risk management services. Cooperative groups will also need to improve their representation management services––such as crop prices––and their support to members favoring self-management and of futures markets.
2/ Is it a good idea to set up futures contracts for dairy products, as proposed by French Agriculture Minister Bruno Le Maire?
The creation of futures contracts for milk (three new contracts: dry milk, industrial butter and lactoserum planned for mid-2010) can be beneficial to the industry but their success is far from being guaranteed. Instances of failed contracts are not rare: the first Euronext wheat contract, the Winefex Bordeaux wine contract, and the sunflower seed contract… To achieve success in agricultural futures markets, all players––especially key players––must agree to the project. These are often agribusiness executives or transformers, who consent to independent price fixing by each party on futures markets in order to secure supply flows months in advance.
Such commitment requirement is necessary so that financial managers take an interest in the market and provide the required liquidity to activate any futures market.
If in the United States, which has a long tradition of futures markets, milk contracts are flourishing, but butter contracts are lagging and meeting with difficulties in attracting investors.
In France, in spite of the Government’s political will to encourage price openness and instigate all means to break the deadlock, there is no guarantee of success as the dairy industry seems to be dominated by a small number of players.
Let’s not forget that futures markets cannot fight low prices over the long term. Contrary to neophytes’ expectations, they cannot automatically raise prices. They provide risk management tools, but are not pretending to replace all European Union subsidies.
3/ In an environment marked by high price volatility, do futures markets represent the means to stabilize prices at the international level?
The debate keeps opposing the proponents of the “almighty market” against those of the “almighty government”, the former advocating that futures markets can stabilize prices, while the latter arguing that they are responsible for price volatility. Agricultural markets are unstable by nature. The stability recorded between the mid-1980s and 2007 in Europe and in the United States was totally man-made, as it resulted from chronic overproduction, and prices were supported by subsidies, but at what price….
Futures markets will not lower such instability, but the data they provide can lead farmers to change their crop rotation contingent upon price levels.
Futures markets contribute to better trade openness, which will be beneficial over the long term. However, the development of futures markets also occurs with an influx of various financial managers. Their arrival brings about consequences that are threefold. Index managers invest in futures markets for the long term and thus create a bullish bias on prices subject to their available funds. Speculators, who only examine “yield/risk” ratios, follow an opportunistic rationale. By trading short according to trends, they enter and exit the markets by providing liquidity, but also contribute to increased price volatility. Thirdly, the trend of financialization of agricultural markets––including carrying out a disjunction between goods delivery commitments and price fixing––also contributes to the unsettling occurrence of a disjunction between physical markets and futures markets. It therefore seems inaccurate to assume that the development of futures markets will enable stabilizing prices at the international level.
4/ What is the role of options contracts? Did their volume increase or not in the past few years? Why?
On the MATIF (the International French Futures and Options Exchange), the volume of options contracts is skyrocketing: the daily volume of wheat contracts soared by more than 180 percent in a single year! Open positions in options are now more important than open positions in futures. Conversely, the ratio between open positions in options and open positions in futures is slightly lower than one on the Chicago Board of Trade (CBOT).
Considering their expansion, options markets therefore play a significant role on short-term price fluctuations. Financial managers used options markets to enter the European market and now operate as counterparts to agricultural players in almost all transactions. By managing their portfolios, they often lead to significantly boosting volatility during a trading session. Options traders obviously belong to the family of speculators. But more than clear-cut upward or downward trends, they in fact take options on volatility. Consequently, if they purchase options, they are betting on a market configuration with “highs followed by lows or lows followed by highs” that are both meaningful and manifold.
5/ Several reports, such as the one issued by the US Senate, have emphasized the need to supervise futures markets. Can you comment on such viewpoint? Among the recommendations put forward, which ones are the most pertinent?
Indeed, in the United States just as in Europe, the temptation to “moralize” runs high. On the American side, the key measure currently considered is that to lower hold limitations for financial managers, who are not investing for coverage purposes but for speculation or indexes management. On the other side of the Atlantic, the European Commission and the European Central Bank (ECB) are considering similar measures. But we must be careful not to scare off financial investors, since we need them to maintain market liquidity. The remedy could turn out more harmful than the ill itself. The European Commission also wants to implement a reporting system on positions taken in futures exchanges, according to the type of players (index investors, speculators, brokers, hedgers…) and modeled after that offered by the Commodity Futures Trading Commission (CFTC), the American regulatory body.
Such proposal is an interesting one to improve market openness. If adopted, it will permit to better anticipate market fluctuations by knowing the positions of each group of investors. Because depending on whether one or another type of investor takes a position, his managerial skills and aversion to risk will vary. For instance, speculators will watch short-term trends and quickly sell their position in case of loss, while options traders will take advantage of market volatility. Conversely, index investors diversify their allocations over the long term and will not react to price trend fluctuations in agricultural commodities but more to disturbances on connected markets, such as oil or financial indexes. Today, it is noteworthy to observe the CBOT’s impressive long-term position of index investors. They compensate for inflation threats in the upcoming months following the economic recovery, and thus clearly support prices.