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Aug 05
2010

Rising wheat prices could affect hedging

Posted by dbedell in wheatRussiaRiskhedginggrainDodd-Frank billCommodity Futures Trading CommissioncommoditiesCME

dbedell

Russian president Vladimir Putin’s announcement on Thursday of a temporary ban on grain exports led to the latest in a series of runs on grain prices on global commodities exchanges over the past few weeks.

Wheat prices on the CME in Chicago have risen almost 80 percent over the past month. For companies in the food production industry, the question is what impact it will have on hedging programs.

After the Russian announcement on Thursday, prices jumped by their daily limit in Chicago and rose in Paris by 6.6 percent.  The run on wheat has been building as Russia—which produces 25 percent of the world’s wheat supply—continues to deal with its worst drought in the last 100 years, according to a report by Reuters.

The UN's Food and Agriculture Organization cut its 2010 global wheat estimate by 25 million tonnes on Wednesday, citing the effect of the drought on grain production in Russia, the Ukraine and Kazakhstan, and planting difficulties earlier in the year in Canada.

If the rally continues and the wheat shortage begins to affect other commodities, such as livestock—as feed prices increase--it could have a big impact on food production companies. Not all hedging programs are able to effectively deal with short term gains or losses in commodity prices.

Any sudden change in prices can often have a big impact on hedging. Last year, a sudden decline in commodity prices led to big losses for food products companies, such as General Mills and Tyson Foods—which took multi-million-dollar write-downs on hedging programs.

In addition, poultry company Pilgrim's Pride entered Chapter 11 last year partially as a result of heavy losses on corn hedges. And Smithfield Foods cited long grain positions as the reason for its unprofitable hog production unit last year.

For those companies that do fully hedge against rising commodity prices, the effect will be felt in the longer-term impact on commodity prices and the increasing cost of new hedge contracts. 

This issue arises just as the Commodity Futures Trading Commission (CFTC) is dealing with the impact of the Dodd-Frank bill on agricultural commodity futures. The bill implies that farmers that trade OTC agricultural swaps should get extra protections beyond what is offered to other commodities traders, according to a report from Reuters.

With its increased powers over the OTC derivatives market, the CFTC must design and implement its policy on agricultural swaps—including who can buy or sell swaps, position limits, defining what constitutes an agricultural swap, and other trade conditions. 

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