Neil Blue takes a look at the canola futures market in a strong carrying charge situation.
Canadian canola stocks at the 2018-19 crop year-end are estimated near four million tonnes, a new record, according to Statistics Canada. The carryover at the end of this crop year is yet to be determined, but it may not increase as much as some have suggested, says Neil Blue, provincial crop market analyst with Alberta Agriculture and Forestry. He says the unfinished canola harvest and unknown timing of a potential resolution of the canola trade restrictions imposed by China leaves the 2019-20 canola carryover uncertain. Alberta Seed Guide discusses the canola market with the crop market analyst.
ASG: What is the current canola market situation?
NB: Cash canola prices are about five per cent lower than a year ago. The basis levels, or difference between the cash and futures price, is mediocre, which implies plenty of supply relative to demand. That is not an unusual situation for the harvest period. Because of a rise in world vegetable oil prices relative to canola prices, crush margins have strengthened, and that is supporting crusher demand.
ASG: What is the canola futures market looking like?
NB: The canola futures market is in a strong carrying charge situation, which is a reflection of the large canola inventory and currently restricted demand. That is, the futures market is significantly higher in successive futures months within this crop year.
ASG: Can you explain a carrying charge market?
NB: Carrying charges include:
- commercial storage rates — as in a commercial buyer’s facility
- interest — typically bank prime interest rate
- insurance costs for that crop — a minor cost
A carrying charge market is one where the higher prices into the future pays all or a large portion of the costs of storing a crop from one period to the next.
ASG: What are the current carrying charges in the canola futures market?
NB: Here are the closing canola futures prices and spreads for November 12, 2019, in dollars per tonne.
|March||471.60||$9.50 above January|
|May||480.40||$8.80 above March|
|July||487.90||$7.50 above May|
The higher successive canola futures prices are not a forecast for higher prices in the future. They reflect the current carrying charge the market builds in for storage, interest and insurance.
ASG: Can those futures market spreads be compared to a calculated carrying charge?
NB: Yes, one can estimate the commercial cost of carrying canola. Using the 60-day period of January to March and applying a commercial storage rate of $0.12 per tonne per day, 60 days storage totals $7.20 per tonne. At $462.10 per tonne for January futures and using a four per cent annual interest rate, the interest cost of carrying that canola would be $462.10 per tonne x 4% ÷ 12 months x 2 months = $3.08 per tonne. The sum of calculated storage and interest costs is $10.28 per tonne. The insurance cost is relatively minor.
So, if the canola market was trading at “full carry” with January canola futures trading at $462.10 per tonne, March futures would be trading at $472.38 per tonne. In this example, with the actual March futures at a $9.50 per tonne premium to January futures, the March futures is considered to be trading at 92 per cent of full carry (9.50/10.28 x 100). A futures market for a storable commodity that is trading near full carry is implied to be well supplied relative to demand.
ASG: What does that carrying charge mean to a canola producer holding unpriced canola in storage?
NB: It means the futures market is offering the producer a fee to store canola, but that storage payment is only collectable if the producer takes some form of forward pricing action. As time passes, that carrying charge erodes out of the market.
ASG: What contracting alternative is there to capture the carrying charge?
NB: Crop buyers may have several contract types. A deferred delivery contract is the most common one to consider in capturing the carrying charge by forward pricing with a buyer of physical canola. Those forward prices, the result of futures price minus basis levels, vary among canola buyers. To judge the best price, producers should shop among the various buyers for the best farm-gate equivalent prices for those forward delivery months. One can then determine how much of the carrying charge within the futures market is being passed along in those forward cash market bids.
ASG: Are there some other pricing alternatives that a producer can use?
NB: A producer with a futures account could sell futures in a forward delivery month to capture carrying charge. This strategy would retain the ability to shop among the various canola buyers for the strongest basis level. Also, it would avoid the physical buyer commitment of delivering No. 1 canola when quality may be uncertain. With this futures strategy, usually the futures hedge is removed when the canola pricing is completed with a physical buyer. Meanwhile, while that futures position is held, the carrying charge will erode out of the market, adding potential profit to the futures trade.
ASG: What about using the options market?
NB: That is another alternative. One could buy a PUT option for a forward delivery period. If the futures market falls during the period that the option is owned, then the option will likely gain value, capturing some of that carrying charge in the futures market. Buying an option has the trade-off of having to pay a premium for the price insurance, but will not require margin or incur any margin calls.
ASG: In summary, then, a carrying charge for a storable commodity reflects the amount of storage and interest that the market is willing to pay.
NB: Yes, and although a carrying charge market is a sign the market is well supplied with product relative to demand, some of that carrying charge can be captured through proactive marketing.
For more information on these strategies:
Neil Blue, Provincial Crop Market Analyst with Alberta Agriculture and Forestry.