Canola pricing strategy

Canola pricing strategy

A look at the canola futures market in a strong carrying charge situation

“Canola stocks at the 2018-19 crop year just ended are estimated near 4 million tonnes, a new record,” says Neil Blue, provincial crop market analyst with Alberta Agriculture and Forestry.

“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. The unfinished canola harvest and unknown timing of potential resolution of the canola trade restrictions imposed by China leaves the 2019-20 canola carryover uncertain.”

He says that in a reflection of the large canola inventory and currently restricted demand, the canola futures market is in a strong carrying charge situation. The futures market is priced significantly higher in successive futures months within this crop year.

A carrying charge market is a typical market where the higher prices into the future pays all or a large portion of the costs of storing crop from one period to the next. Carrying costs 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

Full carry is the total cost of storage, interest and insurance on a commodity.

“The higher successive canola futures prices are not a forecast for higher prices into the future,” he adds. ”They reflect the current carrying charge that the market builds in for storage, interest and insurance.”

He explains how to calculate the full commercial cost of carrying crop using the 60 day period of January to March.

“Calculate storage and interest for that period. Using a commercial storage rate of $0.12 per tonne per day (actual rates vary) 60 days storage totals $7.20 per tonne. At $462.10 per tonne for January futures and using a 4% annual interest rate, 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. Insurance cost is relatively minor. 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% of full carry (9.50/10.28 x 100). A futures market for a storable commodity that is trading near full carry is generally well supplied relative to demand.”

What does that carrying charge mean to a canola producer holding unpriced canola in storage?

Blue says that 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.

“Using current futures prices, if the canola market traded sideways for the 2 months from January to March, by the time March arrives, the March canola futures would have fallen by the $9.50 per tonne carrying charge to about $462.10 per tonne. As time passes, the carrying charge erodes out of the market.”

One action to capture the carrying charge in the market is to forward price using a deferred delivery contract with a canola buyer. Forward prices, the result of futures prices minus basis levels, vary among canola buyers.

“To judge a best price for your canola, you would shop among the various buyers for the best farm-gate equivalent prices for those forward delivery months,” he says. “You can then determine how much of the carrying charge within the futures market is being passed along in those forward cash market bids.”

He adds that another alternative for a producer with a futures account is to sell futures for a forward delivery month to capture carrying charge.

“First off, this strategy would retain the ability to shop among the various canola buyers for the strongest basis level to contract at. Secondly, it would avoid the physical buyer commitment of delivering #1 canola when quality may still 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.”

The use of the options market to capture carrying charge is another alternative.

Blue summarizes that a carrying charge for a storable commodity reflects the amount of storage and interest that the market is willing to pay.

“Although a carrying charge market is a sign that the market is well supplied with product relative to demand, some of that carrying charge can be captured through proactive marketing.”

-Alberta Agri-news