Financial product development company Riemann Agriculture has this week launched a forward contract hedging mechanism for cattle, based on the Eastern Young Cattle Indicator.
The new Riemann Ag product is not a futures product, but an over-the-counter forward contract, operating via the Mercari licenced swap execution facility. The contract is cash-settled against the EYCI index (meaning there no physical delivery), as a bi-lateral contract directly between two counter-parties, with no exchange involved.
When the deal settles at the end, one has to pay the other – effectively taking the counter-party risk of dealing with the other side, but also providing the chance to hedge.
Importantly, it is a financial product, meaning it is regulated and approved by ASIC, which means hedge funds and other speculators can get involved.
In a statement, Riemann said multiple trades had occurred on the first couple of days of trading this week, involving producers, feedlots, stock agents, hedge funds and live exporters.
Volume traded over the first two days since launch totalled 120,000kg, or the equivalent of 800 head of cattle. Prices traded across forward months more or less reflected broader industry expectations over future cattle pricing trends. Trades included November at 665c/kg, December 650c/kg and January/February next year at 630c/kg, reflecting a softer market going forward with the expectation of increased supply.
As an example of how a typical trade might work, if the EYCI today is 688c, a beef producer might elect to lock in for February next year, at 630c/kg as a hedge. The market is already saying there is going to be more supply next year than demand, and international prices are likely to be lower.
If the EYCI next February is instead at 660c at settlement date, whoever sold the contract is going to have to pay 30c/kg to the buyer, and the buyer is going to receive 30c/kg from the seller. Alternatively if the February settlement date is reached and it sits at 620c, a 10c/kg payment goes the other way.
The livestock producer can still deliver the cattle to whoever he want to – saleyards or on grid direct to processor, for example. If he carries the contract all the way to settlement, if the EYCI at that time is 620c, he will receive 10c/kg multiplied by the volume of kilograms that he contracted.
Riemann’s head of product development Scott Still said the company’s new Cattle Forwards and Cattle Options were broad-based risk management products that could be used for hedging and trading Australian cattle, including option contracts designed to provide efficient hedging strategies.
“It allows a centralised marketplace for all the buyers and sellers,” he said.
Mr Still said the cattle contact followed on from the company’s already-established cash-settled wool contract.
“It is encouraging to see early industry support for these new financial risk management products,” he said. “Having robust financial market infrastructure, including regulatory oversight, gives market participants the confidence of dealing in a fair, orderly and transparent market place.”
Access to the Riemann market is via authorised brokers.
Financial hedging tools have not had a happy history in the Australian beef industry, however.
Twice before the industry has tried, and failed, to establish a cattle futures contract. Lack of liquidity due to thin support from processors and supermarket groups was the root cause of earlier failures. Meat & Livestock Australia sunk millions into two earlier attempts to launch cattle futures, but ultimately a lack of a futures ‘culture’ in Australia was the undoing of the ventures, stakeholders said at the time.
Queensland lotfeeder Charlie Mort, whose Mort & Co lotfeeders business was a sponsor of the MLA cattle futures back in the 1990s, said supply chain stakeholders were always looking to cover-off on risk.
“Markets are going to develop over time, but people are looking for options,” he said.
“From our viewpoint, this new product could be something we might consider using at times, but for our specific purposes, the EYCI is not reflective enough of either the feeder cattle we are buying, or the grainfed cattle we are selling,” he said.
“Some might argue that it is the best indicator out there, but it is not very reflective of our business. As a northern lotfeeder, the EYCI does not always relate well to our circumstances or specs on feeder cattle. And certainly on a marketing side, there is often a distinct lack of correlation.”
“I could probably live with the EYCI indicator when buying feeder cattle, but not on the sell side,” Mr Mort said.
“There may be merit in it for some, but like a lot of these contracts, it will have to be further developed, and will need liquidity, on a volume per day basis, to be of any value. But we’ll look at using it, for sure.”
Mr Mort said lotfeeders were the ones most likely to use it, but he said it needed to be tied in more with grainfeeding circumstances.
“If we could ever get a contract that was tied in more closely with the grainfed market, it would get a lot more use.”
A large national meat and livestock supply chain coordinator said the cattle industry had changed a lot since the last cattle futures project had fallen over a decade ago, and there was a lot more forward buying and forward contract options now available – both for feeders and finished cattle.
“TFI, JBS southern, Woolworths, Coles and others already offer forward supply agreements,” he said.
“Because there has not been a futures or a forward contract hedging tool in place for quite some time, the industry has probably evolved, doing it in other ways, at a company level.”
“To be successful, these type of products need to bear relevance to the market players’ requirements.”
“There was a proposal floating around a couple of years ago for a 100-day grainfed futures contract, based on a complex formula including the EYCI, a percentage of offshore market variables and other things. By the time they could offer me a price, I could actually lock 100-day cattle into a forward delivery contract with a processor, at an agreed sell price.”
What is the benefit to either party? Today I can make a booking at tha Meatworks for April next year and get paid at the going rate anyway the same as you are offering, no point going your way! Still only going to receive that day market value.