Speculation about the impending death of Winnipeg canola futures misses the mark, industry watchers say
Winnipeg’s canola futures have plenty of life left, say experts who refute any predictions about the inevitability of a death watch for the market.
A year ago, record open interest was being set in the canola market, but when June 2013 open interest hit three-year lows and July fell even further, it sparked talk it was just a matter of time before canola disappeared like other Winnipeg agricultural futures before it.
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Not so, say those who see a vibrant market that not only remains relevant to farmers, grain companies, crushers and end-users, but will in fact continue to grow as a result of anticipated record Prairie canola production this year.
“As for the comments that the canola contract is in trouble, I think that’s bunk,” says a longtime market participant. “The contract has volume and open interest that we could only dream about a few years ago. And a big crop will mean good volumes for the coming year too.”
Open interest last year exploded as farmers forward priced to lock in good prices in anticipation the market would eventually go down. But when that strategy ultimately failed, they avoided repeating the mistake this year, causing the wide year-on-year open interest disparity.
“There was a lot of forward pricing and it proved to be the wrong thing to do, as it usually is,” says John De Pape, president of Farmers Advanced Risk Management Co. “And so in the following year, it looked like guys weren’t doing it, thinking, ‘That hurt, I’m not going to do that again.’ And that’s why I think there was less open interest.”
Brad Vannan, president and chief operating officer of ICE Futures Canada, the exchange where canola contracts are traded, explains farmers anticipated a record-size canola crop in 2012 and were concerned about maintaining canola values.
“Not only were farmers marketing their current year crop, they were also marketing their next year’s crop, and that resulted in some very high open interest, unprecedented open interest for us,” Vannan says. “We had large open interest in the May, July and November contracts. Our trading levels were very high too.”
But drought conditions in the U.S. caused prices to remain high, and lower-than-expected canola yields in the Prairies also supported values. With those low yields, farmers ended up pre-selling a higher percentage of their production than they had intended, Vannan points out. This year, farmers were reluctant to significantly forward price again.
Seeing that as the reason for the decline in open interest rather than the beginning of the end, Vannan argues against making broad conclusions based on a couple snapshots of data: “It’s like saying it’s cold out so we’re going to have another ice age.”
Open interest has since climbed from those July lows of over 109,000 contracts to 178,741 at the end of October, which was actually off that month’s highs. And while open interest continues to grow again, many say volume is actually a better indicator of market liquidity.
“You can have huge open interest, but if everybody’s sitting on their hands waiting for the market to move, you have no liquidity,” says De Pape. “You can have huge volume, people trading in and out, and at the end of the day, very low open interest. But have great liquidity because there’s so much trade.”
And that volume has risen greatly over the years. One longtime trader noted that in the open outcry days, daily canola volume could be as low as 1,000 contracts and rarely above 5,000.
“I don’t think we ever have days now with electronic trading where the trade is under 5,000, with the more typical days around 15,000 to 25,000,” says the trader.
Vannan adds preliminary estimates suggest October was a banner volume month for the exchange.
“We’ve had the highest average daily volume that we’ve ever experienced and we’re on track to have the highest volume in any single month that we’ve ever experienced. And our volume year to date is about two per cent higher than it was last year, and last year was a record over the previous year.”
There’s also strong convergence between canola futures and the physical market, which is one of the most important facets to consider when judging the health of a futures market, Vannan stresses.
“I think it’s a very healthy contract, it continues to be the focal point in terms of international price recognition, and it’s the flagship contract that anybody that’s pricing canola certainly focuses on and prices off of,” says Tony Tryhuk, manager of commodity trading for RBC Dominion Securities. “We continue to see good participation, not only just the futures but the options as well. Option open interest is fantastic as a result of people looking at alternative risk management techniques and an increase in even speculative trade in the options markets.”
Cereals look for life
While canola futures in Winnipeg remain healthy, the same cannot be said of ICE’s post-single-desk markets of milling wheat, durum and barley.
The exchange introduced those futures contracts in January 2012 and they’ve struggled to generate interest. Barley only had its first actual trades in October of this year.
“You’ve got to have a degree of patience in the marketplace,” says Vannan. “I think you need to experience a variety of market conditions to fully appreciate the value of having a futures contract that is dedicated to representing the market value of the crops grown in Western Canada.”
He points out the separation in North American wheat market conditions. The Canadian Prairies produced a huge wheat crop this year while the U.S. winter wheat crop supply is tight, and its spring wheat is subject to different logistics than wheat in Canada.
“I think some participants are recognizing we don’t have the level of transparency in wheat pricing that would be optimal,” says Vannan. “So people who had previously been reluctant to even consider using another wheat contract, because they’re afraid it wouldn’t have the liquidity they desired and would therefore be a riskier hedge, are now looking at the contract and are saying it might not have the liquidity, but it might be a higher-quality hedge.”
What may convince people to use domestic wheat futures is dysfunction in U.S. wheat markets. As long as the Minneapolis market is functioning, that’s where trade will be focused, but a sudden surge, like the one experienced in 2008 when Minneapolis wheat rocketed to $20 a bushel, would change all that.
“If that were to happen again, I could see Canadian participants who are using that U.S. market today re-evaluating their decision to use Minneapolis, and then start to look at putting their hedges in the Winnipeg market, because it may represent a little less volatility and be more reflective of the supply/demand fundamentals in Canada,” says RBC’s Tryhuk.
Unlike wheat, which has to compete with several contracts with excellent liquidity around the world, barley is unique. And yet, it’s only just recently experienced just the lightest amount of trade.
“Futures work as much as the cash trade needs it. So if the cash trade is more flat price based and there isn’t a functional need for futures risk management because of the way the cash market trades, then barley cannot be successful,” says a market participant. Hedges have simply continued using corn.
One independent trader feels it’s just a matter of time before the grain contracts will be delisted, and adds they were doomed to failure before they were introduced.
“For many years, the exchange has been focused on making the perfect contract for the commercials. They have given no consideration to the needs of speculators,” he says. “Every modification or new contract that the exchange has introduced has met with failure. There is no commercial need for these contracts.”
De Pape argues futures contracts are hard to start, but once they get going, they’re almost impossible to stop.
“Trying to get that volume to begin with is very difficult. I think that you basically have to leave them up there and available for quite a while and get out there and promote it, and get people bidding on the basis of it.”
Vannan says there is a limit on the exchange’s patience and that it can’t indefinitely support unused or little used contracts because it does cost money to maintain them. If there’s no hope, ICE will have to look at removing its support. “But we’re not at that stage yet. It’s still early.”
— Richard Kamchen writes on grain markets from Winnipeg. This article appears in the December 2013 issue of Crops Guide (pages 12-15).
