They used to call Winnipeg the “Chicago of the North.” In fact, in 1943, wheat contracts traded on Winnipeg’s Grain Exchange Building surpassed the wheat volume in Chicago.
But that lead was short lived. The Second World War effectively killed wheat futures in Winnipeg, ushering in the era of the Canadian Wheat Board’s (CWB) single desk.
Just because you can grow a crop, it turns out, doesn’t mean that a fast, fair and open way to sell it will evolve too, even if you can grow a lot of it.
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It’s a lesson the West is learning again.
Until a few years ago, futures for feed wheat and barley, oats, peas and rye were all available through Winnipeg. But these days, canola is the only active commodity futures contract north of the 49th.
Today the Winnipeg exchange is known as ICE Futures Canada, a subsidiary of the Intercontinental Exchange (ICE). The western Canadian grain industry is in the midst of tumultuous change once again.
Yes, the exchange has a chance to grab hold of those lost futures markets.
But whether the Winnipeg Exchange rises again is no simple story.
Futures markets to manage risk
An irony of the story is that it is occurring at the very time that farmers are getting more expert at marketing. Futures trading used to get scoffed at as mere gambling, but more sophisticated marketing strategies mean they can reduce risks, not increase them.
“They’re not that complicated,” says Neil Blue.
Blue was farming in the early ’80s when he noticed strange things happening in the grain markets. Specifically, the same grain, coming from the same bin, was graded differently from spring to fall.
That phenomenon spurred Blue to learn the ins and outs of the markets. Paying attention to marketing in the ’80s, “which was a really tough period in farming, meant the difference in some years between losing money and breaking even,” says Blue.
Blue still farms in the Vermilion area of north-eastern Alberta, though he’s quick to point out his operation isn’t as large as neighbouring farms. He’s also worked as a market specialist with Alberta Agriculture and Rural Development since 1994, teaching courses to help farmers get the most bang for their buck out of the big commercial markets such as hogs, cattle and major grains.
Blue says a futures market provides farmers with flexibility and a way to diversify pricing.
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“You can sign up and lock in a price in advance of delivery without having a delivery commitment and therefore still not have the fears… of having a production shortfall and therefore having to buy out of a contract, which a lot of farmers really, really dislike,” says Blue. If production is wiped out unexpectedly by hail, for example, “you could go back to your futures position and easily remove the portion you’re now overpriced with.”
But helping western Canadian farmers hedge risk isn’t an easy task. Blue is disappointed in the lack of functioning futures markets for crops north of the 49th parallel. A few years ago the Winnipeg Exchange had future contracts for canola, feed barley, feed wheat, flax, oats, peas, and rye. Today canola is the only crop that trades with any volume in Winnipeg.
“It’s quite frustrating now when we do these courses and all we have to talk about are U.S. markets,” says Blue. “It doesn’t encourage farmers to sign up for accounts, either.”
Farmers can, and some do, use futures contracts from U.S. exchanges. But the exchange rates complicate those transactions, says Blue.
Blue isn’t the only one who sees problems with a dearth of western Canadian futures markets.
“The constituents that suffer the most in this type of environment are the producers because before, they used to have two sources available in terms of price discovery,” says Hugh Benham, trader and owner of Market Mentor.
Trading is in Benham’s blood. His great-grandfather, E.L. Drewry, was one of the first members of the Winnipeg Exchange. Benham started with the exchange in 1989, handling commercial accounts.
“It was with a little bit of sadness that the open outcry came to an end,” says Benham, but he adds electronic trading allows him to work from anywhere. Benham left the exchange in 2006, and these days he works from Canmore, Alta.
Benham has worked for several cattle feeders in Alberta. He also wrote a discussion paper for the Alberta Cattle Feeders looking at the possibility of revitalizing Western Barley Futures.
Although five ICE barley contracts traded in early June, Benham says five contracts of open interest don’t add up to price discovery. These days feeders’ and producers’ only option for price discovery is to look at the cash barley market, he says.
Rough transition
As the CWB’s single desk came to an end, ICE introduced a suite of wheat products, including a milling and durum wheat contract, plus a barley futures contract. But the new futures contracts are not trading.
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The last two years have been difficult ones to launch a new futures contract, says Brad Vannan, president and chief operation officer of ICE Futures Canada. Vannan is a 30-year veteran of the grain business. Before joining ICE in 2008, he worked as the vice-president of merchandising and transportation at Agricore United.
Low risk, a stable price, fluid transportation, and little difference between different classes of wheat didn’t add up to success for the new ICE contracts in the first year, Vannan says. The Winnipeg contracts were designed to differentiate the Canadian market from other North American markets, he explains.
And grain industry players were busy adapting to the new marketplace following the single desk’s demise, Vannan adds. Participating in the new market was more work than participating in one of the existing markets, Vannan says, giving commercials and other players little incentive to pick up the new contracts.
This last year of bin busters and transportation bottlenecks was no kinder to the Winnipeg futures contracts. By the time market participants realized the extent of the logistics pileup, it didn’t matter where they hedged their grain, says Vannan.
“I could hedge in Kansas City. I could hedge in Chicago. I could try Winnipeg. But none of them are really going to work because the transportation system is not functioning correctly,” says Vannan.
The ICE wheat contracts do have supply on their side, Vannan says. Wheat production is similar to canola production in Western Canada. “So we felt that there’s enough depth there to facilitate a contract.”
But a contract also needs a breadth of companies willing to use it, says Vannan. “And that usually comes over time. Everybody’s not going to jump in at the exact same time. You’ll have early adapters and then if it proves to be successful, it’ll evolve and more people will join in.”
Drawing people away from incumbent markets is difficult, Vannan says. Within North America, there are three wheat contracts, each over 100 years old, each catering to a specific wheat variety, Vannan points out.
Benham says he thinks there’s interest among some players in reviving barley futures, “but is there an incentive for the commercials? Probably not.” Commercial grain companies can lay off that risk in Chicago, he says.
But Benham is cautious about laying blame at the commercials’ feet. They would likely use the contracts if there was more open interest, he says. Open interest measures the number of outstanding contracts at the trading day’s close, and is a sign of a healthy contract.
Commercials and farmers aren’t the only players needed to make a market successful, says Blue. These contracts need market makers, or firms that buy, then immediately sell from their own inventory or find an offsetting order.
Lots of trading activity also adds up to liquidity, which marks how easily an asset can be bought or sold in the market, says Blue. Liquidity makes for a robust market.
Contract design plays into it, too.
ICE Winnipeg has industry committees to help review contract rules, Vannan says. And, he adds, the exchange aims to create relevant, useful contracts. Contracts that favour one side or the other won’t trade.
Although a small percentage of the contracts are delivered on, “the process behind the delivery goes to the very core of what makes that futures contract functional,” says Vannan.
It’s essential to maintain a strong connection between the futures price and the cash price for grain, says Vannan, “so that the hedge remains relevant.”
Blue had a few calls from farmers this past winter wanting to open a sell futures position and deliver canola against it. A weak basis level makes that option more attractive, he explains.
But Blue says it’s not economically feasible to deliver canola on a sell futures position because delivery locations can levy an administration fee at their discretion. He’d like to see a way to have economically feasible delivery against the canola contracts, or have it cash settled against a three-day rolling average or some other cash index.
Both Blue and Benham are critical of the barley contract ICE created when the single desk ended. Rather than setting the delivery point in Lethbridge, near Alberta’s feedlots, ICE put them in Saskatchewan.
The problem with a Saskatchewan delivery point, says Benham is “it doesn’t give you a realistic price discovery mechanism because of freight back-offs and the way freight works in Western Canada.”
Part of the challenge in creating a futures contract is drawing a broad audience, Vannan says. Narrow contracts don’t help with price discovery because there’s not enough competition between traders, he explains. “It’s like going to an auction and only having two people show up.”
And Vannan says the Lethbridge pricing point is only important in Western Canada. Consolidation in the grain industry has cut the number of commercials, which were important middlemen, Vannan says. Feedlot numbers have also dropped drastically in the last 13 years, and barley acres are about half of what they were.
“If it’s going to work, Canadian barley has to represent a global price,” says Vannan. “But it doesn’t in the same way that canola does, unfortunately, because there are lower-cost suppliers of barley in the world right now.”
Blue says others have tried to create a feed barley cash trading market. Producers would sign on to a cash contract that allowed them to deliver barley at a later date, he explains.
“Those have struggled also, and I’m not exactly sure why,” says Blue. He would like to see either a way to physically deliver against the barley contracts or have it cash settled against a cash index.
For his part, Benham thinks the cattle industry needs to secure a reliable feed source or Alberta could end up exporting feeder cattle instead of finishing them. Possible solutions include developing higher-yielding barley varieties to boost acreage, sourcing other feedstuffs, using proprietary software from AgValue Group, or using marketing products that would allow feeders to source cash barley.
But Benham thinks the feeder industry may develop a different feed barley exchange to provide price discovery. Because futures are derived from functioning cash markets, Benham thinks this is a viable option.
“If you chose to make a market somewhere else, there’d be nothing to prevent you from doing that,” says Benham.
The future of futures
ICE’s wheat and barley contracts aren’t functioning right now, but Vannan seems cautiously optimistic about the future.
“But it’s still early days yet. It’s been two crops — two crops that have come into the marketplace under considerably different conditions,” says Vannan.
Western Canadian farmers are quick to adopt crops that provide the highest returns, says Vannan. Canola is a prime example, where the futures market supported growth in canola production. The industry’s investment in canola technology and farmers’ quick adaptation to the crop also helped the futures market function better, he adds.
“So those things go hand in hand. There’s lots of synergies that come out of that,” says Vannan.
And with recent change in the international wheat markets comes opportunity, Vannan says.
He cites the Euronext wheat contract, traded in Paris, as an example. For several years, that contract didn’t gain volume. But the Black Sea gained prominence as a global grain supplier, making the European contract a better hedge than North American contracts, Vannan says.
“Now it’s probably the fastest growing and one of the most important wheat contracts there is,” says Vannan.
The open wheat market could spell good news for Canadian wheat contracts, he says. North American wheat acres are being pushed farther north and west by corn and soybeans, he adds. Canadian contracts representing Canadian production will be the natural benefactors in time, Vannan says.
“That timing might not be right now. But I’ve got a feeling that it might not be that far away.”
