Price guarantee: Grain futures offer a solution to market volatility

The planned launch of grain futures contracts in Zambia will help farmers and other stakeholders to protect themselves from volatile prices and could encourage other countries to follow suit.

New futures contracts will protect Zambian farmers against shifts in white maize prices © Jake Lyell/Alamy Stock Photo

A new futures contract that would allow farmers, traders, banks and other stakeholders to protect themselves against shifts in Zambian grain prices is expected to be launched by the Johannesburg Stock Exchange (JSE) and Zambian Commodity Exchange (ZAMACE), in May 2018 (see box below).

The US dollar-denominated contracts will be listed on the long-established JSE but for the first time will allow participants to lock in prices for the future delivery of grains produced and stored in Zambia, explains Chris Sturgess, director of commodities at JSE. They will initially cover white maize, followed by wheat and soybean.

To encourage smaller players to participate, each contract will cover 10 t of grain, compared to JSE’s standard ‘lot’ size of 100 t. Five contracts will be launched per year, in March, May, July, September and December, each expiring after 12 months to coincide with harvesting and production cycles.

To buy a futures contract, participants will pay an upfront deposit or ‘margin’ that Sturgess estimates will initially be about 10-12% of the agreed price for one lot.

Mitigating risk

Price volatility in Zambian grain markets is a major risk across the value chain, says Raphael Karuaihe, head of commodities at JSE. Maize prices over the past 2 years have zigzagged between €97 and €244/t. Rather like an insurance product, the futures will help to protect all players in Zambian grain markets from such moves, says the executive director of ZAMACE, Jacob Mwale.

In Zambia’s existing cash markets, “The farmer has to produce a crop and hope like hell when it comes to harvesting that the price will be good,” notes Sturgess. By purchasing a guarantee that will enable them to sell their produce at a fixed price in the future, farmers can avoid panic selling into a weak market and will be able to, “Go to sleep knowing they’ve hedged themselves,” Mwale adds.

But while contract sizes are purposefully small to enable smaller players to participate, either as individual farmers or farmer groups, the margin expense – plus the perceived complexity of trading – will likely deter most smallholders, believes Rob Munro, director of strategy at Musika, a Zambian non-profit that supports ZAMACE with capacity building.

Intermediaries like traders could, however, buy futures to fix the price for a ‘lot’ of grain that they intend to buy, and extend this price to their smallholder suppliers, provided those farmers honour their contracts to deliver the maize, says Sturgess.

Munro agrees, “There are very few forward contracting arrangements between agribusiness and small farmers in the ‘staples’ market and none that include a pre-planting price,” he notes. “If buyers, traders and processors are able to hedge their own market positions, they would be able to pass on to their smallholder suppliers market price indications, which would have a highly beneficial effect on the market, providing confidence in both off-take and price for farmers, and also providing a more solid basis upon which finance can potentially be extended.”

The only way traders like AFGRI are currently able to manage price risk in Zambia is by using bilateral forward contracts, essentially buying grain from farmers for delivery at harvest time at a fixed tonnage and price, and then selling it to millers under a similar arrangement, notes Joof Pistorius, grain marketing manager at AFGRI Zambia. Futures contracts will be, “Very beneficial to farmers, traders, millers, processors, investors, everyone,” he says. “It is something we are all waiting for.”

Financial institutions will also be able to use the futures to hedge against grain prices moving below the amount assumed when they pay advances to farmers against warehouse receipts, Mwale adds. This may increase their appetite for providing warehouse receipt finance in bigger volumes and at more competitive rates.

A functioning futures market will also help improve the wider commodity market environment. Smaller players, in particular, will benefit from, “Greater assurance of offtake, greater visibility of price and a less ‘chaotic’ marketing environment,” says Munro.

Government intervention

Many challenges remain however, not least the threat of government interference in grain markets and resulting price distortion. Although Pistorius strongly supports the concept of futures contracts, he is sceptical that they will work in the existing environment. Zambia’s Food Reserve Agency has a history of periodically intervening by buying maize directly from producers at inflated prices, dissuading farmers from honouring contracts with commercial buyers, he notes. The government also imposed border controls last year, preventing maize exports, creating a local surplus and pulling prices down from €219/t to €97.

This kind of unpredictability has disincentivised long-term grain storage in Zambia, contributing to under-utilisation of the country’s warehouse receipt system – which is a crucial part of the eco-system underpinning futures contracts – adds Munro. He notes however that there has been a “distinct shift” towards reduced government intervention. If this continues, it will be easier for traders to take a long-term view on prices and for a derivatives market (e.g. futures market – see box) to develop.

Pistorius agrees that the government has recently made efforts to intervene less, but says AFGRI and other players would remain nervous of using futures contracts while government interference continues to be a possibility. Mwale, however, points to the “strong support” ZAMACE has received from the government in its work with JSE. He is confident that once the benefits of a liquid futures market have been demonstrated, the government will be persuaded to step back.

Replicating across the region

The USAID Southern Africa Trade and Investment Hub (SATIH), which worked with JSE and ZAMACE to develop the futures contract, believes there is great potential for replicating the contract model in neighbouring countries and building a regional trading platform. This could, for example, see JSE lend its infrastructure to exchanges in Malawi and Mozambique to launch agricultural commodity futures that would be deliverable in those countries.

SATIH is hopeful that at least one agreement to this end will be signed at a 2-day structured trade seminar that USAID will co-host in Zambia in June 2018, with commodities trading and payment services provider, INTL FCStone. The event will also showcase live trading in other agricultural commodity contracts.

ZAMACE is keen to collaborate with other exchanges once the contract with JSE has been launched, says Mwale. “I see them benefiting from the work that has been done with the support of JSE and USAID.”

“If this contract works and is able to achieve that critical mass of activity, that liquidity, the same way white maize contracts work in South Africa, it becomes an opportunity for other players in the region to consider using our ecosystem to also roll out derivative contracts,” says Sturgess. “It certainly has the potential for bringing the region closer together in terms of hedging grain.”

The Southern African Trade Seminar takes place at the Avani Victoria Falls Resort, Livingstone, Zambia on 26-29 June 2018, with the aim to demonstrate the benefits of free trade in Southern Africa and make commodity exchanges in the region more sustainable.

What are futures?

Commodity futures are standardised, exchange-traded contracts in which a buyer agrees to take delivery from a seller of a set quantity – or ‘lot’ – of the underlying commodity at a pre-determined price on a scheduled future delivery date, known as its ‘expiry’.

Participants entering into a contract – or trade – must first pay a ‘margin’ to the exchange clearing house. The margin is a cash deposit or down payment that is calculated as a percentage of the total value of the lot being bought and sold under the contract. When prices for the underlying commodity are volatile, this margin will typically rise to as high as 15% of the agreed price. When prices are more stable, the upfront cost of entering the contract will be lower, at around 6% of the fixed price.

A futures market needs good ‘liquidity’ – numerous participants and a high volume of trading – to work smoothly, as the greater the number of participants, the higher the probability that the exchange will find a buyer for every seller and vice versa.

Helen Castell

The Technical Centre for Agricultural and Rural Cooperation (CTA) is a joint international institution of the African, Caribbean and Pacific (ACP) Group of States and the European Union (EU). CTA operates under the framework of the Cotonou Agreement and is funded by the EU.