Risk Management Solutions for Emerging Agriculture, Presentation by Dr. Raphael Karuaihe, Johannesburg Stock Exchange
About the Webinar
Agriculture is a risky business in which all farmers have to manage the risk of getting low prices for their products, also referred to as commodity price volatility. This challenge is even greater for smallholder farmers who have limited financial reserves. With the effects of climate change increasing uncertainty and instability of food production, price volatility is likely to increase as well in the future.
Dr. Raphael Karuaihe, a commodity derivatives manager at the Johannesburg Stock Exchange, explained how small farmers can protect themselves against price risk. Explaining the mechanisms and differences between futures contract, put options and standardized contracts, he discussed the challenges he faces when working with small farmers and which structures or organizations can help better disseminate the information to farmers. >>Download the presentation.
About the Presenter
Raphael Karuaihe is a Manager Commodity Derivatives at the Johannesburg Stock Exchange (JSE). Raphael joined the JSE at the beginning of 2012 after heading up an agribusiness brokerage firm based in Pretoria. Prior to that Raphael spent many years in the financial advisory services industry where he advised institutional clients on retirement planning, investments and risk management.
At the JSE, Raphael is involved with the design and distribution of tradable risk management solutions for the broader agricultural sector as well as for emergent agriculture.
Raphael holds a doctorate in agricultural economics.
Dr. Karuaihe's interview to FARMD
Agriculture is a risky business in which all farmers have to manage the risk of commodity price volatility. This challenge is even greater for small farmers who have limited financial reserve. What does JSE offer to small farmers so that they can protect themselves against price risk?
The basic price risk management tools used by established commercial farmers, namely futures and options, are the same ones made available to smallholder farmers:
- Futures allow farmers (large or small) to lock in a favourable price of their respective commodities for delivery at a specified future date.
- Options (Put Options in this case) on the other hand, accord farmers the right but not the obligation to sell a specified quantity of a specified commodity at a specified price (called strike price) within a specified period of time. I will expand on this in more detail during the presentation.
What the JSE has done to address specific needs of smallholder farmers is to recognize that the nominal contract sizes for the tradable commodities were too large and at times unaffordable to the smallholder farmer in terms of margin changes. For example if we take our standard contract size for maize (corn) is 100 tons. This means the minimum tradable lot size for this commodity is 100 tons and for many smallholder farmers, this is too big as many of them produce less than 100 tons per cropping cycle. To address this problem, the JSE has introduced mini contracts of 10 tons for maize and the ones for soybeans are being rolled out later this year.
Which commodities qualify for future contracts and why?
The JSE has listed white maize, yellow maize, wheat, soya, sunflower seeds and sorghum as deliverable contracts. We also trade cash-settled agricultural commodities under license from the CME Group and these are: corn, soybeans, soy oil, soy meal, Kansas Wheat, Hard Red Winter Wheat. The deliverable commodities are the grain commodities produced in South Africa.
Many times market participants would approach the JSE to list a particular commodity based on hedging needs. The JSE in turn will do a due diligence to investigate the viability of such a listed commodity. Both producers and processors would be approached to ensure that there is enough support from both demand and supply sides before the commodity finally gets listed. I must hasten to add that not all newly-listed contracts trade successfully. On a lighter notice, introducing new products we often take a spaghetti approach, throw the product out there and see which one sticks. The same can be said about the cash-settled contracts trading under licence from other exchanges. The rationale to list one commodity over another is driven mainly by domestic hedging needs as well as high correlations between prices of the chosen international commodities and their domestic equivalents.
What challenges do you face when offering futures contracts or put options to farmers? Lack of information? Reluctance from farmers?
Derivative instruments are complex even to the educated. So you can imagine what a challenge it is to pass this information in as simple a language as possible. Therefore continuous and repetitive education is essential to the smallholder farmers. These instruments do come at a cost as well. So apart from understanding the overall benefits of hedging and locking in a price, it is absolutely necessary that the farmer understands the cash flows from these transactions. Any misunderstanding will lead to unintended lack of interest. The JSE together with a number of our member firms also distribute daily settlement prices either via the internet, sms or other social media like twitter. Some of our member firms have developed on line applications to assist farmers with pricing examples and how they can either use outright futures or consider option strategies.
See the link to the brokers web page: http://www.bvg.net/index.php/grainmarketingcalculator
Which structure or organization could help further disseminating information to farmers on what is available for them?
Farmer unions, agribusinesses, government institutions (extension services), agricultural training colleges, agricultural expos, farmer day training sessions. I personally would prefer a coordinated structure (one stop shop) between all agricultural stakeholders that disseminates information and educate groups of smallholder farmers. That way the smallholder farmer does not get information overload from different sources, each one advising him different solutions to the same problem. Then promote and showcase success stories that come out of these initiatives. We have seen dedicated initiatives by some of our member firms like Farmwise Grains, Vrystaat Mielies, GroCapital and NWK many of whom have shared some of their stories developing small farmers via their websites. Grain SA, a producer organization has also done significant work to educate and arrange mentors to assist small farmers increase their knowledge of farming. Although much of the training to date has focused on increasing production, there are plans to also include a section of price risk management. In many instances the banking institutions also provide information to farmers to assist them in their financial decision making process.