Analysts consider prospects for Black Sea wheat

by Laura Lloyd
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KANSAS CITY — A new Black Sea wheat futures contract will make its debut on the Chicago Board of Trade on June 6. The scheduled launch was a response to the fact exports from the Black Sea nations — Ukraine, Russia and Kazakhstan — are increasingly important in the world’s wheat trade, and there was a need for better price discovery in relation to the region’s wheat.

“Wheat exports from the Black Sea region in 2011-12 were 35 million tonnes, while U.S. wheat exports were 27 million tonnes, so you can see there are strong exports from that part of the world,” said David Lehman, managing director of commodity research and development at the CME Group.

The Black Sea futures contracted will be traded electronically with trading hours from 2 a.m. Central time to 1:15 p.m. Monday through Friday, which would correspond to a trading day beginning at 10 a.m. and ending at 9:15 p.m. in the Black Sea region.

Mr. Lehman said the CME Group has been building support in the Black Sea region for the contract through education of producers and commercial interests that are not familiar with trading practices in a commodities futures market.

The CME Group plans to give the new Black Sea wheat futures contract plenty of time to build open interest, said Mr. Lehman.

“We’re not going to just give this product six months to develop enough liquidity and then walk away,” he said.

That may be the best strategy, according to the collective wisdom of futures market analysts contacted by Milling & Baking News. While these experts agreed that a successful futures market in Black Sea wheat may be extremely useful in price discovery in a region known for a woeful lack of transparency, they expressed strong convictions that building this market will encounter some serious bumps along the way.

“Cautiously optimistic,” “I wish them well,” and “If you build it they will come” — these were the sentiments of the market watchers.

“We won’t know for a long time if the new contract will be successful,” said Sid Love, president of Kropf and Love Consulting Services, L.L.C., in Overland Park, Kas.

The analysts’ acknowledged doubts that producers and governments would actually hedge their positions in Black Sea futures. Farmers in that part of the world have indicated a lack of knowledge — and perhaps a lack of enthusiasm — about how to use futures, they noted. Government entities also have indicated a lack of willingness to use true hedging with futures.

Dave Manternach of Doane Advisory Services in St. Louis said he believed the CME Group was hoping to replicate the success of the futures market in China, which experienced growing pains in the early going related to a lack of faith in a truly free-market trading environment. Specifically, Chinese officials tried to confine trading to government-set ranges. Unlike the Black Sea contract, which has provisions for making and taking cash delivery of grain, the Chinese futures markets had no such provision, and that was a problem. While Black Sea and Chinese grain futures started out with different designs, both may be similar in the requirement to make changes before achieving success, Mr. Manternach said.

He said he also expected that the concerted education effort aimed at Black Sea producers, processors and merchants will get them onboard once they understand the benefits of using futures. Even then, Mr. Manternach said, it was doubtful futures trading will catch on quickly because there are stakeholders who prefer the limited access to market information that exists today, because it gives them what they consider a valuable advantage in global trade.

There remained a host of other possible obstacles that may limit success, including weak national infrastructure, a predilection for “backroom deals” on prices, the precedent of halting sales on unexpectedly poor crops, and the lack of a free-market tradition, the experts said.

Without the development of participation by legitimate hedgers “you lack critical components of viable price discovery,” added Mr. Manternach, noting that if players “are largely speculative only, you have only the grease and oil that makes U.S. futures function smoothly, not the critical market action between buyer and seller that comprises the actual mechanism of a futures market.”

There were other issues as well.

“Futures depend on steady supplies,” Mr. Love said. “The U.S., Canada and Australia offer reliable supplies” in contrast to the Black Sea region. He noted that nations importing wheat may be willing to pay a little more for supplies they can count on.

“Russian wheat has always been the cheapest in the world,” said Jack Scoville, vice-president, Price Futures Group, Chicago. At the turn of the 20th century, that real estate produced plenty of wheat to sell to other countries, Mr. Scoville emphasized.

Some of the buzz about Black Sea wheat is derived from the conviction that production there has the potential to increase significantly.

“Over time, yields in Eastern Europe and Russia should rise,” Mr. Love said. “They have no place to go but up.”

At the same time, Black Sea wheat, even more than wheat from some of its competitors, is a weather-driven crop, buffeted by harsh winds and a tendency to severe drought, as well as unexpected rains. One positive from this volatile environment: The potential for dramatic highs and lows is likely to offer arbitrage opportunities between Black Sea futures and markets in other countries, the analysts observed.

“The thing that scares me is, if there was (major) drought and the government shuts down wheat exports out of the Black Sea, there could be a force majeure on contracts, and wheat would have to be replaced out of, say, the European Union, and there would be serious market disruption,” Mr. Love said.

Assuming an evolution to larger crops, it doesn’t help being a big exporter if you can’t get the grain to ports swiftly, cheaply and effectively, said Mr. Scoville. Rail infrastructure needs improvement as well, he added.

The seeming limits to producer and domestic milling interest, as well as reluctance from some American grain interests, may lead to another concern: too many speculators and not enough market participants using futures to limit risk and arrive at true prices. Still, assuming producers and governments become comfortable with futures, infrastructure improves, weather markets are managed the best way possible, foreign participants become convinced there is accurate price discovery and the CME Group perseveres with the contract, there is the potential for a flowering in the wheat industry in the region of the world where hard red winter wheat originated, the analysts suggested.

“The Black Sea wheat market could become a major force in the world,” Mr. Scoville said. “They already have the technology. They have a ways to go with trading. And they need to get very efficient. But I am cautiously optimistic that Black Sea futures can become a very useful tool.”

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