The Rising Importance Of The Black Sea Region In Global Wheat Trade
In the past two decades, the mix of top wheat exporters has changed as new centers of surplus production emerge. The Black Sea region (BSR) has become the dominant world wheat exporter, supplying high quality and competitively priced grain. Driven by production in Russia and Ukraine, the BSR accounts for close to 35% of world wheat exports as seen in Chart 1. Russian and Ukrainian wheat can be used for a wide assortment of breads, cookies, flatbreads, as well as blending with other types of wheat. This broad-spectrum utility combined with large supplies, competitive pricing, and geographic proximity to major wheat import markets of North Africa and the Middle East, has led this region to become the world’s top exporter of wheat.
Chart 1: Export sales market share U.S. vs Black Sea region (Ukraine and Russia)
Source: U.S. Department of Agriculture (USDA)
CME Group Financially Settled (Platts) Black Sea Wheat 12.5% FOB Russia Futures And Options Contracts
Launched in December 2017 as a price risk management tool for exports of BSR Wheat, the futures and options contracts have seen quick adoption as a hedging tool and trading instrument by a wide range of physical market participants, including producers, exporters, trading houses, and processors in Europe, the U.S., Middle East, and Asia.
Chart 2. shows the volume and open interest of the Black Sea Wheat futures and options by month since January 2018. Total contracts traded since launch to end April 2020 is 430,000 lots, equivalent to 22 million tonnes of wheat.
In the first four months of 2020, a total of 90,000 lots were traded, a 70% increase from the same period a year earlier. This amounted to 1,050 lots of Black Sea Wheat futures and options per day, or 52,500 metric tonnes (MT) of wheat traded daily. Open interest in Black Sea wheat futures has increased to over 27,000 lots by end-April 2020, a rise of 90% from the same point a year ago.
Chart 2: Black Sea wheat futures and options volume by month
Source: CME Group
Black Sea Wheat Futures Correlates Highly With Regional Wheat Cash Markets
Price correlation measures how effective a hedge would be using a futures contract to manage price risk in a physical cash market. A score of 1.0 is considered a perfect hedge and a figure above 0.80 represents an effective hedge.
Chart 3. shows that the price correlation (based on price levels) for Black Sea wheat prices against black sea regional wheat prices is high – well above 0.80. The price correlations were calculated using the rolling 20-day average of prices over the 12-month period to March 2020. The Black Sea wheat futures contract is an effective hedge for FOB Black Sea 12.5% Russian cash wheat with a correlation of 0.96. The futures are also highly correlated with the CIF Turkey (Marmara) wheat cash prices at 0.94.
Chart 3: Black Sea wheat futures price correlation versus other regional cash wheat prices
Source: CME Group and S&P Global Platts
Basis Trading Using Black Sea Wheat Futures
Basis trading is the buying and selling of a physical commodity such as Black Sea wheat priced against a correlated futures price. This is a widely used trading and hedging concept in grain markets. Related futures and regional/local physical prices typically move up and down together, enabling hedging to occur.
More specifically, the basis is negotiated as a premium or discount to the futures price. The basis is defined as the differences between a regional cash price and correlated futures. Cash prices differ from futures prices due to transportation, handling, storage, quality and currency, as well as local supply/demand factors. A discount or negative basis is where physical prices trade under futures, while a premium or positive basis is where physical prices trade over futures.
Market participants may choose to fix the basis when they agree to a trade or they may choose to let the basis fluctuate until the delivery of the physical wheat occurs. For example, millers that purchase physical Black Sea wheat can use the Black Sea Wheat futures, referenced to the Platts FOB Black Sea wheat assessment, coupled with a negotiated basis to hedge price risk in their location. With a basis trade, only the difference in price between the physical price and the related futures (i.e., the basis) needs to be negotiated between the buyer and seller.
Purchasing physical shipments of Black Sea wheat using futures, or also coupled to the Platts Black Sea wheat assessment plus a negotiated basis enables buyers to use the Black Sea Wheat futures to hedge price exposure to their local wheat prices either within the Black Sea wheat region or other destinations with market prices correlated to Black Sea wheat futures.
Hedging Using Basis
Consider as an example the CIF Turkey (Marmara) 13.5% cash wheat market, which has a 95% price correlation with Black Sea Wheat futures.
Rather than waiting to purchase at a fixed price delivered into Turkey and taking on the price risk inherent in such a trade, a Turkish miller could purchase Russian wheat for future delivery at a basis to a Black Sea futures contract, thereby hedging their exposure to adverse price movements in the Turkish wheat price.
For example, in June a Turkish miller plans to buy 25,000mt of Russian wheat from a Russian wheat grain exporter for November CIF Marmara delivery. Assume that November Black Sea Wheat futures are trading at $250/mt and the CIF Marmara basis is $20 over the futures price for an expected purchase price of $270/mt ($250/mt + $20 basis).
Hedge - Basis remains unchanged
Hedge - basis strengthens to +$50/mt
Hedge - basis weakens to +$10/mt
As the examples above illustrate, the basis is always changing. However, changes in the basis are usually much less volatile than changes in price, so a market participant can significantly reduce risk trading basis compared to trading flat price. A basis trader exchanges flat price risk, which tends to be high, for basis risk, which tends to be lower.
Hedging The Carry (Value Of Storage) Using Black Sea Wheat Futures
The futures markets provide the ability for firms to hedge inter-month spreads and thereby lock in a carry (value of storage). Commercial firms may choose to purchase Black Sea Wheat futures for a nearby futures contract month (such as July) and sell a further dated contract month (such as December) to lock in the value of storage.
Locking in the value of storage is possible where the price of a further dated contract month is higher than a more nearby dated contract month (i.e. there is a "positive" carry in the futures market). For firms that are storing wheat for futures sales, such a strategy can allow them to maximize the returns from storage when the positive futures carry is greater than the physical cost of storage.
The chart below shows the value of the Black Sea Wheat futures September 2020 to July 2020 and the December 2020 to September 2020 spreads. The new crop (for 2020) carry has widened in recent months, reflecting a greater return from storing wheat for future delivery. Based on the data in the chart below, the carry between the September and July 2020 contract months was around $6.50/mt (equating to around $3/mt per month) at the end of April 2020, an increase of $2/mt from the beginning of 2020. The carry between the December and July 2020 contract months was $16.50/mt (equating to $2.75/mt per month), up from around $8.25/mt at the beginning of 2020.
Chart 4: Black Sea wheat futures carry spread – 2020 crop
Source: CME Group
Benefits Of The Black Sea Wheat Futures and Options Contracts
One of the key advantages to trading futures is that it provides companies with the opportunity to fix the price of forward wheat purchases ahead of delivery. This means companies can build long term relationships with their key suppliers having already fixed the wheat price in the futures market.
By using Black Sea wheat (Platts) futures to hedge price risk, companies can focus attention on product quality with the basis negotiated in advance of the delivery. Volumes can be varied according to their need and can be agreed over a short or long-term delivery period. Once term wheat supply agreements are in place, buyers such as millers are well placed to negotiate basis deals with flour buyers fixing contractual volumes over a defined time period. Merchants/traders are also well placed, knowing that they have long-term buying commitments from buyers.
There are several additional benefits to using the Black Sea Wheat (Platts) futures listed by CME Group:
- The Black Sea wheat futures are cash-settled against a Platts index without the risk of physical delivery.
- Hedging is available for 15 consecutive months forward, allowing up to two crop years to be hedged and priced using basis.
- Effective hedge for Black Sea wheat cash markets and other regional markets – high price correlation
- Clearing mitigates counterparty risk and widens the number of counterparties
- Strong participation from physical traders – 80 plus firms
- Price settlements for the futures provided by CME Group on a daily basis
- Numerous brokers providing block futures liquidity to the market
- Arbitrage opportunities vs other Chicago Board of Trade wheat contracts
- Using options on Black Sea Wheat (Platts) futures allow for more complex hedging strategies
Get more information on our Black Sea grain contracts.
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