PURE HEDGES REMOVE RISK FROM THE CANOLA BIN

Originally published on September 22, 2005

 

If you think you are too old to learn new ways to market your canola, consider this. My commodity brokers, Alan Day and Ron Styles of Union Securities Ltd. in Saskatoon, fielded a call recently from an 87-year-old farmer looking to reverse the pure hedge that he had set up on his canola earlier in the year.

Simply put, a pure hedge uses the futures market to manage the canola price risk on your farm. Sales are made in the futures market in spring and summer when canola supplies are known, weather for the upcoming production year is unknown and canola prices are rallying or remaining strong.  Later in the fall, with the canola harvest complete, the pure hedger reverses his earlier futures contract sale with a futures contract purchase.

This usually occurs near or at the time when the farmer's canola crop is sold at the elevator.  According to my calculations in the accompanying table, those who implemented this hedge in 2005 could have secured an additional $1.10 per bushel to their fall-delivered canola revenues and an overall hedged canola price of $6.55 per bu. right off the combine.   

The first step in setting up a pure canola hedge is to open a futures account. According to my brokers, a $2,000 good faith deposit is required for every 100 tonnes of canola to be hedged. On June 22, the Winnipeg Commodity Exchange's November canola futures contract peaked at $323 per tonne.   Subtracting a portion for elevator handling and freight charges, otherwise referred to as a basis of approximately $23.50 per tonne, those who sold canola on that particular day pocketed $299.50 per tonne, or $6.79 per bu. For many of us, our bins were empty on June 22 and we had no physical canola to sell.  What we did have was growing in the field.

For Day and Styles, this isn't a problem. They encourage most of their clients to price up to 50 percent of their upcoming canola crop before harvest.

In our example, 10 percent of the 2005 canola crop would have been priced in May by selling in the futures market at $300 per tonne. An additional 25 percent would be priced in June by selling in the futures market at $320 per tonne and 15 percent would be priced in July by selling in the futures market at $307 per tonne.

By the beginning of September, 50 percent of the hedger's 2005 canola crop has been priced at a weighted average price of $312.10 per tonne. 

The pure hedger then harvests his canola and sells it off the combine, freeing up valuable storage space and turning inventory into post-harvest cash. With the WCE November canola futures contract now trading at $263.40 per tonne and after applying the earlier basis of $23.50 per tonne, he pockets $239.90 per tonne, or $5.44 per bu.

 

 

 

He then offsets his previously booked sales of the November futures contract at a weighted average price of $312.10 per tonne with a purchase of the same November contract at $263.40 per tonne. In his futures account he now pockets a trading profit of $48.70 per hedged tonne, or $1.10 per hedged bu.  His good faith deposit of $2,000 is available for use on next year's canola hedge.

The futures market can also be used by farmers who want to turn their canola into post-harvest cash but still want to participate in any post-harvest price rallies. By buying or going long in the futures market, a farmer can replace the canola that was sold at the elevator with a December futures contract. If canola rallies near Christmas, then the farmer would reverse his position in the futures market and pocket the post-harvest price increase.

For tax purposes, gains or losses from the trading of commodity futures may be reported as capital gains and losses, with only 50 percent being taxable. Alternatively, the taxpayer may report these gains and losses under the Canadian Agricultural Income Stabilization program, if they are considered a hedging strategy and meet certain criteria.

As I left Day and Style's office, I couldn't help but respect that 87-year-old farmer who started farming with horses and was now hedging his canola on the futures market.

 

 

Allyn Tastad, certified general accountant, is a partner in the accounting firm of Hounjet Tastad Harpham in Saskatoon at 306-653-5100, e-mail at allyn@hth-accountants.ca or website www.hth-accountants.ca. He is also involved in the family farm near Loreburn, Saskatchewan.  The opinions expressed in this column are for information only.