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Empirical Investigation of Flexible Pricing and Payment Alternatives on Canadian Wheat Board Pooling for Wheat
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The Canadian Wheat Board (CWB) has a mandate to serve farm managers in Western Canada by marketing their wheat, durum and barley for export and for domestic human consumption. Currently, under the CWB Act, the CWB operates a pooling system whereby producers deliver grain during the crop year and receive the average price for the quality of grain delivered over the crop year. Upon delivery, the farmer receives an initial payment less deductions for freight and elevation. The Federal government guarantees the initial payment. As grain sales are completed during the crop year, and as the supply/demand and forward price outlook become more certain, upward adjustments can be made to the initial payment. The CWB completes all sales, pays all expenses, and distributes the funds remaining in the pool accounts to farmers as a final payment in January following the end of the crop year. As the final payment becomes more certain, interim payments to producers may be made prior to the final payment. This system of pooling and payments ensures that each farmer receives the same price for grain of the same quality delivered during the crop year. Hence, it provides assurance that producers will not be disadvantages due to timing of delivery throughout the crop year. The price pooling system, however, does not recognize the diverse producer needs in terms of risk management and cash flow requirements. The time lag in receiving the final price on delivered grain is identified as a cash flow problem for the farm manger. Additionally, no mechanism is in place to allow managers to lock in a price for grain delivered earlier in the crop year. Despite the initial payment, the farm manager confronts price uncertainty. The final value of the crop delivered to the CWB is not fully determined until after the crop year is over. Moreover, the price uncertainty is larger at seeding time and during the early part of the crop year when information on world production is less available than later in the crop year. The federal government commissioned a panel in October 1994 to examine Western Canada's grain marketing system in response to the request of farmers to make the system more flexible and responsive. The recommendations of the Western Grain Marketing Panel are embodied in the amendments to the CWB Act, Bill C-4. This Bill allows pricing alternatives designed to address the diverse cash flow and price risk concerns of farmers. Offering these alternatives to producers, however, exposes the CWB to new risks. Some of these risks are price risks, exchange rate or currency risks, quantity risks, grade spread risks, and counter party risks. This study describes and evaluates the risks involved in offering Flexible Pricing and Payment Alternatives (FPPA) to farm managers. Farm managers could manage cash flows and price risk using different alternatives. Two types of FPPA - the Fixed Price Contract (FPC) and the Early Pool Cash Out (EPCO) - are evaluated in the study. The FPC is the contract that enables the farmer to lock in a price prior to seeding. The EPCO is the contract that the farmer can sign, after making a delivery, to receive a price now in lieu of the final payment. The FPC is equivalent to a forward contract on the pool. This contract would enable a farm manager to lock in a fixed cash price prior to the commencement of the crop year, either before or during seeding. When the grain is delivered, the farm manager is paid this fixed price. The grain covered would not participate in any further pool account payments from the viewpoint of the farm manager. To maintain the integrity of the pooling system, the physical grain would still be part of the CWB pool from the CWB's viewpoint and would be included in the calculations of the pool pay out. The farm manager gives up all opportunities for an increase or decrease in the pool value due to changing market prices. The CWB assumes the risk associated with any future changes in pool values. The EPCO would enable participating farm managers to receive their initial payments when they deliver their grain and then a fixed final payment, prior to the end of the crop year. They would not participate in any additional final payments This pay out could occur either at any time during the crop year or at the end of the crop year. Again the CWB would assume the risk associated with any future changes in the pool account value. In addition to describing and evaluating the risks involved in providing the FPPA, this research measures the effectiveness of using public risk markets such as the Minneapolis Grain Exchange (MGE), Chicago Board of Trade (CBOT), and Kansas City Board (KCBT), to manage the risks. This report evaluates the risk associated with offering the Fixed Pricing Contract (FPC) and the EPCO. In the process, currency risk and grade spread risks are estimated and sensitivity analyses on the results are performed.
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- Date created
- 1999
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- Type of Item
- Report