Australian Wheat: Enhancing our Global Reach

Executive Summary

The launch of Australian Wheat futures on July 24, 2017, enhances the global reach of the Chicago Board of Trade’s (CBOT) suite of wheat contracts. This contract reflects prices of wheat exported out of Australia and will serve the price discovery and hedging needs of a wide array of industry participants, including farmers, processors of wheat in Australia, wheat importers in Asia, and international traders. Institutional investors wishing to carry out spread trades against CBOT’s U.S. and European wheat futures contracts would also find this tool useful.

CBOT Corn, Soybean and Wheat Futures:

CBOT, part of the CME Group, is the world’s top exchange for the trading of agricultural futures. Corn, soybean, soy oil, soy meal and wheat futures have a total trading volume of over 970,000 futures and 200,000 options contracts a day, and open interest tops 3.7 million contracts.

Figure 1: Corn & Soy Volume & Open Interest (000 lots)

Figure 2: CBOT Wheat Volume & Open Interest (000 lots)

Corn and Soybeans: Three Major Players

The fundamentals underlying CBOT corn and soybean contracts are relatively straight forward. The U.S., Brazil and Argentina are the major exporters of these products and account for 74% of global corn exports and 89% of global soybean exports. On the demand side, China alone accounts for 63% of global soybean imports.

Given the relative simplicity in the trade flows of these two crops, the CBOT corn and soybean futures contracts have proven adequate in meeting the hedging needs of the international market.

Figure 3: Top Corn Exporters and Importers

Exports

Mil MT

Imports

Mil MT

USA

Brazil

Argentina

56

26

25

Japan

Mexico

South Korea

15

14

10

Global Total 144 Global Total 134

Source: USDA 2016 data

Figure 4: Top Soybean Exporters and Importers

Exports

Mil MT

Imports

Mil MT

USA

Brazil

Argentina

58

56

9

China

EU-27

Japan

86

13

3

Global Total

139

Global Total

136

Source: USDA 2016 data

Wheat Production and Exports are More Diverse Geographically

In contrast, wheat is more geographically diverse in terms of production, exports and imports. Wheat is a staple in many countries, used in making bread, pastries and noodles. As such, it is produced by many countries with the right weather conditions. At least 10 countries produce more than 25 million metric tons (MT) of wheat annually. However, no single country accounts for more than 17% of global exports, or 7% of global imports. This makes the hedging of regional wheat prices relatively more complex.

Figure 5: Wheat Production and Trade are More Diverse

Production

(mil MT)

Exports

(mil MT)

Imports

(mil MT)

EU-27

144

Russia

30

Egypt

12

China

128

USA

27

Indonesia

9

India

90

EU-27

25

Algeria

8

Russia

72

Canada

22

EU-27

7

USA

63

Australia

21

Brazil

6

Canada

32

Ukraine

16

Japan

5

Australia

28

Kazakhstan

9

South Korea

5

Ukraine

27

Argentina

8

Morocco

5

Pakistan

25

Turkey

6

Philippines

5

Turkey

18

Mexico

2

Turkey

5

Others

102

Others

12

Others

104

World

745

World

174

World

170

Source: USDA 2016 data

Types of Wheat: Hard or Soft, Winter or Spring, Red or White

Wheat is commonly  classified by color, hardness and their growing season. It can be as hard or soft wheat, red or white, and winter or spring. There are six official classifications in the U.S., including hard red winter (HRW), soft red winter (SRW) and hard red spring (HRS). The classifications are slightly different in Europe and Australia.

Hard vs Soft: In general, hard wheat has more protein content and is used for baking bread, whereas soft wheat has more starch and is used for making pastries. Processed hard flour typically contains up to 15% protein content, but any wheat that has over 11% protein content is usually classified as hard wheat.

Winter vs Spring: Winter wheat is planted in the fall, becomes dormant during the cold winter months, resumes growth as the weather warms, and is harvested in June and July. In the northern hemisphere, spring wheat is planted in April and May, and is harvested in August and September.

In the U.S., over 80% of total production is hard winter wheat, grown predominantly in the western plains states region. Soft winter wheat, the second leading class produced in the U.S. is grown primarily in the eastern part of the U.S. Midwest corn belt. Spring wheat is grown in the norther plains – from North Dakota to Saskatchewan (Canada).

In Europe, winter wheat is the predominant variety and is grown across the region, from France to Ukraine. Some spring wheat is also grown in Russia.

Figure 6: HRW and SRW are both winter wheats

Figure 7: EU and Black Sea are both winter wheats

CME Group’s U.S. and European Wheat Contracts

Until recently, CBOT had four listed wheat futures contracts. The underlying contracts were for two U.S. winter wheats (hard red winter and soft red winter), and two European winter wheats (European Union wheat and Black Sea wheat). Although SRW carries the ‘soft’ wheat title, both hard and soft wheat grades are deliverable into the CBOT contract.

Correlations: Given the overlap in the deliverable grades of wheat into the SRW and HRW contracts, it is not surprising that their price level and price return correlations are over 0.9. U.S. and European wheat prices can also be highly correlated over the short term (of over 0.8)1, which would explain why investors sometimes use them to hedge Australian wheat prices. However, over the longer term, price correlations between different regions tend to be low (as shown in Figure 9), and this would justify the need for a regional benchmark for hedging Australian wheat prices.

Figure 8: CBOT Wheat Prices

Figure 9: Correlation of SRW, HRW and EU Wheat

September 2016 to
June 2017

Price Level
orrelation

Log Return
Correlation

SRW vs HRW

0.93

0.91

SRW vs EU Wheat

0.04

0.33

HRW vs EU Wheat

0.10

0.29

Source: CME Group, Bloomberg

Figure 10: Brief Description of CBOT Wheat Futures

Name of Futures Contract Chicago Soft Red Winter Wheat Kansas City Hard Red Winter Wheat European Union Wheat Black Sea Wheat
Short Name Chicago SRW KC HRW EU Wheat Black Sea Wheat
Winter or Spring Winter Winter Winter Winter
Hard or Soft Both grades Hard Hard Hard
Country of Origin USA USA Europe Europe
Areas Grown Ohio to New York to South Carolina Texas to Kansas to South Dakota Western Europe Ukraine, Turkey, Kazahstan & Russia
Globex Code ZW KE WEU BSW
Bloomberg Code W A Comdty KWA Comdty WUEA Comdy BSWA Comdty
Contract Unit USD/bu USD/bu EUR/MT USD/MT
Contract Size 5,000 bushels 5,000 bushels 50 metric tons 136 metric tons (~ 5,000 bushels)
Price as at 19 June USD 4.79/bu USD 4.72/bu EUR 176.25/MT -
Contract Value USD 23,975 USD 23,625 EUR 8,812 -
Contract Months Mar May Jul Sep Dec Mar May Jul Sep Dec Mar May Sep Dec Mar May Jul Sep Dec
Delivery FOB Chicago /Toledo/Ohio and Lower Miss Rivers and NW Ohio USA Kansas City, Hutchinson, Salina and Wichita USA Rouen France Novorossiysk, Tuapse and Taman Russia; Illichivsk, Nikolaev, Odessa, and Yuzhny, Ukraine; and Constanta Romania

Source: CME Group

What About Australian Wheat?

Wheat sowing in Australia normally starts in autumn or early winter (May to July), and harvest occurs in late spring (November). Annual production is about 25 million MT, which equates to US$3 billion at the current price of US$120 per MT. While this accounts for only 3% of global production, low domestic consumption enables Australia to export 14 million to 18 million MT of wheat (10% to 15% of global exports) per year.

Figure 11: Australian Wheat Belt

Wheat is also categorized mainly by protein content, ranging from 13% for Australian prime hard (APH) wheat to 9 % for Australian standard white (ASW). CBOT Australian wheat futures are based on the APW grade, which has a minimum of 10.5% protein content.

Australian Wheat FOB (Platts) Futures

Unlike the U.S. and Europe, in Australia there is generally one wheat harvest a year in Australia.  Although APW belongs to the ‘white’ wheat variety, some Australian farmers hedge their wheat prices with CBOT KC HRW futures and options. The CBOT Australian wheat contract is based on the Platts assessment for the Australian Premium White variety, and offers Australian wheat traders the ability to directly hedge their physical wheat exposure.

CME Group listed the new Australian wheat futures contract for trading on July 24, 2017. The contract is cash settled against the spot price referred to as “APW Wheat FOB Australia” published by Platts. The foundation of the Australian wheat futures contract is price assessments which follow a rigorous methodology to ensure that they closely reflect the underlying cash market.

As one of the top five wheat exporting countries in the world, Australian wheat meets the demand from the Asia Pacific and Middle East regions, including countries like Indonesia, Japan, South Korea, Malaysia and Vietnam. Currently, there are no liquid over-the-counter derivatives market to reflect the prices of Australian wheat exports, however, some exporters are beginning to base export prices on Platts’ APW assessments.

The decision to list the CBOT Australian wheat futures was based on demand from our global commercial customers, who are seeking a new product to manage the price risk of wheat traded in Asia. By listing this new contract, we will provide the market with a tool to manage the price risk of wheat exported from Australia, and wheat imported into Asian countries from Australia.

Figure 12: Contract Specifications of CBOT Australian Wheat Futures

Contract unit 50 metric tons
Price quote U.S. dollars and cents per metric ton
Trading hours CME ClearPort: Sunday – Friday 5:00 p.m. – 4:00 p.m. CT with a 60-minute break each day beginning at 4:00 p.m.
Tick size $0.25 per MT
Product code AUW
Settlement method Financial
Exchange CBOT
Venues CME Globex and CME ClearPort
Listing schedule Twelve consecutive months
Expiry Last business day of the contract month
Floating  price Arithmetic average of Platts APW Wheat FOB Australia assessments published in the contract month

Source: CME Group

Flour Mills Can Also Use AUW Contract

Besides wheat exporters who supply wheat to other countries, the AUW futures contract can also be used by the downstream industry, such as domestic flour mills and fast food chains. A flour mill would try to manage price fluctuations by locking in its purchase prices of wheat early if necessary, or delay fixing its wheat purchase prices if it expects flour prices to fall.

The flour mill could pass rising flour costs to its customers, such as bakers and food processors who supply fast food restaurants. Alternatively, the mill could hedge its flour costs so that it can establish a fixed price for its customers. The AUW futures will be closely correlated with domestic Australian wheat prices, and could be used by farmers to protect against price fluctuations of local wheat.

Currency Risk for Australian traders

All hedgers face risks associated with supply, delivery, product quality, price, basis values, and currency.

Currency risk, in particular, is a multi-dimensional consideration.  Domestic wheat prices in Australia could be falling but a falling AUD/USD could cause local wheat flour prices to rebound.  Alternatively, higher domestic prices can be partially offset by a stronger AUD, which the U.S. dollar- denominated AUW contract would not fully hedge against.

Conclusion

The listing of the AUW futures contract adds another product to CME Group’s global coverage of the wheat prices, across the U.S. and European and Asia-Pacific regions. The AUW price reflects the prices of wheat exported from Australia and it could be a benchmark for other wheat grades in Australia, with market-determined price differentials. The contract will meet the needs of commercial participants in the Asia Pacific market, and it should be appealing to farmers, cooperatives, merchants, international traders, importers, exporters and processors.

As an instrument that closely tracks the cash market, the AUW contract will be attractive to institutional investors who seek trading opportunities in this market, including spreading with the CBOT’s U.S. and European wheat contracts. Traders will benefit from margin efficiencies and convenience by trading and clearing wheat contracts on the same platform.

References

  1. Price correlation from April to June 2017 is 0.97 for SRW vs HRW, 0.83 for SRW vs EU Wheat, and 0.80 for HRW vs EU Wheat.

 

All examples in this report are hypothetical interpretations of situations and are used for explanation purposes only. The views in this report reflect solely those of the author(s) and not necessarily those of CME Group or its affiliated institutions. This report and the information herein should not be considered investment advice or the results of actual market experience.

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