FX Markets Drives Increased Hedging Opportunities in Black Sea Wheat Trades

The Chicago Board of Trade (CBOT) Black Sea Wheat futures market is a major wheat benchmark in which Russian and Ukrainian exports account for about 30 million tons (40% of total Russian wheat production per year) and 17 million tons (68% of Ukrainian wheat production per year), respectively1. The pricing centre for the Black Sea is the Russian port of Novorossiysk. The reach is much more international with markets as far afield as the Middle East and Far East Asia, making it a good arbiter for international trade in wheat.

International trade in wheat is conducted in US dollars, making the CBOT contract a valuable hedging tool. But the conversion of trade revenues into local currency means there is an additional foreign exchange (FX) risk which may need to be managed.

Foreign exchange rates fluctuate separately from the price of agricultural commodities, and movements in the foreign exchange rate can have a substantial positive or negative impact on incomes from international trade.

Russia produces a substantial amount of wheat and supplies the international market. Estimates for the 2019/20 season put Russian wheat production at 80 million metric tons, with 30.7 million metric tons of this amount likely to be exported2. Russia has been the world’s largest exporter of wheat for six years.

Movements in the Russian ruble (RUB) can have significant implications on the returns that are generated from Russian exports of wheat. For example, we can look at market prices in the period up to and including September 2020.

Chart: Volatility in USD/RUB FX Rate Creates Price Variation in Income for USD and RUB Impacted Producers in Black Sea Wheat Markets

Volatility in USD/RUB FX Rate Creates Price Variation in Income for USD and RUB Impacted Producers in Black Sea Wheat Markets

Source: CME Group.  Active month CBOT Black Sea wheat futures settlement price; converted to RUB using CME RUB/USD futures settlement price.

During this period of increased global uncertainty, prices for wheat in US dollars had fallen 7% in comparison to the values seen at the end of the fourth quarter of 2019. At the end of September 2020, the active futures contract was priced at 227.50 dollars per metric ton. However, over the same period, there has been a depreciation in the value of the RUB in relation to the US dollar, moving from around RUB 62.50 per dollar to RUB 78.40 per dollar. This latter effect will be beneficial for Russian wheat exporters, as the CBOT price expressed in RUB has increased from RUB 13,395 to RUB 17,836 per metric ton ‒ which is approximately a 33% increase.

Such significant volatility in the FX markets highlights the uncertainty that exporters face. It is worth noting that any move in the FX rate that benefits an exporter – i.e. an appreciating USD versus RUB since the exporter is selling in USD – will conversely have a negative effect on the importers (a depreciating RUB versus USD since the importer is buying in USD).

CME Group offers futures and options contracts on the Russian ruble FX rate, which can be used to manage this FX exposure. These contracts are cash settled with reference to the rate for US dollars priced in Russian rubles, as published by the Moscow Exchange. Each futures contract is valued for RUB 2,500,000. Using prices at the end of September 2020, this equates to a contact value of $31,900, which can be compared to the dollar value of a Black Sea wheat futures contract of $11,375.

Below is an example of how the CME Russian Ruble futures contract can be used to hedge the FX component of a Black Sea wheat export transaction.

Scenario

In late August, a Russian wheat producer has an export order to a miller for 25,000 metric tons of wheat, to be delivered at the end of November. The agreed terms are for payment in US dollars at a rate equal to the CBOT Black Sea Wheat November futures price on the delivery day, minus $10 per metric ton.

Example transaction information

Wheat export quantity

25,000 metric tons

Agreed sale price

CBOT Black Sea Wheat November futures price minus $10 per metric ton

Current CBOT Black Sea Wheat November futures price

$223.25 per metric ton

CBOT Black Sea Wheat futures contract size

50 metric tons

Current CME Russian Ruble December futures price

$0.012970 per Russian ruble

CME Russian Ruble futures contract size

RUB 2,500,000

For the producer, this creates a two-month period of uncertainty as to the revenue that will actually be achieved. From a price risk management perspective, the producer is exposed to the price of Black Sea wheat, but as they earn their income, they are also exposed to the FX rate between the US dollar and the Russian ruble. Both price risk components can be hedged with futures.

The producer can manage their exposure to the wheat price using the CBOT Black Sea Wheat futures contract. In wheat, one futures lot equals 50 metric tons of wheat, therefore, a total of 500 lots of Black Sea wheat for November delivery will need to be sold.

The exposure to the wheat price can be hedged with CBOT Black Sea Wheat futures. With each futures contract representing 50 metric tons of wheat, selling 500 futures for the November contract month will effectively hedge this position with respect to the price of wheat.

The price of the CBOT Black Sea Wheat futures November contract is 223.25 dollars per metric ton. By selling 500 lots of futures at this price, the exposure to wheat price fluctuations will be hedged. With a price of 223.25 dollars per metric ton established through the use of the Black Sea Wheat futures hedge, the producer can be confident in achieving a dollar revenue of 213.25 dollars per metric ton on the sale of the wheat, which includes the agreed discount of $10 per metric ton with the miller. The FX component of the transaction can be hedged using the CME Russian Ruble futures contract (product code RU). To determine the hedge transaction required, the producer needs to determine whether to buy or sell futures and the quantity to be transacted.

Even though the CME Russian Ruble futures contract is a cash settled contract, buying one contract is equivalent to buying Russian rubles in exchange for US dollars. Selling the futures is equivalent to selling Russian rubles in exchange for US dollars.

The Russian wheat producer will wish to convert the US dollar proceeds into Russian rubles upon completion and delivery of the wheat, and therefore, will be buying Russian rubles. The associated FX risk exposure can be hedged by buying CME Russian Ruble futures contracts. These futures should be purchased to implement the hedge and sold to close out the position once the FX hedge is no longer required. This will create a “futures pay off” on the FX portion of the hedge ‒ being the difference between the price they paid and the price they closed the trade out at. Trading in the CME Russian Ruble futures terminates on the 15th day of the contract month, and if that is not a business day, then the business day after that3. This would make December the appropriate futures contract month to hedge this transaction since the CME Russian Ruble futures contract is listed in quarterly cycle serial contract months only.

The number of FX futures needed to hedge the transaction can be calculated by considering the currency exposure.  With the wheat futures hedge, the producer will expect to receive US$ 5,331,250 from the sale.

The futures price, quoted in US dollars per Russian ruble, is $0.012970, which is the equivalent of RUB 77.101 per US dollar. At this exchange rate the sale proceeds will be RUB 411,044,719. The contract size of the CME Russian Ruble futures contract is RUB 2,500,000, therefore, to hedge the FX exposure, the producer needs to buy 164 futures.

We can examine what might happen to this hedged position in different outcomes. To focus on the FX component, let’s assume that the wheat price is unchanged over the one-month period.

Outcome one: Using futures to hedge a declining Russian ruble FX rate

A decrease in the value of the Russian ruble can also be viewed as an increase in the value of the US dollar, measured in Russian rubles. In this example, we assume a decrease in value from $0.012970 to $0.012670 per Russian ruble, a decline of 2.3%. This can also be seen as a change in value from RUB 77.1010 per US dollar to RUB 78.9266 per US dollar.

With the wheat price stable at 223.25 dollars per metric ton, the US dollars proceeding from the sale are $5,331,250, and the return from the wheat futures hedge is $0. In local currency terms, the proceeds are RUB 420,777,427, which is higher than anticipated had the exchange rate not changed.  This higher outcome is offset by a loss made on the FX futures position. Overall, the cashflow has been maintained in line with expectations, which is the purpose of the hedging strategy.

 

Physical wheat

Physical RUB cashflows

Russian Ruble futures

Late August

 

Expected RUB 411,044,719

Buy 164 lots of December Ruble futures @ 0.012970

Late November

Sell 25,000 metric tons @ 213.25 dollars/ton

Actual RUB 420,777,427

Sell 164 lots of December Ruble futures @ 0.012670

Futures pay off

 

+ RUB 9,732,708

-$123,000

(- RUB 9,707,972)

Outcome two: Using futures to hedge an increase in the Russian ruble FX rate

An increase in the value of the Russian ruble can also be viewed as a decrease in the value of the US dollar, measured in Russian rubles. In this example, we assume a marginal increase in value from $0.012970 to $0.012980 per Russian ruble. This can also be seen as a change in value from RUB 77.1010 per US dollar to RUB 77.0416 per US dollar.

Again, with the wheat price stable at 223.25 dollars per metric ton, the US dollars proceeding from the sale are $5,331,250, and again the return from the wheat futures hedge is $0. However, in local currency terms, the proceeds are RUB 401,752,072, which is lower than anticipated had the exchange rate not changed. To compensate, the FX futures hedge position records a gain of $123,000, which equates to a gain of RUB 9,732,708.

 

Physical wheat

Physical RUB cashflows

Russian Ruble futures

Late August

 

Expected RUB 411,044,719

Buy 164 @ 0.012970

Late November

Sell 25,000 metric tons @ 213.25 dollars/ton

Actual RUB 401,752,072

Sell 164 @ 0.013270

Impact

 

- RUB 9,292,646

+$123,000

(+ RUB 9,269,028)

Conclusion

Black Sea wheat markets remain volatile and hedging price risk remains an important consideration. In addition, the volatility in foreign exchange markets can also be an unpredictable factor that firms are looking to hedge. By hedging foreign exchange risk, companies are able to stabilize future cash flows ‒ which in turn creates greater confidence in business performance.

The CME suite of Agricultural futures sit alongside a number of key Foreign Exchange futures contracts, providing participants with the key hedging tools to manage growing risks in the sector.

Salient features of the futures contracts discussed in this article.

Contract

Black Sea Wheat futures

Russian Ruble futures

Exchange Listing

CBOT

CME

Commodity Code

CME Globex: BWF
Clearing: BWF

CME Globex: 6R
Clearing: RU

Contract Size

50 Metric Tons

RUB 2,500,000

Quotation

US dollars and cents per metric ton

US dollars and cents per Russian ruble

Tick Size

0.25 cents per metric ton
$12.50 per lot

$0.000005 per RUB
$12.50 per lot

Listed Months

15 consecutive months

20 March quarterly contract months plus eight nearby non-March quarterly cycle serial contract months

Last Trading Day

Last business day of the contract month

Trading terminates on 15th day of the contract month

Settlement Method

Financially settled

Financially settled

Final Settlement Price

The floating price for each contract month shall be equal to the arithmetic average of the “FOB Black Sea wheat (Russia, 12.5%)” price assessment published by Platts for each day that it is determined during the contract month.

Reciprocal of the “RUB MOEX (RUB05),” which is the “Russian ruble per US Dollar” spot exchange rate, for settlement in one business day, reported by the Moscow Exchange (MOEX).


1 Source: USDA FAS (US Department of Agriculture Foreign Agricultural Service)

2 Source: USDA FAS (US Department of Agriculture Foreign Agricultural Service)

3 See https://www.cmegroup.com/trading/fx/emerging-market/russian-ruble_contract_specifications.html.

4 In this example, the exporter needs to buy 164.42 RUB futures contracts to hedge the FX risk. However, since the exporter can only transact in whole contracts, the exporter needs to round the number of RUB futures for the hedge to the nearest whole increment. The exporter thus buys 164 RUB futures to complete the FX hedge. This slight imprecision in the exporter’s hedge ratio, however, does not negate the overall purpose or effectiveness of the FX hedge.

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