The Indian edible oilseeds and oils industry is keen to see commencement of futures trading after it was theoretically thrown open by the government last month. Futures trading was discontinued in the late 1960s.The oilseeds industry, with support from groups of producers, traders, processors and end-users, had been asking for permission to re-introduce futures contracts in oilseeds, oils and oilmeals. Following the indication in his budget proposals of the finance minister, the government has given a go-ahead for futures trading in the edible oilseeds complex (seeds, oils and meals).
While the go-ahead has been given, the oils consuming industry, seeds and de-oiled meals trading community await the actual commencement of futures trading at various commodity exchanges.
The advantage of futures trading in the oilseeds industry is that the trading can take place simultaneously in several commodity exchanges depending on the regional importance of each oilseed crop; and having a trading counter at otheroilseeds exchanges and thus, integrating it throughout the country.
For example, the cultivation of groundnuts is more in the state of Gujarat and soyabean in Madhya Pradesh due to climatic conditions, giving it a significant regional importance.
Oilseeds are normally not for direct consumption. They are first processed by the small scale crushers and the extracted oil is sold in national and international markets.
At this stage one has to be clear about the two groups of oils. Major edible oils are groundnut, soyabean, sunflower and rapeseed/mustard and vanaspati while major non-edible oils include ricebran, castorseed and coconut oil.
Between these two main groups, substitution is difficult. Within non-edible oils, even though substitution possibilities are not perfect, manufacturers are often able to change their production process to some degree, shifting from one oil to the other in response to relative price movement.
Edible oils are more substitutable than oilseeds, and, baring movementrestriction they can be transported quite easily. Consequently, oil prices are usually well co-related over the long run.
The crushing margins are highly volatile which makes it a necessary for introducing risk management tools. The Indian oilseeds processors have very few means of defending the processing margins when world prices move against them.
Futures market could provide the oilseeds industry with the much-needed risk management tool to compete more effectively. It should be noted that edible oilseed contracts are likely to complement edible oil contracts. This is true from the fact that edible oilseeds contract alone, could have a difficult life because it is likely that they will not attract much interest from the oilseeds processing industry.
Once futures trading in edible oils would be introduced, the demand by oilseeds processors for the combination of both -- oilseeds and oils futures contracts -- is likely to be large as it will give them the ability to estimate and secure their futureprocessing margins.
An effort will have to be made to generate participation from the trading and indirectly, from the farming community -- through commission agents, oilseeds growers' associations and co-operatives -- in order to generate market liquidity. Futures trading in castorseeds has been conducted in some three commodity exchanges at Mumbai, Ahmedabad and Rajkot. The importance of futures trading therefore, in castorseed and its oil would be clear with an example. (Futures trading in castor oil is expected to commence soon at Mumbai.) Let us presume a castor oil mill enters into an export contract for the June shipment at $705 per tonne, that is, a value of Rs 30,000 per tonne considering dollar-rupee rate of Rs 42.55 (or Rs 3,000 per quintal).
If the spot price of seeds is Rs 1,460 per quintal, the mill would have to buy 2.5 quintals of seeds to get an output of one quintal of oil (this is a standard ratio).
If they do this, then on adding the crushing and other overheads of the mill theentire cost would be as under:
Spot purchase of seeds: Rs 1460 X 2.5 quintal = Rs 3,650
Crushing cost (inclusive of labour overheads) = Rs 125
Total cost = Rs 3,775
Sale price = Rs 3,000
Loss per quintal = Rs 775Now, if the futures price for seeds was at Rs 1,450 per quintal and the mill had purchased one futures contract (which is standardised at the exchanges at 50 quintals per contract). A rise to Rs 1,465 in futures price in May, when the seeds are required for crushing and the spot price is also Rs 1,465 -- the miller can square up the futures contract and purchase the seeds in the spot market. Thus, his result would be:-
Spot purchase of seeds: Rs 1,465 X 2.5 quintal = Rs 3,662
Costs = Rs 125
Total costs = Rs 3,787
Sale price = Rs 3,000
Gross loss = Rs 787
Futures profit (1,476 - 1,450) X 50 quintals = Rs 800
Net Profit = Rs 13The important strategy required here is the timing and pricing of the futurescontract with the spot trading and one's production cycle. There are various situations which occur and hence, an expertise of a hedge consultant is required.
On the whole, the commodity futures markets will provide farmers, traders, processors and exporters a mechanism for hedging their risks and improving price discovery in their forward planning decisions. At the same time, the benefits of futures trading would extend beyond the boundaries of individual firm activities. Marketing, storage and processing margins will narrow as a result of the reduction of the costs associated with uncertainty and risks, to the benefit of growers and consumers. By providing a mechanism for price discovery, futures markets helps growers, traders and agro-processors to make better production decisions.
(The author is the CEO of Prophecy Investments, a commodities risk management and trading consultants)
Copyright © 1999 Indian Express Newspapers (Bombay) Ltd.
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