Food commodity exchange programme

The commodity exchange functions are very similar to those of a stock exchange. The exchange provides the facility (the trading floor and the trading pits) for futures trading, a governing board which establishes and enforces trading regulations, and the clearing house, which operates the mechanism of ‘clearing’ all transactions on a daily basis and which accounts for the flow of funds on each trade (Schaffner et al., 1998). Such transactions require reliable market information systems, particularly in developing countries, such as in the SADC region. This need in Southern Africa comes from the realisation that limited scope and restricted access to market intelligence is a

major handicap to the efficient operation of liberalised food markets. Without such a system, the development of external trade with regional and international markets will also be handicapped.

Lack of knowledge on price levels, trends, freight rates, locations, trade arrangements and food requirements in neighbouring countries and regions stifles agricultural development. Producers and traders benefit from access to better information on the regional and world market trends in terms of prices and quantities (SADC/FAO, 2002). The objective is to explore and develop a system to improve market-based grain purchasing and procurement options, including commodity exchange and futures markets, such as the SA Futures Exchange (SAFEX). The information system will develop the following: (1) the collection and dissemination of regional marketing information on grains, especially that relating to maize, wheat, beef, etc., including the quantities, quality, prices and locations of regional supplies, and (2) the promotion of a regional commodity exchange/futures market, and facilitation of the purchasing of options utilising the revolving regional Food Reserve Trust Fund by linking national commodity exchanges (SADC/FAO, 2002). This section aims to determine whether hedging through futures and options strategies by way of private commodity exchanges either to contract for forward supplies of grains at a fixed price at a future date, or else the buying of the (tradable) option in order to acquire grain at a given price at some future time, is an alternative to public stocks.

According to Devereux (2003), a final alternative to physical grain stocks is the use of futures markets by national governments or SADC as food security insurance. In 2001, SADC Ministers of Agriculture commissioned an investigation into this mechanism, which concluded that it should be seriously considered as one component of a diversified portfolio of risk management strategies against food security threats. According to Devereux (2003), SAFEX was identified as potentially having the capacity to manage this scheme, which would, in short, function as follows: Following first-round production forecasts (which would usually take place in February in SADC countries), the relevant governments (and/or private traders) would decide whether to purchase an option from SAFEX to buy maize at a fixed price at a future date – say September or December, depending on the size of the projected maize deficit. The cost of this option, at 5% to 10% of the total purchase cost, is the ‘insurance premium’ that will either be taken up, sold on or allowed to lapse, depending on the actual harvest outcome. If managed at the regional, rather than at the national, level, such an approach has the potential to promote intra-regional trade, to strengthen the role of private actors, and to reduce the need for national governments to hold either large physical grain stocks or large financial reserves (Devereux, 2003). In line with FEWS NET (2001) offers to governments and the

private sector, SAFEX offers a cost-effective alternative to holding large physical stocks of staple commodities, such as maize (yellow or white) and wheat. These commodities can be purchased in South Africa, well in advance of the upcoming marketing season. For example, as soon as a country realises that its domestic maize supplies are likely to be in short supply, it could obtain the necessary tonnage of maize through SAFEX by purchasing call-options on futures contracts for delivery, say in September and December. Doing so would allow countries to secure and guarantee the physical availability of the commodity at a specified price (FEWS NET, 2001).

Grain producers, traders and processors will be able to trade better in a ‘free’ market, responding to the forces of supply and demand in setting prices, if the proposal (see Appendix 2) that calls for the introduction of a second (new) futures contract, which will allow physical settlement through the use of maize of an international origin, is implemented. In practice, they all look to the prices generated through the formal commodities market that was established following deregulation, namely the Agricultural Markets Division of SAFEX, as the benchmark for the prices they ask or offer in the ‘spot’ market of daily trading in maize (Vink & Kirsten, 2002).

The Marketing of Agricultural Products Act of 1996 smoothed the way for a new marketing order in the South African grain industry. SAFEX was formed in 1996/7, and introduced the trading of derivatives (futures and options) for white maize, yellow maize, wheat, sunflower and beef (though the contract for beef was later cancelled). The price for future contracts and options are generated on the exchange in the form of ‘bids’ and ‘offers’ and reflect the views of market participants on the prices of the specific products at different dates in the future. These instruments are also used to hedge price risk. By using the SAFEX market effectively, market participants can minimise their price risk, which, in turn, lowers their cost of doing business. These savings can then be passed on to the consumer in the form of lower prices for food and other commodities.

Therefore, part of the reason for holding stocks is to guard against the price risk of food grains only being available at high prices when needed. An alternative to public stocks is to use private commodity exchanges either to contract for forward supplies of grains at a fixed price at a future date, or else to buy the (tradable) option to acquire grain at a given price at some future time. If there are enough buyers and sellers, such exchanges promise participants a range of possibilities that fit their needs for flexibility and for the degree of risk they are willing to bear. Within SADC, SAFEX, which is based in Johannesburg, is the largest such exchange (Gravelet-Blondin, 2003,

cited in Wiggins, 2003).

FEWS NET (2006) indicated that South Africa has managed to ship out a total of 1.33 million MT (of the available surplus of 5.50 million MT) of white maize to destinations all over Africa, with 1.26 million MT going to SADC member states. The largest single recipient country has been Zimbabwe, which received a total of 781,735 MT (between May and January), while drought- affected Lesotho, Mozambique, Malawi, Swaziland and Zambia together purchased 273,000 MT.

According to FEWS NET (2001), the actual need to keep physical reserve stocks varies from country to country. The costs involved in physically storing large quantities of cereal stocks are often high, typically ranging between US$20 and US$40 per tonne per year, depending on storage and other costs. The availability of SAFEX options may well reduce the real need for physical reserves, and could result in substantial cost savings. If such a strategy were to be adopted, a regional financial reserve could be established in the event that stocks secured through SAFEX are actually purchased.