Derivatives program to smooth GrainCorp earnings

Derivatives program to smooth GrainCorp earnings


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GrainCorp is hoping financial risk management products will help protect it against climatic variability.

GrainCorp is hoping financial risk management products will help protect it against climatic variability.

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GrainCorp announced last week it plans to use a derivative product to help mitigate production risk.

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IT FLEW underneath the radar last week with GrainCorp's announcement it plans to demerge its malting business from its other income streams, but the grain storage and handling giant's plan to use derivative financial instruments in its bulk handling business to minimise risk could be a massive move for the company.

While full details of the derivatives concept are not yet publically available, the company confirmed it would be a 'cap and collar' type product in regards to total east coast grain production.

If total east coast production is below a certain nominated tonnage GrainCorp will receive a per tonne payment for every tonne below the figure, while in good seasons, there will be a payment for every tonne above the nominated threshold.

The system is not an insurance product such as a form of multi-peril crop insurance, instead it is believed GrainCorp will work with an as yet unnamed company who will provide a service similar to a put or call option on futures markets.

Options on futures markets give buyers and sellers the right to buy or sell at a predetermined price for a fee, limiting exposure to upside or downside risk, which, in GrainCorp's case would mean it could limit the downside risk on production.

It is believed the system will be based on total production on the east coast, not on GrainCorp receivals, as that is a part of the company's core business and something it should be able to manage itself in terms of winning a particular share of the market.

It is also understood there will be no weather derivatives used, with all calculations based purely on east coast grain production.

The rationale in paying for a risk management product rather than simply self-managing by storing capital to access in poorer seasons for necessary works is that it is a lot less capital intensive and allows the company to freely invest when needed no matter the current seasonal situation.

While Long Term Asset Partners (LTAP) mentioned the use of risk management products in its pitch for GrainCorp last year, it is believed the GrainCorp proposal last week is a result of internal research and planning developed separately to LTAP's yet to be publicly disclosed ideas.

The grains industry will be watching the developments with interest. Intensely variable seasonal conditions in Australia have been identified in the past as one of the key constraints in unlocking outside capital for investment in Australia's ag sector, and if the derivatives system successfully smooths out the peaks and troughs of earnings, others are sure to look carefully at similar concepts.

The story Derivatives program to smooth GrainCorp earnings first appeared on Farm Online.

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