How hedging U.S. commodity prices helps manage risk
The Canada-U.S. dollar exchange rate is one of the factors determining the profitability of your farm. Currency markets are so volatile, every bit of national or international news can impact the exchange rate and, therefore, your bottom line. Hedging tools can eliminate these unpredictable fluctuations from your profitability equation, but few farmers are taking advantage of them.
Three years ago, Brian Hildebrand, a diversified grain producer from Foremost, Alta., started taking out currency options with his financial institution to hedge his U.S. sales after deciding he needed to find better ways to manage how and when he was converting his sales into Canadian dollars. Now Hildebrand locks in his exchange rate for all his crops priced in U.S. dollars.
Currency markets are so volatile, every bit of national or international news can impact the exchange rate and, therefore, your bottom line.
“Wheat prices (for example) are set on the Minneapolis or Kansas City exchanges, so even if you sell your crop to a Canadian buyer for Canadian dollars, you have some currency risk,” Hildebrand explains. “There can be a two or three per cent currency fluctuation in very short order.”
“A large portion of the commodities that Canadian farmers produce are hedged through the Chicago Mercantile Exchange or CME,” says Anil Aggarwal, a foreign exchange dealer with EncoreFX in Ottawa. “This creates a disconnect because whether you’re selling your product in Canada or the United States, you’re fixing the price based on the U.S. dollar. This creates currency risk.”
If you only price in a slight profit margin in the spring based on a 72-cent dollar, you might have a problem if the dollar rose back to 75 cents by the time you delivered in the fall. Your wheat, corn or cattle would be selling for 4% less than you expected.
“Doing nothing leaves you totally exposed to fluctuations in the spot market at the time of your sale,” Aggarwal says. “Sometimes you win, sometimes you lose. However, there are different ways to manage this risk. Options and forward contracts, for example, allow you to lock in a rate for a set period of time.”
These types of contracts can be fully customized for amounts and dates, Aggarwal says. You could take out one that would lock in a 72-cent dollar for 100% of your contracted sale on your delivery date if you wanted to completely offset your currency risk, or one could offset 60% of the amount to allow for participation in favourable market movements.
“Hedging your dollar is just another level of risk management,” Hildebrand says. “The first step is recognizing the risk you’re facing. After that, it’s really no different than hedging wheat, cattle or any other commodity.”