Hedging 101 - Class Now In Session

The impressively lush bloom on the olives, curiously also reported in California, and the continued rain - this week another 80 l/sq.m. - have the early predictors up and running. Already, with the flowers not yet fallen in many places, we are hearing prognostications of a record 2008 crop. That would mean around 1.5 million metric tons and increase of 35% over this year's average-ish harvest. Among the events that the intervening seven months can bring to bear on this outcome would immediately stand out the lateness with which the flowers are appearing and the corresponding extreme likelihood of the sudden arrival of a spell of very hot weather - from which we have so far been spared this spring. A few days of temperatures approaching the 35ºC while the fruit is in its infancy will put an end to that kind of talk. This is not to say that there is any indication of that happening. Mid-morning today the temperature was about 11 degrees accompanied by heavy rains.

Keeping in mind that world prices do not depend entirely on the Spanish climate in any given year, it might be worth a look at the progression of olive oil prices in 2004, in which this country was blessed with the current record crop of 1.4 million metric tons of oil.

In December 2003, with the harvest just starting to show up at the mills and the normal panic over the possibility of further falling prices coupled with concerns over storage capacity, about 35 million kilos of extra virgin olive oil went out the doors at an average price of 2.07€ per. That was as bad as it got, by April the average price paid having risen to 2.66€/kilo. Seems that rising demand was suddenly thought to be sufficient to make up for the bumper crop after all.

The next noticeable event is the fairly abrupt drop in the month of August. This is probably explainable through the generalized belief in these parts that prices in fact rise in that month. Alot of oil, then, is held back through the slow summer season in anticipation of that happening... and when it doesn't. Boom! Prices quickly fell to the mid 2.30's and remained there for the exercise. Incidentally, the holy grail is the three euro mark, the equivalent to five hundred pesetas, and many producers fish for it every year - seldom is it hooked, we might add. The table shows that year's progression.

We can't really talk of the rôle the olive oil futures market, MFAO, might have played in this scenario. It opened in February of 2004, but really was not to start attracting attention as an alternative until a year later. But a look at the current relationship between current cash and futures prices shows that the commercials are really not taking advantage of its facilities to smooth out these very large interannual swings. As we have mentioned before, it is mostly being used as a second cash market, probably to the detriment of the system.

The MFAO serves as a platform for trading the lesser lampante grade olive oil, which naturally crosses at a discount to extra virgin or virgin. But, in theory, it should move lock step with the other classes and serve as a hedging vehicle for all grades - especially given its use as filler for oil sold as EVOO in a certain boot-shaped Mediterranean nation. The chart we have compiled from data at the MFAO and PoolRed websites shows that, this year, that was not the case. The ten weeks prior to May delivery show a spread between the futures and cash EVOO ranging from three and a half cents to almost twenty three by closing, this culminating in an overnight ten cent drop in the lampante spot on May 21, as 3 million kilos were crossed in one day. Ibex Salad is not alone in suspecting that these were wash trades orchestrated by a few large, herein unnamed, bottlers to put the fear of the lord into recalcitrant co-op directors.

That notwithstanding, it is fairly evident that millers and producers missed, probably through a lack of understanding of the function of the MFAO, a glorious opportunity to lock in a premium of 20-odd cents a kilo. 'But what about the skinny volume?', the reader asks. Point taken, but have a look at the July contract (May no longer available for perusal) first bid and ask at close. From the beginning of March to when the spread hit ten cents - still a bargain - on April 10th, a producer could have hedged 1.4 million tons. And this without our being able to dig down into the depth of market, and only being for July delivery. For the sake of argument, we'll only triple the figure. Of course, the hysteria of the moment was that prices were going to hit the three euro mark, so nobody bit. But we'll be asking our co-op chief a couple of questions if it turns out he sold at an average of 2.50€ the kilo.