How far away is the era of futures-based agriculture? Cotton farmers no longer have to gamble on the market
1. With seed cotton “futures”, cotton farmers no longer have to “gamble” on the market
In the eyes of the villagers of Dongjiawan Village, Dong Yuanfa is a “veteran cotton grower.”
Dongjiawan Village is located in Qixingtai Town, Zhijiang City, Hubei Province, and is a major local cotton-producing area. Dong Yuanfa, now 56 years old, started growing cotton at 18, and in the blink of an eye it has been nearly 40 years.
Years of cotton-growing experience have made Old Dong fully feel the power of the market. “Growing cotton does not use much machinery, and it takes a lot more effort than growing other crops. After toiling for more than half a year, all you count on is selling it for a good price after autumn. But the market price is really impossible to predict; with every rise and fall, your pocket can be quite different.”
In the 2010—2011 cotton year, domestic and international cotton prices saw a rare and violent fluctuation of “first doubling, then halving.” The wildly rising and falling market caused many cotton farmers to lose out. But that year Dong Yuanfa not only did not lose, he also earned quite a bit more. His “magic weapon” for making money against the trend was seed cotton “futures.”
Dong Yuanfa said that in 2011, he signed a 4,000-jin “futures” order with a cotton cooperative under Hubei Baiyin Cotton Industry, agreeing on a price of 6.5 yuan per jin. His 10 mu of cotton fields produced a total of 6,000 jin of seed cotton. “That year the cotton price jumped badly. By the time I settled with the cooperative, the market price was only 4.35 yuan/jin. My 4,000-jin order instantly brought in 8,600 yuan more. At the time I was really too conservative; if I had signed more, I could have earned even more.” Even now, when mentioning this, Old Dong still regrets not having been bolder.
Seed cotton “futures” are not a formal trading product in the futures market; in fact, they are orders signed by cotton farmers with cooperatives. Li Chun, general manager of the Agricultural Products Division of Hubei Baiyin Cotton Industry Group, introduced that, like ordinary orders, seed cotton “futures” contracts also stipulate that cotton farmers must sell seed cotton that meets grade requirements to the cooperative on time and in the agreed quantity at the contract price.
But unlike ordinary orders, in this kind of order the enterprise has already used the futures market for hedging to lock in the sales price of the agricultural product in advance. The purpose of signing the contract is that the contract purchase volume and the hedging volume are basically equivalent. The purchase price agreed in the contract is determined by working backward from the price at which the enterprise participates in hedging in the futures market. In order to control farmers' contract performance risk, the contract requires farmers, when signing the contract, to pay the cooperative a deposit equal to 15% of the contract amount. Li Chun said, “This model is equivalent to farmers indirectly using the futures market for risk management, stabilizing their income. Before even sowing, they already know the sales price of cotton and no longer have to gamble on the market.”
In fact, in addition to locking in the sales price in advance, Dong Yuanfa could also obtain seeds and fertilizer supplied uniformly by the cooperative. During the planting process, the cooperative provided farmers with technical guidance by organizing technical training sessions and building high-yield demonstration bases. It also built an SMS platform to send farmers information such as cotton growth characteristics and field management key points, and cotton spot market trends, and guided farmers, when seed cotton came to market, to pick, dry, store and sell separately by grade. “The reason for doing this is to control quality from the source. Only with good quality can the enterprise's operating efficiency be guaranteed, and only then can the enterprise pass it back to farmers through the order price.” Li Chun said.
2. Make flexible use of futures to insure “contract farming”
Today, the global agricultural product market has entered a high-risk era of severe price fluctuations. As domestic and international markets become increasingly closely linked, and domestic and international uncertain factors transmit to each other, China's agriculture has also entered a stage of high input, high cost and high risk. Natural risks, quality and safety risks, and especially market risks, are having an increasingly prominent impact on agricultural production and operation.
The stable development of agriculture depends to a large extent on the prevention and control of risks. In traditional agricultural production, small farmers facing a large market find it difficult to avoid the impact of market price fluctuations. In response to this drawback, the rise of contract farming has to some extent stabilized farmers' income and psychological expectations, but in practice, the risk of agricultural product price fluctuations is to a large extent shifted onto enterprises. When market prices are high, farmers' risk of breach of contract is high; when market prices are low, enterprises face losses.
In response to this problem, in recent years some leading enterprises in agricultural industrialization have begun, on the basis of contract farming, to explore futures-based agriculture, a new type of agricultural production and operation model, that is, introducing the futures market into agricultural product planting, procurement, processing, sales and other production and operation processes. At present, the most widely applied is the “company + cooperative + farmer, order + futures” cooperation model of Hubei Baiyin Cotton Industry.
Experts believe that the biggest advantage of futures-based agriculture lies in forming an effective interest linkage mechanism. On the one hand, enterprises are linked with specialized cooperative organizations and farmers through orders; on the other hand, enterprises are linked with the futures market through futures. Li Chun said, “Enterprises use the futures market to discover prices and determine order prices more reasonably. When the order price is high, it can stabilize farmers' income expectations; when the price is low, it can help farmers adjust their planting structure. At the same time, by participating in hedging in the futures market, enterprises avoid the risk of agricultural product price fluctuations and lock in profits.”
Another advantage of futures-based agriculture lies in risk transfer. Market risk is eternal. The huge market risk faced by agricultural production cannot be completely eliminated by introducing futures, but through enterprises' hedging operations in the futures market, the risk between enterprises and farmers can be transferred to the futures market. From foreign experience, the coordination of the agricultural product spot market and futures market helps form a reasonable price system.
Futures-based agriculture can also promote the upgrading of the agricultural industry. The futures market has strict quality inspection standards for delivered physical goods. According to national standards or standards stipulated by futures exchanges, agricultural industrialization enterprises will devote themselves to improving production technology and processes and improving quality. The government and agricultural production entities will also increase investment in water conservancy, science and technology, machinery, and improved seed cultivation, improve standardized production capacity, and thereby drive industrial upgrading.
3. Improve policies, innovate tools, and strengthen the construction of the agricultural risk management system
Jiang Yang, vice chairman of the China Securities Regulatory Commission, recently said that China's futures market has now listed 21 agricultural product futures varieties, and a variety system covering grain, cotton, oil and sugar has basically taken shape. As the number of varieties increases, more and more agriculture-related entities are using the futures market to manage production and operation, and connecting with other financial tools to achieve effective risk management.
But on the whole, the current agricultural risk management and service system is still not sound enough. To further improve the quality and level of the futures market in serving “agriculture, rural areas and farmers,” many problems still remain to be solved.
As for the model of Hubei Baiyin Cotton Industry, namely “company + cooperative + farmer, order + futures,” although a deposit system was designed to avoid farmers' breach of contract risk, relying only on existing futures tools is not foolproof. For example, when the market price is 15% higher than the order price, farmers may still breach the contract, but if the deposit is raised further, it will increase the burden on farmers. Therefore, experts suggest that China should study and launch agricultural product options to facilitate agriculture-related enterprises and farmers in managing agricultural product price risk more effectively. Farmers or cooperatives can directly buy put options to manage the risk of agricultural product price declines, or enterprises and farmers can sign a floor-price order in advance, and the enterprise can then buy agricultural product put options in the futures market to hedge the risk exposure it faces.
The futures market is a standardized market and has specific requirements for agricultural product quality and delivery regions, but the domestic agricultural product market is broad and scattered, and quality uniformity is still not strong. In particular, fresh agricultural products can hardly meet standardization requirements. In the future, the futures market needs further breakthroughs and innovation, relying on the exchange-traded market to strengthen the construction of the over-the-counter market, amplify market functions, and further enrich and improve services for the agricultural industry.
At present, various domestic financial and intermediary institutions still lag in cooperating with the futures market to advance services for “agriculture, rural areas and farmers.” Banks have not clearly defined the relationship between agriculture-related credit and hedging, and the “futures + insurance” business is still in its early stage of development. Relevant experts from the Dalian Commodity Exchange proposed attracting broad participation from various financial and intermediary institutions to provide new products, new tools and new services for solving difficulties in agricultural financing, expanding agricultural insurance, and meeting the risk management needs of agriculture-related enterprises.
At present, smallholder production by individual households still occupies the dominant position in China, and farmers' awareness and ability to participate in the futures market still need to be enlightened. In recent years, the scale of new agricultural operating entities has continued to expand. They are more sensitive to market risk and more eager for effective risk management methods, but most still do not have the awareness to use the futures market to avoid risk. In the future, greater efforts are needed to cultivate farmers' modern market awareness, guide them to learn to use the futures market, grasp the initiative in production and operation, improve their ability to navigate the market, and escape the dilemma of “increased output without increased income.”