By Nelson Low, executive director
for commodity products, Asia, CME Group
China’s huge appetite means
it is almost always a factor in setting the price on a range of
commodities. Now we see a new trend, as China is not just
buying pork and soybeans on international markets, but gobbling
up a range of international food and agricultural companies as
This is significant because we can now
expect Chinese buying to ripple not just across agricultural
commodity markets, but also international derivative markets,
as companies seek to manage the risks that come with these
As Chinese companies find themselves with
newly-acquired foreign operations, including a plantation in
far-flung Kalimantan and a wheat mill in Belgium, they have
also acquired much of the know-how and expertise needed to use
derivatives to manage risk in cyclical commodity
There is also a leapfrog in size:
following these acquisitions, the new entity will have a bigger
balance sheet, which confers more buying power on international
commodity markets and thus its related futures. In effect, the
Chinese book will get bigger.
This outward pivot happily coincides with
efforts to internationalise the Renminbi and liberalise the
capital account. These foreign acquisitions can only nudge this
process forward as the RMB gains further acceptance and
recognition as a currency of settlement.
Rather than just stockpiling commodities,
the authorities see the need to improve wider industry
efficiency through consolidation and acquisition.
There are a number of reasons to believe
this trend will continue.
For one, it appears to be a
state-supported policy. Ding Xuedong, chairman and CEO
of China Investment Corporation (CIC),
China’s sovereign wealth fund, has publicly stated
in a recent op-ed piece in the Financial Times that
CIC "wants to invest more in agriculture around the world and
across the entire value chain".
This in part comes back to
China’s changing appetite as Beijing seeks to
rebalance the economy to prioritise consumption over
investment. As household incomes rise, this also means people
are eating better, with a greater demand for more
protein-intensive diets and higher quality produce.
In the past, Chinese meat producers have
rarely used derivative risk management tools as they have been
primarily focused on domestic production. But this has changed
with the purchase of Smithfield, as now WH Group will have to
manage risks internationally.
These risks have been apparent this year
as volatility in pork prices related to the porcine virus in
the U.S. has been accompanied by steep price increases.
Equally volatile, beef prices have seen a similar price trend
(thankfully not due to illnesses). The U.S. had one of the
smallest cattle herds on record in 2013.
Another area where we have seen new buying
activity is in agricultural commodities, where China National
Cereals, Oil and Foodstuffs Corp (COFCO) has been on the
acquisition trail. This year it bought a 51% stake in Noble
Group’s sugar, soyabean, and wheat operations for
$1.5bn, which came on the heels of it buying a similar stake in
Dutch trader Nidera.
These acquisitions represent a departure
from previous food security policies where China has focused
primarily on supporting internal production, or building up
stockpiles of agricultural commodities.
Here again, these new companies will
provide COFCO with considerable expertise on using global risk
management techniques and potential efficiencies through the
consolidation of multi-continent supply chains. This is
likely to accelerate the process of Chinese companies becoming
accustomed with using derivatives contracts to manage
Dairy is another important food industry
where China is taking steps to improve efficiency by
accelerating consolidation efforts. Here China is already
the world’s largest importer of dairy products, a
demand which in recent years has contributed to pushing up
The government has publicly stated plans
to consolidate the industry with the creation of about 10
large milk-powder groups, each with annual revenue of more
than two billion yuan ($323m). Further out, it plans to
shrink the number of companies to three to five large
milk-powder groups with annual revenue of more than five
billion yuan each.
By forming enlarged entities with larger
operations dealing in greater quantities of milk, it also means
a bigger price risk exposure.
These new Chinese dairy juggernauts will
have little choice but to turn to domestic and international
dairy futures exchanges, like CME Group and New Zealand
Exchange, to hedge their price risks.
Of course, using derivatives successfully
and effectively to manage risk takes time. What we have
sometimes seen in the past in less developed markets is a
tendency to first dabble in derivatives to put on speculative
positions. This can be costly and lead to a "once bitten
twice shy" outcome.
Yet equally there are pitfalls if
companies abstain from using risk management tools with the
misguided notion this is being risk adverse –
especially when operating in global markets.
One example of this is if you go back to
the 2004-2005 China soybean crisis, where many domestic
producers were unprepared for intense price volatility. The end
result was that a large number of Chinese entities had to sell
out to multinational firms.
Ultimately, the lesson here is that
agricultural and food companies need to learn how to use
derivatives effectively to manage risk in today’s
volatile and inter-linked global commodity markets. If
they can, this will boost efficiency, profitability and ensure
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