a better market mechanism for agricultural commodities overview

Developing Agricultural Commodity MarketsThrough a Better Trading Platform

13th Annual Farmer Cooperatives Conference

Cooperatives: Looking Forward

December 6-7, 2010

Brad Miller, Vice PresidentPractice Leader of Auctions & Competitive Bidding

Copyright © CRA International. All Rights Reserved.2

A Better Market Mechanism for Agricultural CommoditiesOverview

Market design

Implementation – a case study

Results

The future


Market DesignChallenges

• Challenges for all market participants– Negotiations are time-consuming and costly

– Parties wonder if they got the best deal

– Limited ability to manage risk and uncertainty

– Information and transaction costs are too high

• Challenges for coops and its members– Need price transparency and reliable price signals

– Need credible information about current and future market conditions

– Need to manage price and quantity volatility

– Coops must continually demonstrate value to members


Market DesignAdvantages of well-designed, structured bidding mechanisms

• Can be designed to best meet the needs of both buyers and sellers

• Ability to achieve various goals

• Fair, open, transparent, objective, non-discriminatory, quick process

• Minimizes information and transaction costs

• Effective price discovery mechanism and quantity allocation

• Maximizes participants’ interest and participation

• Those who value the product the most will win, optimizing prices and revenue

• Win-win for both buyers and sellers– No regrets, no complaints– Can use resources better, administer contracts more efficiently, make better planning

decisions– Value pie is made larger


Market DesignHow do you design the market mechanism?

• Confirm the objectives

• Define the products, draft the contracts– Substitutes vs. complements

– Common value vs. private value

• Identify the participants– Few vs. many, current vs. new entrants

– Range of reasons for participating

• Then, determine the optimal market design to meet the needs– Forward auction – one seller, many buyers

– Reverse auction – one buyer, many sellers

– Multi-seller, multi-buyer exchange

• Develop the detailed auction rules

• Host Information Website and Bidding Website


Market DesignAgricultural commodities -- auctions

Bi-lateralContracts

Opaque

StructuredProcess (RFP)

Informal Negotiations

Flexible Standardized

FormalAuction

The greyzone

Auctions provide significant process efficiency, price discovery, and risk management benefits

Well-constructed auctions will assign products to those who value the products the most

There is flexibility in auction design – must be tailored to meet the objectives of the buyers and sellers

Transparent


ImplementationCase study: globalDairyTrade

Fonterra is leading dairy exporter, one of the world’s largest dairy producers

gDT’s vision: to be trusted by buyers and sellers to discover current market prices for the products being traded and will be accepted globally as a reference price for associated markets

gDT platform now recognized worldwide as establishing credible market prices used in the dairy industry

Dozens of products and contracts auctioned simultaneously

Monthly events starting in July 2008, twice-per-month starting September 2010

Market format is a simultaneous, multiple-round, ascending-price “clock auction”– Bidding occurs round by round

– Price for each product announced before each round

– Bidders bid desired quantities at the announced prices

– After a round, if a product’s demand > supply, then increase the product’s price for next round

– Auction closes when demand = supply for each product

– Allows for price arbitrage (substitutes) and optimal bundles (complements)


Customers can bid on any or all of the contract periods, and change their bids between periods and products as the prices change

Example:

March June September December

March Trading Session

Contract 1:

Contract 2:

Contract 3:

Key:

Shipment Lag

Shipment Period

May

Jun Jul Aug

Sep Oct Nov

ImplementationCase study: globalDairyTrade


How does globalDairyTrade work?T

OT

AL

BID

S R

EC

EIV

ED

PRICE ANNOUNCED EACH ROUND

This is offer price – this increases during

the event

This is the volume of bids received – this decreases

as price increasesFonterra announces the volume that it wishes to sell

Volume on

Offer


TO

TA

L B

IDS

RE

CE

IVE

D


Volume on

Offer

$2000 $2100 $2200 $2250 $2300 $2325 $2350

And the starting price

Customers bid the total volume that they wish to purchase at the starting price

EXCESS DEMAND

When total demand from all bidders exceeds volume on offer so the price is increased

How does globalDairyTrade work?


$2000

TO

TA

L B

IDS

RE

CE

IVE

D


Volume on

Offer

$2000 $2100 $2250 $2300 $2325 $2350

Customers re-bid at the new, higher, price

Demand still exceeds volume on offer so price is increased again

EXCESS DEMAND

$2200$2100



$2000

TO

TA

L B

IDS

RE

CE

IVE

D


Volume on

Offer

$2000 $2100 $2250 $2300 $2325 $2350

Bidders re-bid at the new higher price

$2200$2100 $2200



$2000

TO

TA

L B

IDS

RE

CE

IVE

D


Volume on

Offer

$2100 $2250 $2300 $2325 $2350

Bidders re-bid at the new higher price

$2200

The price continues to increase and each round bidders re-bid at the new higher price

PRICE INCREASES

DEMAND DECREASES



$2325$2000

TO

TA

L B

IDS

RE

CE

IVE

D


Volume on

Offer

$2100 $2250 $2300 $2325 $2350

The price is increased until the amount bidders are willing to purchase equals the amount we want to sell

$2200

THIS IS THE PRICE THAT ALL BIDDERS PAY



www.globaldairytrade.info


Results: gDT Prices Compared to Corn Prices

0

20

40

60

80

100

120

Jul-08 Oct-08 Jan-09 Apr-09 Jul-09 Oct-09 Jan-10 Apr-10 Jul-10 Oct-10

Pri

ce In

dex

= 1

00 f

or

July

200

8

gDT Price Corn Price


Results: gDT Prices Compared to Soybean Prices

0

20

40

60

80

100

120


Pri

ce In

dex

= 1

00 f

or

July

200

8

gDT Price Soybean Price


Results: gDT Prices Compared to Wheat Prices

0

20

40

60

80

100

120


Pri

ce In

dex

= 1

00 f

or

July

200

8

gDT Price Wheat Price


Results: gDT Prices Compared to Cotton Prices

0

20

40

60

80

100

120

140

160

180

200


Pri

ce In

dex

= 1

00 f

or

July

200

8

gDT Price Cotton Price


Results: gDT Provides Transparency and Credibility

• Over 300 qualified customers from 56 countries– 100-140 bidders active in round 1 of each trading event

– About 65% of the bidders win product

• 32 trading events (July 2008 through November 2010)– Over US$ 2.5 billion transacted

– 700,000 MT (1.5 million pounds) transacted

• More products and volume have been added to the platform– Skim milk powder, whole milk powder, anhydrous milk fat, butter milk powder

– Forecast is to transact 578,000 MT (1.3 million pounds) over next 12 months

• About 25% of Fonterra’s domestic production is on gDT– There is scope to add value as the co-op members require

• Provides reliable, credible prices and market information, benefitting coop members and the marketplace

• Followed closely by the rest of the market and by financial institutions


The Future

• gDT: possibility of additional sellers joining the platform – thus becoming a multi-seller, multi-buyer platform

• Similar trading platform – CranberryAuction – has been developed for Ocean Spray for cranberry concentrate

– 5 trading events since July 2009

– Delivering true market prices with significant price transparency

• Can be designed and tailored to meet the needs of both buyers and sellers in a variety of markets

• Allow more potential buyers and sellers to participate in the market

• Complementary with other transactions – need not replace all other transactions

• This is not just theory – there now is extensive experience in a variety of industries – electricity, natural gas, chemicals, telecommunications, etc.


Example: Electricity Procurement Auction

$ 0

$ 2 0

$ 4 0

$ 6 0

$ 8 0

$ 1 0 0

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25

Round

Pri

ce (

$/M

Wh

)

0

5 0

1 0 0

1 5 0

2 0 0

2 5 0

# T

ran

ches

of

Su

pp

ly

# Tranches Bid Price ($/MWh)

Starting Price

Final Price


Example: Natural Gas Procurement Auction

$0.00

$0.50

$1.00

$1.50

$2.00

$2.50

$3.00

$3.50

$4.00

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15Bidding Round

Pri

ce (

$/m

cf)

0

5

10

15

20

25

30

35

40

45

Nu

mb

er o

f T

ran

ches

Bid

# Tranches Bid Price

tranches sold

Starting Price

Final Price


Meeting Co-op Challenges Through Better MarketsChallenges

• Challenges for all market participants– Negotiations are time-consuming and costly

– Parties wonder if they got the best deal

– Limited ability to manage risk and uncertainty

– Information and transaction costs are too high

• Challenges for coops and its members– Need price transparency and reliable price signals

– Need credible information about current and future market conditions

– Need to manage price and quantity volatility

– Coops must continually demonstrate value to members

Brad Miller, Vice PresidentHead, Auctions & Competitive Bidding

CRA International d/b/a Charles River AssociatesJohn Hancock Tower200 Clarendon Street

Boston, MA 02116+1-617-425-3000 Tel

+1-617-425-3132 Fax

www.crai.com

a better market mechanism for agricultural commodities overview

Documents

better market mechanism

market designhow

current market prices

optimal market design

credible market p

future market conditionsneed

reference price

auction design