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
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A Better Market Mechanism for Agricultural CommoditiesOverview
Market design
Implementation – a case study
Results
The future
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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
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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
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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
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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
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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)
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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
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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
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TO
TA
L B
IDS
RE
CE
IVE
D
PRICE ANNOUNCED EACH ROUND
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?
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$2000
TO
TA
L B
IDS
RE
CE
IVE
D
PRICE ANNOUNCED EACH ROUND
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
How does globalDairyTrade work?
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$2000
TO
TA
L B
IDS
RE
CE
IVE
D
PRICE ANNOUNCED EACH ROUND
Volume on
Offer
$2000 $2100 $2250 $2300 $2325 $2350
Bidders re-bid at the new higher price
$2200$2100 $2200
How does globalDairyTrade work?
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$2000
TO
TA
L B
IDS
RE
CE
IVE
D
PRICE ANNOUNCED EACH ROUND
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
How does globalDairyTrade work?
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$2325$2000
TO
TA
L B
IDS
RE
CE
IVE
D
PRICE ANNOUNCED EACH ROUND
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
$2200
THIS IS THE PRICE THAT ALL BIDDERS PAY
How does globalDairyTrade work?
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www.globaldairytrade.info
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Results: gDT Prices Compared to Corn Prices
0
20
40
60
80
100
120
Jul-08 Oct-08 Jan-09 Apr-09 Jul-09 Oct-09 Jan-10 Apr-10 Jul-10 Oct-10
Pri
ce In
dex
= 1
00 f
or
July
200
8
gDT Price Corn Price
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Results: gDT Prices Compared to Soybean Prices
0
20
40
60
80
100
120
Jul-08 Oct-08 Jan-09 Apr-09 Jul-09 Oct-09 Jan-10 Apr-10 Jul-10 Oct-10
Pri
ce In
dex
= 1
00 f
or
July
200
8
gDT Price Soybean Price
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Results: gDT Prices Compared to Wheat Prices
0
20
40
60
80
100
120
Jul-08 Oct-08 Jan-09 Apr-09 Jul-09 Oct-09 Jan-10 Apr-10 Jul-10 Oct-10
Pri
ce In
dex
= 1
00 f
or
July
200
8
gDT Price Wheat Price
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Results: gDT Prices Compared to Cotton Prices
0
20
40
60
80
100
120
140
160
180
200
Jul-08 Oct-08 Jan-09 Apr-09 Jul-09 Oct-09 Jan-10 Apr-10 Jul-10 Oct-10
Pri
ce In
dex
= 1
00 f
or
July
200
8
gDT Price Cotton Price
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Results: gDT Provides Transparency and Credibility
• Over 300 qualified customers from 56 countries– 100-140 bidders active in round 1 of each trading event
– About 65% of the bidders win product
• 32 trading events (July 2008 through November 2010)– Over US$ 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
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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.
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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
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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
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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