The ball is rolling in the grain and oilseeds industry to find a more financially viable solution for everyone following the JSE’s “location differential” announcement, which industry players say will limit the expansion of soya bean production and the extended industry. The differential has been contentious for some time now. But what is a location differential and what is the rationale behind it?
Why a location differential?
The JSE operates the local derivatives market for commodities. Some of these are cash-settled at expiration while others are physically settled. All locally produced grains and oilseeds are physically settled, with the current exception of soya instruments.
For these physically settled contracts, the JSE requires a single reference point of delivery. This is in Randfontein where all the millers were situated 30 years ago.
The JSE uses a standard model they use to determine location differentials and this model takes as inputs: transporter rates, rail rates, rail-road splits, return load factor and payload of the truck to ultimately produce the differential rate.
“This is necessary because standardisation of listed derivative securities is the cornerstone of any futures market”, says Raphael Karuaihe, head of commodities: capital markets at the JSE. “This means the rights and obligations of parties to these listed instruments are the same for all market participants. We standardise quantity, quality, date of delivery and location.”
The ‘cost’ of underlying transport elements to ensure delivery is thus deducted from the final quoted grain price, per ton, which the producer agreed to deliver at a set date.
For example, a Schweizer-Reneke seed farmer is subject to a location differential of around R400/ton in his area (based on the distance from Randfontein).
Soya been derivatives
The JSE introduced the new location differential, effective 1 March 2021, for listed derivative securities with soya as the underlying commodity, a couple of weeks ago. “This followed an extensive consultative process with the industry to ensure an orderly implication process,” says Karuaihe.
He says that soya beans have been included since volumes produced have quadrupled over the last 18 years.
“When we started trading these soya instruments in 2002, soya production in the country was about 130 000 metric tons and only concentrated in the Mpumalanga province. It was then decided to allow the physical market to grow to a sizeable level before considering the differential system,” he says.
As of today, soya production has grown exponentially to an estimated 1,3 million metric tons, with geographically dispersed silos as delivery points across the whole country. This prompted the need to start introducing the differentials for soya instruments as well,” he adds.
Grain South Africa (Grain SA) is one of the industry organisations that does not approve of this approach. It says in a public release that “it is with disappointment that we take note of the Safex decision to introduce a differential on soya beans from March 2021.
“This follows after many discussions, research plans and motivations proving the contrary, between Grain SA and the JSE regarding differentials. As Grain SA we will continue to participate in the conversation and procedures in every effort to improve the system.”
Grain SA, like many other stakeholders, is concerned about the potential impact on local soya production as a result of the decision to implement a location differential.
But farmers and other members of the value chain say that times have changed, and setting a delivery differential based in Randfontein is no longer a workable or fair estimation of transport cost.
They say milling technology has become scalable and many of the millers are now around the corner to silo facilities where farmers deliver their produce.
“Between millers and the co-ops, farmers are being milked dry,” a farmer told Business Maverick. “If we are quoted R2 000/ton for our maize for example at the beginning of the season, we only pocket R1 800 at delivery, with the co-ops and millers pocketing the differential difference. Yet we carry all the risk of delivery.”
He adds that it puts unnecessary pressure on the producers, who are trying to survive within already-thin margins, in a weak rand environment. Most of the local farmers’ input costs are based in US dollars with equipment like tractors (think John Deere), and other material like fertiliser (think Kynoch and Profert), being imported from America. South Africa imports about 80% of its fertiliser requirements per annum.
“And we are on the hook for all of it,” he adds. “And the JSE seems oblivious to this plight. It is becoming unaffordable for farmers further away from Randfontein to pay for a travel differential that is not necessarily required.
Area differential should be scrapped
The farmer community wants the area differential to be scrapped in its entirety. It also wants the other differentials pertaining to the grain settlement process to become more transparent. Other commodity contracts traded on the JSE include white and yellow maize, sunflower seeds and wheat.
But this is not the only frustration the agricultural value chain has with the JSE future commodity contracts policy and procedure. And they have taken matters into their own hands.
Stephen Kruger, an executive at Grain SA and a maize producer based in Viljoenskroon, and fellow farmer Janus Strydom from Hoopstad have established a new producers’ platform to find amicable solutions to the JSE’s monopoly.
They have already signed up 1 600 producers (out of 4 000 participating farmers in the country) in a matter of three weeks and the effort has been dubbed BaseDif, until its official launch in the upcoming month or so.
He says they are seeking sustainable solutions. The organisation has been in talks with an intermediary who has been investigating technology platforms from abroad and are very close to finding a solution that is tailored to their needs and will help them address their most pressing problems.
“This could be a worthy competitor to Safex in marketing our produce,” he says. BaseDif members are especially dissatisfied with the one-sided way the JSE market performs, especially with the likes of differentials. The biggest one being that the geographical delivery point is in Randfontein.
“Producers further away are being increasingly disadvantaged,” says Kruger.
Another major issue up for resolution includes the JSE’s limits set on the tonnage increments to be traded on the bourse.
“The current system does not allow any producers to participate under 100-ton units,” says Kruger. “That doesn’t allow much scope for emerging farmers to participate in a formalised market.”
“We are looking into presenting scaled-down solutions, which will allow emerging farmers to participate. We also want to extend the offering wider than just grains. Think pork bellies and frozen orange juice traded on Chicago Mercantile Exchange’s (CME) spot market.”
South Africa does not have a commodity spot market, and futures and options prices are derived from spot markets abroad. Business Maverick could not find an official answer as to why this is the case.
Kruger, mainly a maize farmer, got involved even though he is not a planter of soya beans, as he believes the new differential will affect every grain farmer’s bag. “If soya producers are forced to make other choices because soya production becomes too expensive, it reduces the market for other crops and harms everyone’s profitability because prices are forced.”
Profitability at stake
Furthermore, the relative profitability of soya beans to other crops will weaken, resulting in far fewer hectares of soya beans.
“The fact that there was no differential actually caused the cultivation of soya beans to expand dramatically in the western production areas. There are people who say if the differential is set, the price will rise accordingly.“
Kruger says many more soya beans are actually needed in the country if future consumption is taken into account and the differential will remain a problem:
“Grain SA actually has excellent alternatives to the differential, which is also very fair, and it’s a pity the JSE didn’t take their views into account or wanted to postpone the issue any longer. We want to handle the matter responsibly and our primary goal is to represent producers taking into account the full value chain.”
Buyers, millers and agribusinesses are also crucial, he says.
Kruger adds that at this stage, the various role-players are having an in-depth conversation, but there has been no direct contact with the JSE. “We just want to look after the grain producers’ interest in this issue and ensure their profitability.” – Daily Maverick