Why Contracting May Be More Expensive Than The Bulk Oil Spot Market

Posted by Hannah Broaddus

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Most people assume that to save the most money on their bulk oil ingredients, that they should be contracting their oil at an ideal time. The answer is, as always, more complex than that. Chances are that if you are booking canola or soy (or an oil that is based off those markets) that a year-long contracted price may be more expensive than the current spot market.

And just why is this? We’d like to walk you through some of the reasoning behind this — it all has to do with the CBOT, and how future bookings work.

This article is ideal for those of you who may be new to canola or soy contracting and you’re curious how the market works.

 

How Oil Contracting Works In General (And The CBOT)

Blog46-Blackboard-Chart-Upward-Growth.jpgWhen a price is worked up for canola or soy, there are a few different components that will make up the final price: the board and the basis.

The Board: This is the ever-fluctuating market price, best explained as the stock market for agricultural products. You can visit the Chicago Board of Trade (also called the CME group now, since they merged years ago) and find these prices online. This is the starting point that your supplier will base their current costs off of.

These numbers update all the time when the market is open; they are updated every few seconds online to reflect the current status.

The Basis: This is the additional cost to produce your final product. Depending on the packaging that you buy in and the supplier that you buy from, they may or may not quote you explaining this piece. This includes the mark ups from the mill/refinery, the packaging, your suppliers’ costs, along with any freight costs to get it to the final point that it is quoted from.

 

How Oil Futures Contracting Works

When an oil is contracted for the future, both the board and the basis will often be different from a quote based off of the spot market.

The board’s pricing is sectioned out by every other month (expect for the pre-harvest time when the months are priced individually as the market is more volatile). If you contract for a certain time period, the board price will be based on the months that you plan to take the oil, or that your supplier will need to bring it in for you.

These board time periods are divided out as follows:

  • January
  • March
  • May
  • July
  • August
  • Sept
  • October
  • December

Your suppliers will typically give you the option to average the cost of these months if you plan to take the oil evenly over the course of the year, or you can have different prices locked in for each period or even each quarter.

Typically board prices go up the further out into the future you book, until the next year’s harvest. That’s because future’s pricing typically mitigates the risk that the market will go up in the future at some point and that what’s going to happen with the market is really unknown.

Once in a great while, futures pricing may be cheaper than current spot pricing if there is something unusual going on with the market or the crops, so keep in mind that there’s always exceptions.

 

A Real Life Example

canola soy commodity market planning

Let’s pretend that your company is booking soybean oil for the next year, contracting for an average delivery of 5 totes a week. You’d like to lock in a steady price over the course of the next year.

Common logic may assume that you could book all 260 totes (52 x 5) at the current spot price (which is usually the lowest price on the market). This is true ONLY if you can take all 260 totes at once — or if you can convince your supplier to bring in your entire years inventory for the year and sit on it as it looses freshness.

If you want to take these totes spread out evenly over the course of the year (as 99% of most companies would for inventory, space and cash flow reasons) this means that you will likely need to book a futures contract. This also means that you’ll be getting freshly crushed oil over the course of the year, so there’s many reasons to prefer booking your contracts this way.

Your will have both a current board or spot price (Dec 2016) to compare it to, as well as prices out into the future. I’ve used an example pulled from the CME group website below, so that we can look at real numbers together.

CBOT Soybean Board Example.png

If you are new to the CBOT “vocabulary”, 35.02 is equivalent to $0.3502 /Lb when you’re looking at per pound price of oils.

  • Dec 2016 35.02
  • Jan 2017 35.27
  • Mar 2017 35.45
  • May 2017 35.63
  • Jul 2017 35.84
  • Aug 2017 35.80

If you were booking a contract to receive oil from December 16’ to August 17’, you would take the average of these prices to get your basis. In this case, the average of the above numbers is 35.50 vs. the December basis of 35.02.

Then you would add in your basis cost which is custom to your products, your suppliers, and the months that you have booked. Then you would have your final pricing!

As you can see, because you’re using averaged prices that include the futures pricing that is most often higher, the entire contract is booked at a higher rate than the current market. That said, this higher price helps to mitigate the risk of the market going up in the future, to give you steady pricing over the course of the year.

 

An Important Pricing Note

Keep in mind that some suppliers offer pricing like this (with a separated board and basis) while others offer final product pricing which is simply your total cost. If the latter is the case, you can still keep an eye on the board to understand how your costs may be changing over time or could be affected by a jump in the market.

 

Which Oils Are Contracted In This Way

The oils that are most commonly contracted using this method is the high volume, conventional oils: soybean, canola, etc.

There are also other oils that aren’t exactly like this, but they will be highly affected by the CBOT. For example, a 75/25 canola & EVOO blend oil will have 75% of it’s price based on the CBOT market.

Similarly, Non-GMO Canola Oil is booked completely based off the soy market (similar to canola). Neither of these oils are typical conventional soy or canola, but they are highly affected by the fluctuations in the market just the same.

 

In Conclusion

Booking a contract based on the futures market is a great way to keep your costs steady over the course of the year. Just remember that the average price for the whole year may be higher than what you could buy on the spot market today — this has to do with how the futures CBOT market is structured, not a choice made by your supplier.

The reason these futures contracts are higher has to do with how they mitigate the future risk of the market going up.

Topics: Harvest/Commodity Market

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