David Derwin, commodity portfolio manager with PI Financial, has been working with some of his farm clients for many years on currency hedging strategies as a risk management tool. Recently, he has helped bring these strategies into a package called the Currency Ag Strategic Hedging (CASH) program. This program helps protect farmers from a rising Canadian dollar while allowing the potential to take advantage of the upside when the dollar falls.
“The underlying strategies and reasoning behind the CASH program are not new, but putting it into a more disciplined, systematic approach to currency hedging is the next step in that evolution,” says Derwin.
Any kind of hedging, on sales or currency, is basically a risk management tool. Many farmers are already hedging whether they realize it or not.
“A lot of farmers will use deferred delivery contracts with elevators or minimum price contracts which is really just price insurance to help them protect their revenues and avoid risks,” says Derwin.
Currency hedging is no different than hedging commodities, says Derwin. “It might be more indirect, but we’re in a global market and just about everything that we grow gets priced in terms of U.S. dollars in a world-wide market.”
Canada is a net exporter of agricultural commodities, which means that when the dollar is at par there is a big difference in the value of the currency versus when it’s at the current level of around US$0.75.
“That difference in the currency is going to have an impact on the basis levels that they see at the local elevator, and on the cash prices growers receive,” says Derwin. “As an exporter, you want a low dollar so that it helps our products to be more competitive in the global market. If the Canadian dollar makes some movement from 73 cents to 78 cents, it doesn’t seem like a big move but that’s going to be about a five or six per cent change in the value of that currency. The currency has an impact on the gross revenue that a farm is going to generate over the course of a year.”
How does hedging work?
If the Canadian dollar today is US$0.75 and it goes up to US$0.85, with a hedging program farmers would protect a portion of their sales revenue against that rise. As the Canadian dollar rises, the basis level is typically not as good; because the Canadian currency has gone up, global markets may look for somewhere more affordable to buy grain.
“If the U.S. dollar has gone down, it’s cheaper to buy in the States or maybe some of the Eastern European currencies, or even the Australian dollar drops, so global buyers can buy cheaper from Australia,” says Derwin. “It’s not necessarily that simple but a high currency makes it more challenging for Canadian exporters in general and farmers in particular.”
On the other hand, if the Canadian dollar drops to say US$0.65, farmers want to be in a position where they haven’t just locked in the currency, so they can take advantage of the upside. “If the currency is trending lower, you don’t need to be as active on your hedging because a weak dollar is good for us,” says Derwin. “It’s not necessarily going to be the case where every penny that they move they’re going to capture all of that, but what it does do is let them get the benefit of a weaker dollar as an exporter.”
Currency hedging in a marketing plan
Having strategies in place to manage the currency risk, is just another part of a good overall marketing plan for the farm, says Derwin.
To do this, a farmer can set up a farm commodity hedging account which allows them to access the options and futures strategies used within the CASH program. Then, Derwin and the farmer will start looking at the gross revenue of the farm.
“That’s the starting point because currency affects 100 per cent of your revenue,” says Derwin. “Then we start looking at whether there are some natural hedges built-in to the farm business, such as the fertilizer, inputs, fuel or equipment that they buy because these are essentially priced in U.S. dollars.” Farmers use Canadian currency to pay local suppliers, but prices are affected by the value of the U.S. dollar. There’s some natural offsets there a producer might want to look at in terms of some of their expenses and their net exposure to the Canadian dollar,” Derwin says.
Then it’s a case of deciding how much of the farm’s gross revenues the farmer wants to manage under the program to address currency risk.
Alberta grain producer Casey Christensen began using currency hedging about a year ago as a tool to help mitigate risk on his farm south of Lethbridge, Alta.
Christensen first estimated his gross sales and then determined which commodities are most susceptible to currency fluctuations, which in his case is mainly wheat and canola crops. “Our products that are exportable have the most risk if the Canadian dollar begins to rise against the U.S. dollar, so for us that’s wheat and canola. We determined the value of those crops and put a hedge on it based on where we think the currency might go in the future,” says Christensen. “My feed barley, that just goes to a local market.”
Derwin does not advise trying to hedge 100 per cent of gross revenue with just one strategy.
“I advise having a few strategies so there is a bit of flexibility, so maybe someone will set a third to a half of their overall gross revenue as a good starting point to have under this kind of program,” says Derwin.
Derwin says it’s a good idea for farmers to manage currency risk throughout the year. “Over the course of a year there could be many times when a farmer’s going to price the grain and materialize what the currency exposure is going to be, so why not develop something that would help them address the fact that they don’t know exactly when they’re going to sell that grain?”
As he sells his grain, Christensen can decrease his hedge. “But if you feel the dollar is at its lowest stage and might go higher, you can lock in some dollar value even further ahead, for 2021 for example,” says Christensen, who also does currency hedging on urea fertilizer, his main input priced off the U.S. dollar.
Who should hedge currency?
Farmers don’t necessarily need any in-depth knowledge to participate in currency hedging, although Derwin admits that many of his clients who use it are comfortable with other hedging tools.
“Clients who have a certain amount of knowledge, understanding and comfort with hedging are more confident in putting in place the different strategies and programs, he says. “But it can be someone who is very new to it or someone who’s been doing it for 10 or 20 years, they are often still looking for guidance in the process.”
Anyone with obvious currency exposure is a candidate for currency hedging. Farmers in supply-managed sectors may not have the same currency risk because they serve a mainly domestic market. But a large grain farm with a lot of dollars on the line can feel currency fluctuations acutely. Anyone who feels that big movements in the currency could affect their bottom line is a good candidate for hedging.
Derwin is based in Winnipeg and deals primarily with prairie grain and livestock producers. “There is obviously a direct connection there because these producers are impacted by what happens in the States. Usually, people have some experience already, or are a little more proactive on the marketing side, and realize that they should look at something to manage currency risk.”
The need for currency hedging has always existed, but lower grain prices in recent years and higher land prices are definitely driving interest, says Derwin.
“We’ve had a couple of tough years in farming, so that makes people realize that revenues or income is grinding lower, and makes things challenging, and land prices are higher so there’s more interest that’s accumulated,” he says. “When things get tight is when people start looking at ways to find a way to squeeze out extra nickels, dimes and quarters.”
The other factor that has a lot of growers looking at currency hedging is the fact that the Canadian dollar has been low for a long time and many feel it’s due to take a jump in the near future.
“The Canadian dollar tends to move in some fairly big cycles, five to 10 years, so there’s seven years on average where you have big moves up and down,” says Derwin. “We’ve been below 70, but you look back on a long-term basis and this is a low level. The fact that we’re down here at 75 again doesn’t mean we’re going back up to par next year or in six months, or 18 months, but we want to start thinking about this now and put strategies in place because if and when it does get back to par it’s too late.”
There is always a certain amount of uptake to learn any new skill, but Derwin says that should not deter anyone from trying their hand at hedging. “Don’t let the fact that you’ve got to put a bit of effort into understanding it deter you because it’s really not that complicated, you just need to spend a bit of time doing it,” he says.