An Exploration of Market Pricing Efficiency During the Dairy Options Pilot Program

Marketing,

FUTURES AND OPTIONS MARKETS, BASIS, AND THE TIMING OF GRAIN SALES IN MONTANA

The performance of the grain transportation industry, historically low real grain prices, and decreasing government support for grain prices have renewed interest in local grain prices and shipping costs. An understanding of the relationship between local cash prices and futures prices is an important part of minimizing the price risk associated with growing and merchandising grain. The ability to recognize the seasonal patterns between these prices offers improved profit potential for marketing grain. A Montana producer's decision of when and how to market his/her crop can have a great impact on net profit. Farm managers can use cash sales at or after harvest, forward contracting with a local grain elevator, or hedging with the use of futures and options contracts. To best select between these tools, the producer must be able to interpret different price quotes in order to determine the equivalence in terms of time, place, and quality. Being able to compare the different pricing alternatives at any given time allows the producer to decide which method provides the greatest return. The local basis is the difference between the local cash price for hard red spring wheat and the current price for the relevant futures contract (usually the Minneapolis contract). By understanding the local basis, the producer can compare futures prices with cash and forward contract price quotes. There are large seasonal patterns in the basis for Montana spring wheat. These seasonal patterns primarily reflect changes in the demands placed on the transportation and handling system. The local cash value of spring wheat is effectively determined by the basis (which reflects freight and quality adjustments) and wheat futures prices. Futures exchanges provide a standardized price for a specific location, delivery time, and quality. The futures contract price gives buyers and sellers a well-known price based on the standards of the futures contract. Grain buyers and sellers can then use this standardized futures price as a base, adding quality premiums and subtracting transportation costs to price different grades of hard red spring at various locations. Besides qualitative differences, the wheat basis in Montana reflects arbitrage of wheat between different locations. The Pacific Northwest export market will normally provide the highest values for Montana spring wheat, so Montana merchandisers tend to price from Portland quotes. However, this Portland price for hard red spring wheat will reflect the Minneapolis Grain Exchange futures prices plus a transportation premium plus/minus any quality adjustments; prices will adjust to reflect all transportation costs and quality differences. This adjustment allows Northern Plains producers to use these centralized futures markets as pricing instruments, even though their wheat may move to other locations. The structure of freight pricing is critical for the movement of grain to Pacific Northwest ports and the prices received by Montana farmers. Freight rates from these Montana locations to Portland have been stable in real terms (adjusted for inflation) over the past ten years, whereas other components of the basis have shown considerable seasonal variability. The problem with Montana's freight rate stability over time is that other spring wheat growing areas with more effective grain transportation options have seen declining real freight prices. Understanding historical basis requires knowledge of the factors that influence the basis. This knowledge can be as important as knowing the cost of producing spring wheat. The first step in keeping historical basis information is to record the local cash price of spring wheat. Daily cash price quotes are available at the local grain elevator. Two useful Web sites are: (1) Montana Grain Growers Association (portions require a subscription), which provides current price and basis information at: (www.montanamarketmanager.org) and (2) USDA's Agricultural Marketing Service (www.ams.usda.gov/lsg/mncs/index.htm), which provides daily prices and weekly summaries for grains and other agricultural commodities. Also, the Montana Wheat and Barley Committee compiles historical price and basis information for specific state locations and the Montana Agricultural Statistics Service's annual publications give state average prices received for grains and livestock on a monthly basis. For further information contact David Buschena in the Department of Agricultural Economics and Economics at 406-994-5623 or e-mail him at [email protected] marketing, futures, basis, freight rates, marketing strategies, Marketing, Q1,

RELIABILITY OF OPTIONS MARKETS FOR CROP REVENUE INSURANCE RATING

Revenue insurance, only recently introduced for major crops in the U.S., has captured a considerable share of the multiple-peril insurance market. This study evaluates the predictive reliability of using price distributions inferred from options markets to rate revenue insurance products. We find for periods early in the crop growing season that price distributions inferred from options trades offer greater reliability than distributions based on historical futures trades. Options-based price distributions should receive further consideration in crop revenue insurance rating, but current administrative constraints must be considered.Risk and Uncertainty,

An Exploration of Market Pricing Efficiency: The Dairy Options Pilot Program

Put options have been recommended as a substitute for price support programs (Gardner, 1977), and subsidized option purchases have received some support in lieu of subsidized insurance programs. Put options are an interesting alternative to price supports because their market-determined price levels allow for flexibility and adjustments to relevant current and expected market conditions. One difficulty with the use of put options as a substitute for commodity price supports is the relative thinness of these options markets for some commodities. Market thinness is defined here as the absence of traders willing to take the necessary opposite position in the market in lieu of a relatively large price premium, particularly for a large number of contracts. We explore empirically how a thin market responds when trading increases as a result of a subsidized put option program. USDA initiated the Dairy Options Pilot Program (DOPP) in 1999 in an effort to provide dairy producers with real-world experiences trading options (Vandeveer et al., 2003). Subsequently, additional rounds of DOPP occurred to give more producers a chance to participate. In total, over 1,300 producers bought 6,500 milk put option contracts through the DOPP program from 1999 to 2002. In contrast, over this four-year period total put options traded at the CME milk futures market totaled over 36,000 contracts. This, the volume from the DOPP program represented a fairly large share of total trading activity in the dairy put options market. An interesting feature of the subsidized milk options program is that dairy farmers may have made relatively little use of commodities markets due to the long-standing dairy price support programs. If this is the case, many of the dairy farmers making use of this subsidized options purchase program would have been relatively uniformed traders. Although DOPP may have increased trading volume, market performance may or may not have been enhanced due to the relative unfamiliarity with options trading by these dairy producers. We define a measure for observed options pricing efficiency using Black's formula in our study of the DOPP program, and statistically evaluate the size of the "error" in options pricing. We find that DOPP trades occurred at statistically significantly higher prices than did other trades, that DOPP volume had a price-reducing effect on other options trades, and that some brokers with large DOPP volume filled these orders at relatively large prices.Marketing,

An Exploration of Market Pricing Efficiency: The Dairy Options Pilot Program

Demand and Price Analysis,

Measuring the Impacts of Wolves on the 'Market' for Elk Hunting: Hunter Adjustment and Game Agency Response

The reintroduction of the gray wolf to Montana and other western states has to date largely pitted ranchers against environmental groups, with the U.S. Fish and Wildlife Service (USFWS) as the central agency for this reintroduction. There is also another group affected by wolves that to date have had little influence on this reintroduction. Hunters have diverse views on wolves, and accordingly have not spoken with one voice concerning their reintroduction. This lack of a common view is mirrored by the Rocky Mountain Elk Foundation's (one of the largest hunting groups in North America) evolving policy statements in 1995 and 2003 that specifically addresses that their membership will take different sides to wolf reintroduction, and that the group supports state control of wolves, 'ultimately achieving an appropriate balance between wildlife, habitat, and people' (Rocky Mountain Elk Foundation, 2005). Part of the ambivalence of hunters towards wolves stems from the general lack of published knowledge regarding the actual impacts of wolves on game populations, game behavior, and ultimately hunters- satisfaction. This lack of knowledge arises due to the complex nature of the predator/prey relationships, the extensive movements of wolves and their prey, and the difficulty of obtaining good population estimates of both wolves and particularly their prey. Additionally from an economic perspective, hunters- property rights to game are ill-defined, with the political strength of hunting "rights" and their values quite difficult to determine. This paper provides estimates of the effects of wolves on hunter opportunities, where these opportunities are influenced by actions taken by both the game agency and hunters in response to the spread of wolves. We utilize observed measures for these effects -permit availability, hunter success, and measures of hunter - to assess the impacts of wolves on hunters. We focus on elk − a game species that are both vulnerable to wolves and that is in high demand in Montana. Our estimation approach draws from a hedonic model in which hunters compete for a rivalrous good (elk hunting opportunities) that is not allocated through a price mechanism. Hunters in most western states compete for hunting rights by entering a special permit lottery in some cases, while they compete in other cases by undertaking costly activities to obtain a right under open access. Hunters compete for these rights under open access by racing to reach hunting areas early, establishing expertise and customary areas, and in other ways consistent with Barzel (1997). Both types of competition are observable using different instruments as in Nickerson (1990), by Buschena, Anderson, and Leonard (2001), and by Scroggin, Berrens, and Bohara (2000). Hunters are empirically modeled in such a way that allows them to benefit from elk and also from experience value of wolves. The paper provides not only a study of agency decisions in response to impacts of a threatened species, but also applies a relatively little-studied method of determining factors affecting demand and agency decision for goods distributed via a non-price mechanism. Our application (1) uses observable measures of hunter competition that reflect good valuation, (2) statistically accounts for the endogeneity of hunter and agency decision, and (3) models the simultaneous equilibria across numerous and diverse hunting districts (the "goods" being competed for in this case). Our statistical estimation shows that as wolf populations in a particularly high profile region outside Yellowstone National Park become established in a hunting district, (1) the state game agency reduces the supply of special hunting permits, (2) there are fewer hunters hunting in that district under open access licenses, and (3) hunter success rates for both special permits and open access decline with increased wolf pressure in areas with the heaviest wolf pressure. We find that the game agency and hunters respond to reduced hunting opportunities, and that their responses are larger in magnitude for high-profile (political profile) wolf populations. We believe that this paper is quite relevant to numerous parties involved in resource allocation, endangered species policy, state and federal agencies, and recreational users of public and private lands. The paper should be of interest to resource economists as it provides an application of an observable "market" for desirable resources as a complement to elicitation-based valuation methods. We expect the paper to generate a good deal of interest and discussion regarding the methodology and policy implications. Barzel, Yoram. Economic Analysis of Property Rights: Second Edition. Cambridge, UK: Cambridge University Press, 1997. Buschena, D.E., T. Anderson, and J Leonard. "Valuing Non-Market Goods: The Case of Elk Hunting in Colorado and Montana." Journal of Environmental Economics and Management 41 (2001): 33-43. Montana Fish, Wildlife and Parks. "FWP Takes Lead in Wolf Management in Montana." http://fwp.state.mt.us/news/article_3700.aspx. June 24, 2005. Nickerson, Peter H. (1990) "Demand for the Regulation of Recreation: The Case of Elk and Deer Hunting in Washington State." Land Economics, 66, 437-447. Rocky Mountain Elk Foundation. "Our Positions" (official position statements on wolves). Bugle, the Journal of the Rocky Mountain Elk Foundation. July/August, 2005. pp 78. Scroggin, David, Robert P. Berrens, and Alok. K. Bohara. (2000). "Policy Changes and the Demand for Lottery-Rationed Big Game Hunting Licenses." Journal of Agricultural and Resource Economics, 25(2): 501-519.Resource /Energy Economics and Policy,

TRADE LIBERALIZATION AND INTERNATIONAL MERGER IN COURNOT INDUSTRIES: THE CASE OF BARLEY MALTING IN NORTH AMERICA

When free trade merges formally distinct non-competitive industries, welfare should increase. Additional incentives for mergers may reduce these gains from free trade. We show the importance of such arguments in an analysis of the malting barley industry in North America before and after the Canadian/U.S. free trade agreement.International Relations/Trade,

Chickpea Production and Price Risk Management in the Northern Plains

Demand and Price Analysis,

Biotech Food Labeling and Consumer Response: An Analysis of the Effects of Voluntary rBGH-labels on the Market for Fluid Milk

Consumer/Household Economics,

CHANGING STRUCTURES IN THE BARLEY PRODUCTION AND MALTING INDUSTRIES OF THE UNITED STATES AND CANADA

Substantial changes have taken place recently in the regulation of agricultural trade in North America. The effect of these changes on trade in agricultural commodities is of particular interest to producers and policymakers in the Northern Plains and Rockies region. In this paper, we discuss specifically the malt barley production, malting, and brewing industries in light of these new trade agreements and their ramifications. We evaluate the incentives that free trade provides for mergers between barley malting firms, and then we assess the consequences of these mergers on the realized gains from trade for consumers, barley producers, and malting firms. The globalization of markets has fundamentally changed the world in which economic agents operate. Trade has been liberalized through multilateral world-wide agreements such as the General Agreement on Trade and Tariffs (GATT) and through regional free trade agreements such as those within the European Union, the Canadian/United States Trade Agreement (CUSTA), and the North American Free Trade Agreement (NAFTA). A striking phenomena which has accompanied trade liberalization has been the international merger of firms and the creation of many jointly owned multinational operations. There are two distinct types of malt barley that differ in their yield and in their production areas in North America. Montana and the Canadian provinces grow primarily high-quality two row barley, while North Dakota and Minnesota produce primarily six row malting varieties. Two row barley yields more malt per bushel for maltsters, but it is more prone to disease for barley producers. The opening of the border between the United States and Canada has made large quantities of two row barley available to U.S. malting firms and brewers. The trade policy literature suggests that trade liberalization will have a profound impact on domestic policy choice, making the costs of any government action to increase market prices above the prevailing world price more expensive. Open borders should also provide discipline on how industries price in the domestic market. With import restrictions such as tariffs in place, the non-competitive industry structures that raise prices in the domestic market can exist with limited fear of foreign competition. With freer trade, however, the industry faces more potential competition. When a free trade policy merges formally distinct markets for which stable industry structures exist, this creates additional incentives for mergers within the newly combined industry that reduce these gains from free trade. This analysis was motivated by observing the malting barley industry in Canada and the United States. In 1985, prior to CUSTA, the two domestic markets for barley malt were distinctly separated by import license requirements into Canada and import tariffs in the United States. As such, both countries had large malting industries, but there was little trade flow between the two countries in malting barley, in barley malt, or in beer. Four firms controlled 90 percent of the Canadian malting market, and six firms controlled over 80 percent of the U.S. malting market before CUSTA. As a result of mergers after CUSTA, five firms owned 90 percent of the malting capacity in North America. Economies of scale and elimination of high cost plants often drive industry consolidation. Interestingly enough, despite all of the merger activity among malting firms, there were very few plant closures and very little new capacity built. Even new entrants to either the United States or Canadian industries purchased the assets of existing firms, rather than building new plants. We review relevant literature for firm behavior and report the results of a model for the incentives for plant mergers in the North American malting industry following CUSTA. We evaluate malting firm profits, the changes in malting margins, the price effects, and the overall welfare effects of the creation of the free trade area and subsequent mergers within the industry. We found that free trade, in the absence of mergers, increases output in both countries and reduces malting margins leading to large gains for consumers and producers of malt barley. The agreement, however, also increases incentives for mergers. With the mergers that took place, we show that merging barley malting firms have incentives to decrease output by about 21 percent, while their producers' surplus increased by approximately 34 percent. The net benefits of free trade to consumers and input suppliers are reduced by mergers, while the profits of merging firms are increased by them. Overall, with free trade and mergers, there is still a net social gain relative to pre-CUSTA. Malt production in Canada increases by over 12 percent, while that in the U.S. is slightly lower, leaving North American consumers, firms, and barley producers better off.malting barley, industry concentration, free trade agreement, Industrial Organization, Q1, F1,