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  • QA 109
    Question:
    When the nearby price on the futures market is above the forward price, does this affect logistics in producing countries? If so, how?
    Background:
    How does backwardation on the futures markets influence logistics?
    Asked by:
    Logistics Manager - Vietnam
     
    Answer:

    It may do because backwardation* usually encourages the holders of surplus (unsold) stocks to supply them to the spot or cash market. Holders in producing countries looking to benefit from higher spot or nearby prices abroad will obviously try to sell/ship as quickly as possible. This will increase demand for trucking and shipping space and, in extreme cases, may cause bottlenecks. *Backwardation: a market condition in which futures prices are lower in the distant delivery months than in the near or nearby delivery months.

    To expand on this the following…

    • Usually, backwardation appears when nearby coffee is in short supply. This causes the cash or nearby price to rise above the forward quotations: the market then displays an inversion or backwardation. If on the other hand the market considers current supply adequate but fears future supply will be smaller, then forward prices on the futures market will be above the nearby price. If that forward premium is high enough for traders to carry stocks into the future then we have what is called a carry or forwardation.

     

    • Backwardation can also appear because of purely technical reasons. There may be sufficient supply in producing countries but at a given moment there is insufficient spot coffee for delivery against the futures market. For example because roasters have taken up most of the available spot stocks, or because the trade (speculators) are withholding stocks in order to  'squeeze' the nearby position(s) on the futures market. If roasters generally have enough stocks and purchases of physical coffee in their books then they will not follow the backwardation trend and will only be willing to buy for later shipment, obviously at lower prices.

    Exporters holding stocks will of course try to benefit from the higher nearby price(s). And, if the roasters refuse to follow the backwardation trend, meaning there is no demand for physicals at these prices, then the futures market in fact becomes the best buyer… Exporters will therefore try to sell for quick shipment that will enable coffee to be tendered against the higher priced nearby futures position(s). In this connection see also topics 08.09.04 and 08.09.05 in the Guide itself.

    This pressure may result in a lack of shipping space: shipping lines cannot suddenly provide more vessels because of a temporary spike in demand. It can be very frustrating for exporters that they cannot actually get the goods to a suitable delivery point from where these could be tendered against the futures market. Alternatively, if the backwardation is caused by unusually high roaster demand for nearby delivery, the same problem may arise. Now exporters can easily get the physical business but, again, they may not be able to get the shipping space (or even empty containers) because all has been taken already, particularly in smaller (feeder) ports. And sales for later shipment will of course have to be priced against more distant and therefore lower priced futures positions… Please see section 09.02 that discusses selling physicals against futures positions for more on this.

    Modern shipping schedules are increasingly like train timetables: routes and port calling dates are set months in advance and cannot be altered at whim. In any case there are no 'spare' container vessels making it difficult to introduce 'one off' changes. So yes, backwardation as currently the case in the robusta market (early August 2006) can impact on logistics…

    Another potential consequence is that growers/traders rushing to 'catch' the higher price for earlier delivery sometimes supply lower quality. This can result in logistical problems of a different kind for an exporter, for example when the moisture content is too high and coffee has to undergo final drying before it can be exported.

    Posted 08 August 2006
     

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