Thursday, July 6, 2006

The Chicago Board of Trade, the world`s largest agricultural futures market, has had a dramatic increase in the trading of corn contracts because corn is viewed as an energy crop as well as an agricultural one.

Open interest (the number of contracts held by market participants) in its corn December 2008 contract has increased from 409 at the start of 2006 to more than 35,000 at present, with most of the new interest coming from the bio-fuels sector. Euronext.Liffe, which operates Europe`s largest agriculture futures market, has also had a big jump in volumes. lt responded this week by allowing traders to buy and seil its feed wheat (10w grade wheat used for animal feed) futures contract over the next three seasons, whereas it had been possible to trade up to only two years ahead. The European wheat season ends in November.

Wheat is expected to become the main feedstock for ethanol making in Europe. In the US it is corn and in Brazil, the world`s largest ethanol producer, it is sugar cane. "We normally only see interest in the wheat contract by up to 18 months out. But now we are getting more and more requests to provide contracts to the end of 2008, so that ethanol producers can hedge their wheat exposure," said Peter Blogg, head of commodities product management at Euronext.Liffe.

Mr Blogg said there was also demand for longer-dated wheat contracts coming from the farm sector. He said wheat growers and grain processors expected the European Union`s price support system to be removed in the next three years as part of a reform of the EU`s Common Agricultural Policy.

"As the EU moves towards dismantling the intervention price support system there are real risks of very bw grain prices leading to cuts in production that are then followed by upsurges in prices because of grain shortages," said Malcolm Shepherd, managing director of Green Spirit Fuels, a bio-ethanol start-up group.

"This price and production volatility can only be handled by growers and grain consumers managing their risks through futures markets," Mr Shepherd said. Green Spirit Fuels, which was started last year by farmers` co-operative Wessex Grain, is building a plant in Somerset, to produce 1 30m litres of bio-ethanol a year from wheat and intends to use 1 m tonnes of UK wheat each year from 2009. The UK produces about 1 5m tonnes of wheat a year but none is used for ethanol production.

Most of the focus in Europe is on bio-diesel. This is due to a lack of European diesel refining capacity, which forces Europe to import diesel from the US. In contrast, Europe has surplus refining capacity to produce petrol, making the region a big exporter of petrol to the US.

The European energy sector is therefore looking to the emerging bio-diesel sector to fill some of the region`s diesel production void.

Bio-fuel is the main driving force behind the 17 per cent rise in Euronext Liffe agricultural futures this year, with the rapeseed contract the best performer. Rapeseed futures are up 17 per cent and rapeseed options almost fourfold. Prices for rapeseed, an important feedstock for making bio-diesel in Europe, hit a two-year high last month of Euros 256.50.

Oil World, the German oilseeds research group, estimates the global rapeseed market will fall into deficit next year as consumption rises5 per cent to 50m tonnes, led by higher bio-fuel demand. At the same time, rapeseed production is tipped to fall 1 per cent to 47.8m tonnes from 2006.

But an industry report released this week by the Organisation for Economic Co-operation and Development showed that most countries were unable to produce biofuels at a price that could compete with fossil fuels without government subsidies.

The OECD warned that higher grain supplies for the traditional food sector would in turn have repercussions on the bio-fuel sector as growers tried to balance the competing demands on crops for food and energy.

Copyright Financial Times