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 FUTURES PAST?

Several attempts have been made to render some parts of the wine market more liquid – and more transparent and efficient at the same time. But could these initiatives also bring about more stability to the prices paid to wine/grape producers as well as to those charged to consumers? Some time ago, producers of Bordeaux en primeur and merchants dealing in these fine wines around the world were given a serious opportunity to reduce their exposure to risk by trading in proper wine futures.

Futures contracts are a powerful financial instrument that makes it possible to transfer price volatility ('risk') from people who seek to avoid it to those who wish to take it. They allow buyers and sellers of the goods to cover – in full or in part – their normal transactions against unwanted price changes, by using a proven technique called hedging. Investors ('speculators') provide the necessary liquidity for this to happen. And since futures are essentially used for hedging, less than 5% of the volumes traded on futures exchanges typically result in physical transactions (i.e. in the goods being either delivered to or collected from the exchange) when the contracts reach maturity.

In September 2001 the Pan-European exchange
Euronext launched what should be considered the world's first proper wine futures under the name 'Winefex Bordeaux', for the 2000 and 2001 vintages. This came weeks after the fine wine traders Bordeauxindex had opened up their own on-line 'two-way price service for Bordeaux 2000' en primeur.

Strictly speaking, en primeur wine sales are
forwards and not futures.

The main difference between the two services was that whilst Bordeauxindex.com agreed to act as an honest broker (market maker) and thus to buy and sell en primeur (i.e. forward) contracts in some 35 individual wines in a continuous way, the futures exchange Winefex.com offered the possibility to trade in three different futures contracts, each defined on a basket of 140 wines from Bordeaux with an en primeur history of at least two years. Winefex.com also had the expertise of Europe's leading futures exchange Euronext, who owned
MATIF and LIFFE. (Euronext later merged with the New York Stock Exchange and, in early 2011, was poised for further consolidation.)

The advent of wine futures horrified the wine establishment, mainly because of the populist view that futures could only increase instability. Yet according to The Economist, in January 2001, trading on Bordeauxindex.com was already having a sobering effect on the inflated en primeur price of the 2000 vintage and was likely to impact on the next. The price of the 2001 vintage was itself being traded on the Winefex exchange at that time and the next batch of futures contracts which were due to open in July, for the 2002 vintage (i.e. months before the grapes are even picked and nearly a year prior to the date at which the en primeur prices are officially announced – in the spring following harvest), should have come to reinforce Winefex's stabilising properties. Sadly, trading proved too thin and was suspended after the set trial period of nine months.

The fairly complex
specification of the Winefex contracts may have deterred some in the wine trade from using wine futures as an effective tool for managing risk in their day-to-day business. When it launched them, Euronext was confident that once futures' effectiveness had been proven, producers and traders would overcome their usual scepticism and become keen users of them, as had been the case in other markets. It hoped it could then extend futures to other wines from Bordeaux (e.g. to génériques – wines that are traded in bulk, before their accréditation, and that made up 60% of the region's sizable production of 555 million litres in 2000/01). Wines from other well-known regions of France and the world were meant to be added to the list later. But such plans were apparently too disruptive of the traditional ways in which most of the Bordeaux wine trade liked to operate.

April 8th, 2011

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Reference: Chapter 8 of The Common Wine Policy and Price Stabilization (Avebury/Gower, Aldershot, 1988) deals with futures in a comprehensive way. My book and an earlier doctoral dissertation at the University of Newcastle upon Tyne, proposed the introduction of futures contracts for ordinary (table) wine as a means of reducing fluctuations in income to producers (and merchants) who wished to do so, and as an alternative to costly market intervention by the European Community.

NB: Buffer stocks schemes (buying cheap at a time of surplus to sell dear at a time of relative scarcity) are theoretically fine but usually fail for want of courage by stock managers in the face of pressure from their political masters, with the result that stocks are piled up high until the money runs dry.
 

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DEFINITIONS

Quotations from The Economist Guide to Financial Markets (2nd ed., by Marc Levinson. London: The Economist / Profile Books Ltd, 2000). The bits of text featured in square brackets are my own.


Futures [contracts]: "A futures contract represents a deal between two investors who may not be known to each other and are unaware of one another's motives (see below). A futures contract is a derivative, because its price and terms are derived from an underlying asset, sometimes known as the underlying. A new contract may be created any time two investors desire to create one. Although there is a limit to the amount of copper that can be mined in a given year, there is no limit to the number of copper futures contracts that can be traded. Motives: all futures-market investors operate from one of two fundamental motives: hedging (this involves the use of futures or other financial instruments to offset specific risks) or speculation (this involves trading with the intention of profiting from changes in the prices of futures contracts)." 
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Forwards: "Contracts that set a price for something to be delivered in the future." NB: some draw/drew a sharp distinction between forwards and futures, the difference being that futures are interchangeable contracts (because of their standard terms) whereas forwards are not. It is the interchangeability of the contracts that makes hedging possible. [use your 'back' button to return to text]

Hedging: "This involves futures or other financial instruments to offset specific risks – typically against a price fall for a grower and a price rise for a buyer. In every trade the two parties take opposite positions. The buyer of the contract, who agrees to receive the commodities specified, is said to be in a long position. The seller […] in a short position. It may not own the commodities it has agreed to deliver, but it is obliged to have them or to pay their value in cash at the expiry of the contract. Once a trade has been completed, the participants are both obligated to the exchange rather than to each other. Either party may terminate its contract at any point by arranging an offset [e.g. a producer deciding at any moment to end its November delivery obligation would buy – at the current price– the same number of November contracts that he previously sold, and the two sets of contracts would cancel each other out. This is often referred to as liquidation of the initial contracts.] A hedger […] is likely to regard any loss on the futures market as a sort of insurance premium." [use your 'back' button to return to text]

Specification: "A futures contract contains the specifications of the transaction. The specifications of all contracts in a given commodity on a given exchange are identical, apart from the expiration date. This standardisation is an important feature of futures markets as it makes contracts interchangeable, freeing traders and investors from the need to worry about unusual provisions. The specifications cover the following: contract size, quality, delivery date, price limits (the smallest allowable price movement, known as a tick or a point), position limits (to prevent speculators from cornering the market by owning a large proportion of the contracts and thus being able to manipulate the price; they do not usually apply to investors who can prove to the exchange that they are hedgers) and settlement: Most futures contracts do not lead to the actual delivery of the underlying products. However, the contract specifies when and where delivery must be made and may provide for the alternative of cash settlement." [use your 'back' button to return to text]

Euronext was set up in 2000 as the merger of the Paris, Brussels and Amsterdam exchanges. The Paris exchange, Parisbourse SA, owned MATIF. Euronext acquired LIFFE in October 2001. MATIF: Marché à terme des instruments financiers, Paris (est. 1986). LIFFE: London International Financial Futures Exchange (est. 1982). Other futures exchanges: CBOT (Chicago Board of Trade), CME (Chicago Mercantile Exchange) and Nymex (New York Mercantile Exchange) in the US; Eurex (Germany and Switzerland), LIFFE (UK), LME (London Metal Exchange) and MATIF in Europe; Tocom (Tokyo Commodity Exchange) in Japan) and BM&F (Bolsa de Mercadorias & Futuros) in Brasil. [use your 'back' button to return to text]

En primeur sales/purchases: wines sold forward in cask, in the spring following harvest. [use your 'back' button to return to text]

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Pierre Spahni - Economic Research & Consultancy for Wine - Tel  +41 22 800 1607 Fax 800 1608