Derivatives

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Done like Kraft Dinner

Kraft is in trouble. Accused of manipulating the derivates market to control the price of wheat, they are being investigated for misconduct.

But is this manipulation really as bad as it seams? The P4Capital executive team discusses the nature of the derivates market, and what crime, if any, Kraft has actually committed.

Stay tuned.

Transcript


In this week’s P4Capital discussion, the executive team talks about everyone’s favourite food – Macaroni and Cheese! Well, not really –  instead they explore the controversy surrounding Kraft and their manipulation of the derivatives market.

So enjoy some Easy Mac and stay tuned.

Jim: Today’s topic is Kraft versus the CFTC

Jeremy: Yeah, now I don’t see what the big deal is here. Kraft is being accused of manipulating the derivatives market for futures on wheat because they bought some wheat futures that they didn’t intend to actually receive delivery on, and the CFTC apparently has a problem with that. But isn’t this pretty much the whole nature of the derivatives market?

Jim: Absolutely it is, and if we take a look at what is the regulators problem, is what they’re saying is that they don’t want others onto the market that can take the market into an artificial place. So for example we all know that Kraft is probably the single biggest buyer of wheat because of their cereal divisions in North America. So they can be a somewhat easy target for a regulator to go after, and it’s not actually Kraft that they’re after – it’s all the others that could come onto the market and play Kraft behaviour. So for example the Jeremy empire comes onto the market and buys a billion dollars of the wheat futures out there – what does that mean for Kraft? Kraft is now going to have to pay a premium on the remaining crop if you will. All sorts of interesting things can happen from that point in time on, including a major rise in consumer price.

Shaheerah: Yes and they usually only keep about two month supply in the inventory. They never actually had 15 million bushels wheat like with this transaction, which is actually three times their storage capacity. Some of the wheat that was involved in this transaction is actually used in other products like cookies and crackers which is not even made by Kraft group. That’s kind of fishy.

Jim: So there’s a famous case where, the three of you are far too young to remember, but it was the Hunt brothers cornering the silver market back in the late 70s. And again, that’s a traded future or a traded commodity if you will. I’m sure that the aged regulators that will be of my vintage will remember that, and are saying to themselves okay it’s not silver and the Hunt brothers, it’s wheat and Kraft. I’m sure that’s part of this ruling as well too.

Amanda: Could this impact stretch out beyond just Kraft and wheat?

Jim: I think it’s a slap on the wrist. Don’t know – Jeremy, what are your thoughts?

Jeremy: Well again, I think we’re kind of making a mountain out of a molehill. The actual amount that Kraft got on the trade was about 5.6 billion dollars, that’s probably a daily profit for them. I mean – what’s the big deal? Other people trading in and out of wheat futures can affect the market adversely as well.  Are we going to stop allowing wheat future trading?

Jim: Yeah, I think it’s the precedent they’re after. I truly believe it’s the precedent of trying to corner a crop  or a metal. That’s my contention at least.

Shaheerah: Yeah, so when they buy all these futures, why does it make the stock price go down?

Jim: Could be a couple of reasons for that one. A the major buyers off the marketplace being Kraft, so the rest of the crop from different wheat boards and the farmers involved in that could be doing a bit of panic selling, so that could be reason one. Or two, which is probably closer to the truth, and that is you have bumper crops which are plentiful, and you get more supply than normal, and since there is a spoilage factor you can’t keep that for years and years. You have the supply but what happens on the demand curve is that it doesn’t change at all and the pricing elasticity falls, and possibly that would be the main reason the price would fall.

Jeremy: Well spot price is the daily price, so I don’t necessarily see how when Kraft buys wheat futures how that would negatively affect the price today. How do you see that happening?

Jim: Yeah, I don’t disagree on crop pricing aspects of it, but usually spots are also used for trend too. I’m just saying it could be your computer generating systems are saying, “hey, wait a minute, the trend is going to be down.”

Jeremy: Yeah, it could be.

Shaheerah: And they actually went as far as to do an investigation and they found some internal emails from the procurement team at Kraft, which said that Kraft was in line to save seven million dollars on the commercial cost of wheat, and make up to three million from moves in the futures market if all goes according to plan.

Jeremy: I say well done Kraft!

Jim: Same here! Hoo Hah! It’s well done, and isn’t that what the corporate treasury is supposed to do?

Jeremy: Yes, agreed!

 


That was the P4Capital team discussing the derivates market, and mistakes that Kraft committed. Want to know more? Check out our website  and previous posts at www.planet4it.com or follow us @p4capital. Thanks and see you next time.