 Welcome all and thank you for attending tonight. So now is an introduced Jodi Raze, who is our Senior Consultant with Rural Solutions. She can give us some background on Sheet Connect and introduce, main presenter, Mike Avery. Apart from Jodi's obviously extensive qualification, she's also comes from a very practical background. Jodi grew up in the South East on a family farm and now lives and works a serial livestock property in Central Air Peninsula and is based in our Minnipur office. So I will hand over to Jodi who will give you a bit more of a rundown on Sheet Connect. Thanks, Philippa. As what I said, the program tonight is brought to you by Sheet Connect SA and I'm the Pastral Region Coordinator for that program. Philippa asked me to mention the beautiful photo you see there is actually from our wall on our property. So it's a photo I took in our recent shearing. So just a bit of background about what is Sheet Connect. So Sheet Connect is an extension project run by primary industries and region South Australia looking for opportunities for producers to do practical programs where they can make positive change to their farm production and management practices. And that's focused both in the pastoral area, but also in the agricultural areas of South Australia. If you want to know a bit more about Sheet Connect, we have a Sheet Connect website, so sheepconnectsa.com.au and you can also follow us on Twitter. We couldn't have this webinar tonight or part of the other programs that are presented by Sheet Connect SA without the support of numerous funding bodies. So we'd like to thank them, AWI, Perza, The Sheep Industry Fund and the NRM Board, South Australian Arid Lands and SA Murray, Darling Basin. Just a disclaimer, Perza, from Perza about liability or responsibility for any information that you may hear and is presented tonight. And it's my pleasure to introduce Mike Avery. Mike is the partner at Southern Aurora Wool and has been there for a number of years. He's got over two decades of experience in the wool industry and holds a number of industry positions and they have included being a director at the Australian Wool Exchange for six years. And so it's my pleasure to introduce Mike to present tonight's webinar on forward pricing of wool. Good day. Thanks a lot, Jody. Well, we'll get into it fairly quickly because we've got a number of slides to go through. I'll quickly just give you a rundown of our company. Who we are obviously is Southern Aurora and our job is to provide solutions in agricultural commodity markets. What we do, we offer brokerage in OTC products but also in physical commodities and futures options and foreign exchange. We also do development for Ryman on different OCC products and we have a advisory structure finance wing. We're currently looking at a few other new products. They include cotton, revamping the current cattle contract. Also lambs not on there but it should have said milk rather than cattle. Canola, we're looking at dairy and water at the moment. This is a view of the guys and girls that are involved. We'll move on quickly and get into what we want to talk about is wool and forward pricing. I always like to start with a mission statement or something and that is that the value of certainty is more important than the fear of lost opportunity. I think that's an important place to start because we are talking about forward pricing and certainty in a business that has a lot of volatility. I'll just quickly give you a definition on what is price risk management and the types of contracts and obviously that's key to what you want to hear tonight. Price risk management is all about margin management. It's not trying to pick the top of the market or anything that. If we can do that life would be very easy but it's about managing price and because price is not necessarily the most important factor to a successful business it's managing margin and historically wool like most agricultural commodities are very volatile and that volatility makes forecasting budgeting and cash flow management difficult and affects how business is perceived and also its long-term sustainability. Hedging is a price risk management strategy that's designed to minimize exposure to market risk that's associated with changes in supply and demand and price. Hedging products such as wool forwards they need to be simple and hopefully at the end of this you'll see that they are but they've got to be versatile in their application and it's intended just to reduce risk and increase stability. The types of forward contracts physical forwards you've obviously been accustomed to that come via the broker. We've got the OTC forwards that are based on the AWECS MPGs and that's what I'll be talking about tonight and also hopefully if we have time cover options which you've probably been presented as minimum price contracts. The physical forward contract is where the grower contracts through his broker or an individual exporter deliver their wool sometime in the future to agree specifications. Now as you know with wool those key parameters are micron length strength, vegetable matter yield style and all these present issues because of the relevant primes and discounts that are attached and assessed by the individual purchaser and that's where the downside in the physical forward because the buyer needs to consider all these parameters in factoring his own primes and discounts if wool falls outside those species and the buyer needs to consider those risks involved and formulate a premium discount schedule accordingly. That differs from the Ryman over the counter product is what we're talking about tonight because it's cash settled, it's independent, it's based against the AWECS exchange nominated price guides, it's the midpoint of the north and south MPGs. We do a few bespoke contracts based ex-west for some of our western Australian clients but the ones we're talking about tonight are the ones that are the screen traded so that the bids and offers are visible through an app or on your laptop. They're a wholesale product so therefore it's a business to business where the grower via their wool broker goes direct to the exporter and processor. There's no premium discount schedule attached because they're based against the MPG and the primes and discounts are ascertained at the time when you will sold not against that particular contract. So the grower sells at auction on the maturity date and receives the marketplace premium discount and the profit or loss is then applied to their total account sale whereas they may have hedged 20 bales of wool against the 200 bale clip that they've sold at that time and the profit or loss on that hedge of that 20 bales will be attributed to their account sale. There also is the ability obviously to buy that contract back should the occasion arise. Now we'll just talk about the market dynamics and how the exporter is pricing, the exporter and processor are looking at the drivers of the market and as a producer I think that's what you also need to do when you're formulating your strategies so you can regulate your returns just as the same as the exporter and processor do and they use those forward hedging to manage their margins rather than margin their margins as it says on the screen there are to reduce their risk exposure to adverse market movements. The exporter prices these bids based on their greasy sales or the expectation of those sales and the exporter tends to trade both sides of the market depending on the changes in the supply and demand dynamics. They use it a way to for to to increase their position whether it's a board or sole position based on on where they're going. Processors on the other hand tend to to be to come traditionally from just the buy side where they're looking at that that that pricing basis the sales of their tops yarns and and finish goods. Hopefully you're getting these screenshots in the same order that I'm seeing them that's just a cut of the AWICS daily price guide which comes out the evening after every auction which gives you the price for the spot market of that day and the movement so that's that's available through AWICS every sale day. What you will see on your app and your screen is is what that market the forward market looks at and that's just a screenshot that's up there now of what the major microns are. We do deal from 18 through to 30 microns not all the microns but 18 eight and a half, 19, 19 and a half, 21, 22, 23, 28 and 30 so a fairly wide coverage not always the best way to do things according to the purists because you tend to move liquidity away from from a standard. Those of you who have been in the business for a long time remember the original SFE or City Future Exchange contract. Wool was the first traded contract on the futures exchange going back to the 1960s. There was only one wool type that was traded and that was a 21 micron to everyone. All growers had to look at their own basis and we'll get on to what basis means against the 21 so if you were growing 19 microns you only had a 21 micron contract to hedge. When we developed these contracts the feedback from the grower side was that there needs to be more variety to reduce that basis and exporters have taken that on board and are bidding accordingly. That's just a shot of what the app screen looks like which obviously hasn't got the same detail. The one you're looking at is for 21 microns. Each micron has its own screen so it hasn't got quite the same capability or the same depth that that is applicable in the other screens. Now the other major contract that is that is dealt are options. Now this is usually a topic that has people glazing over because it can be presented as a very difficult concept. It really is fairly simple. It is very similar to an insurance product. What is this guaranteed minimum price contract and whether the price premium is determined according to time, a strike price volatility the current at the money price which is where the futures price is for that time and it is what is termed a put option and what you probably have seen as delivered by your brokers as a minimum price contract and that's what it is. It gives the grower the right but not the obligation to have a sole contract sometime in the future and for this right they pay a premium and just like an insurance premium. The grower chooses the date which is aligned to their projected auction date and he chooses a price level where he'd like to take protection. Now that price level is a big driver of what that strike price or premium would be. The seller of the contract which is usually an exporter will price the premium based on their view of the market, the relativity of the strike price to the current futures price which is the at the money price and the current spot and they'll use the implied volatility and the time to maturity. Now volatility is a complex thing. It is derived well actually the mathematicians that derived volatility guys called Black and Sholes got the Nobel Prize for mathematics so that will probably give you an idea of how complicated it is but it looks at the movement of price over time and has a complex mathematical formula behind it to imply volatility to that market. When I was first looking at futures probably 25 years ago I went to a seminar and was told asked what was the the most volatile commodity that was traded on the world soft commodities market at the time and fortunately wool wasn't the highest volatile market it was the second highest but most volatile was onions. I thought oh well at least I'm not working in onions. These models all incorporate these factors and they guide the buyer and the seller to ascertain where fair value is and where fair value is what the market is predicting the insurance premium should be and as you know is fairly evident the more time you put into a a minimum price contract the higher the strike sorry the the premium will be it's just like if you want to insure your car for six months it is less expensive than insuring it for for 12 months and the same thing about the volatility if you consider volatility like the incident of of accidents and that's why if you are fortunate like myself to have young drivers in the family your premium is much higher than if they're older drivers because the occurrence of something happening the volatility of the chance of an accident is higher for them so it's really not a complex concept if you break it down into into that that idea of it being an insurance product but the key in why some growers use a mixture of both options and forward pricing outright forward pricing is that the option has that upside for the grower where they're just looking to guarantee against an adverse event but are still in the market because they have the option and not the obligation to take up that sold contract whereas you know an outright you have you have sold a contract so you have the obligation to to deliver so it's deliver the wool but but to contract that price. Mike if I might just interrupt you there briefly with a couple of questions so we've got is there is there a general percentage that you find growers contract of the total clip? Yes I'll uh I was I was going to get to that but we'll get to that now usually in a hedging strategy and we'll talk about some of those strategies a little later growers will start off at at shearing looking at their next season and they'll either have price targets or they'll have time targets where they like to hedge forward let's say 12 months out they'll do their first percentage and that might be as low as 5% or 10% of their clip within the first two or three month window then another 10% in the three to six month window and then another 10% in the six months to up to closer to the shearing date and so they'll look at pricing two or three or four times along that curve to a total around about I'd say for those that are actively involved in the contract they're looking at doing no more than about 30% of of their clip you know they're just they're taking their getting that certainty around around some of it and whether that is to of course it's price driven and we'll look at some of those those drivers a little later but if the prices are very very high and well above their cost of production they may choose to have that percentage a little bit higher and where that sits in history but in sort of an average market you're looking around about 30% and Mike you mentioned earlier with the no obligation situation so if something horrendous were to happen in regards to some sort of natural disaster fire etc and you're not obligated to fill those contracts that for an option yes for an outright no you need you're going to be cash settled against that you have a contract that says I've sold for next December 20 bales just like if you had a physical forward contract you've got to meet that obligation an option is you have the option they're the diff the main difference between the two so let's say you you bought a 21 microns are currently say 18 87 so a 1700 option for December 30 cents then you would pay a premium of 30 cents and you have the the option of if the market was to fall below 1700 of of triggering that option and taking that sold futures because it's going to finish in the money if if it doesn't then nothing happens it's out of the money you've paid you 30 cents premium or whatever it was and you've paid your insurance nothing happens a little bit like yeah being happy that you ensured the car but you didn't have an accident but you've got the insurance behind you if you do have an accident you've got there in this case the accident is that the market fell to $10 and you have a sole contract at $17 and so yeah but the the bonus for the option is that should say the price stay at 1880 where it is today for 21 microns then you will have not the if you'd taken a an outright forward contract at $17 then yes you would get for 100% of your clip 1880 if the price stayed stable till December but you would pay out 180 cents against that forward price so you in that case you would have been far better taking a 1700 put option and paying away 30 cents so the option gives you the opportunity to get the upside of the market should stay there and get the upside not just on your total clip the 70 or 80% that you've that's unhedged but also on the 20% or 30% that you did hedge with an option you also can can be involved in that having paid away 30 cents so you're getting no deduction from your from your outright hopefully that explains it yeah that's great thanks Mike it's it's a very you know it isn't an easier easy concept to understand where as you know when you're looking at pricing your your clip with a an outright forward sale what you're doing is is locking in some of your clip at that price and and and saying okay fine and we'll look at some some numbers that are on there later on where where prices are forward and so you you're looking at at basically hedging some of your cost of production against against the forward market should there be there something happen and I guess the next statement really sums up how I would say difficult the process is but of of wading through or navigating the the future and that's Donald Rumsfeld the American Secretary of State once made a quote and said there are no knowns there are things that we know and there are known unknowns that is to say the things we know we don't know but there are also unknown knowns and there are things that we don't know we don't know now that might seem incredibly confusing at the time poor Mr Rumsfeld was was very much derided for saying something until people actually looked at it and thought about it and if you relate that to the wool market then we do have a lot of known knowns we have current and historical prices of wool and competing fibres we have current historical supply and demand we have via the forwards of forward curve and growers know their cost of production so there's a lot of things we actually know or we can get our hands on knowing what we don't what the unknowns that we know are here's a bit of a tongue twister Mr Rumsfeld but they're the future supply and demand and that's going to be impacted by weather price currency global macroeconomics government policy these things that we know happen but we're not so sure about and that's what risk management is all about by trying to wade through those things we we we know that we need to try and get out and one Mr Rumsfeld unknowns unknowns which was about I think probably what was it weapons of mass destruction we we had our own fortunately didn't in impact Australia when the black swan events which are these known unknowns in 2010 we had rift valley fever in South Africa and all of South African wool was quarantined by China so all the demand for wool or the supply that was possible for out of South Africa was there was a moratorium and the outcome we saw in Australia was quite advantageous to us through September of 2010 through to July where you'll see a chart where the market went at that time now not all of that was was on that but that was really something it was a black swan event that pushed the price of wool up because supply globally although Australia is by and far the largest supplier of of marina wool um South Africa is was at that stage a significant supplier into into Europe particularly and entered into into China and Mike we've got a question here that's probably on a bit we were just discussing prior to but it says should the options be used closer to sale of wool or as a tool to use throughout risk management strategy and this growers just said that it has been some advice that they've received from brokers if if the volatility is not so high and prices are low and the projection is prices may go high then then options can be a very good value option again choice for a grower to make because of that fact that they can be involved in the upside of the market at the moment and and there's the question leading to the question the closer you get to maturity uh affects uh the impacts on the on the premium quite significantly so they'll probably look more attractive closer to uh the shearing date then then well into the future because the unlike uh an outright where the the the seller of the option which is usually the the exporter he's he can't put that directly into his export book not the full value of it he can only put a percentage of it and that percentage is actually quite is quite significantly tied to the time factor and the the time is one of the big drivers of the cost of the premium just as as I said if you compare it to um ensuring a car if you're only ensuring for six months it's half as cheap as 12 months in options that's pretty much the same it's not exactly linear but it's it's close to it and uh and so it may it may prove from a price point of view uh better uh to do it close we did one very close to shearing uh uh the other day when the premium was was very low and the strike was was close close to the market but the grower was just here he was he was only six weeks out from shearing we were at 1900 cents but the market very volatile for 21 microns and he was looking just to to take some cheap insurance you know if you look at 20 cents on 1900 cents it's fairly cheap as a percentage uh just in case one of these black swan events uh or uh something impacted whether it be uh currency or something yeah government policy you know there's a fair bit of risk out there in the world of government maybe not just our government but you know if we give an example of of mr trump you know talking about uh trade trade embargoes or a trade war you know that could impact uh us significantly even even though uh we're not directly involved the the kick on from something like that so he was looking at a a very short term option just so uh he he was happy to pay away 20 cents because uh you know if the price of wool fell a dollar he uh he wanted to make sure that uh he had some some cover over some some big event highly unlikely and when something's highly unlikely just like in any insurance business it is the the cost of it is quite cheap so uh it's I think for a grower uh if the price is right options are are a good strategy it's it's just liquidity an issue and and uh and getting close to that fair value model if it if uh if you know the volatility and uh and the time then it's it's easy to calculate using a model to say what is a fair premium and um you assess you know what um and that that premium is driven obviously by price and you might want to just say okay um I'll take a well out of the money option so so a strike price well below where the current level is but I just want insurance in case something uh outrageous happened to the market but I would think on a on a ratio we're probably doing 90 forward prices against uh about 10 of options um when the market was was moving in an upward scale 12 months ago that percentage was probably higher on the options um exporters had a view that the market was was going to continue up and were quite happy to write options at these current historically high levels you know the rider of the option is is really on a hiding hiding to nothing if you know they're aggressive with their premiums because uh you know we had a couple of instances in the last uh week or two if we're talking on say 19 microns where we saw the price decline over six selling days well over a hundred cents now if um if an exporter had priced an option with a premium of of even 50 cents uh he's lost his uh he's lost most of his premium um lost his premium but the strike price had fallen below he um he's he's got very little reward in that he captures the premium just like any insurance you pay it up front he's captured say 50 cents premium and you've seen the price start to fall back down to the strike level or past the strike level so it's it's quite a risky proposition writing options at the top of the market and and they're they're currently priced accordingly hopefully that uh covers that question yes thank you Mike no worries and what we're talking about in this all this data it's out there and available through your local broker or through the National Council AWEX AWI and and ad consultants it's just you know the job of the of the grower to uh to press his his brokers to make sure he's he's well informed and you know I get a lot of that data through from the brokers and they're they're pretty good at doing that uh and and making growers aware of it but if there's any particular stuff that that that growers need it can it can be sourced this might be a good time to even tell our our attendees about the handouts that we've got there in reference to elders and landmark and quality wool but they can download at any time they choose and have a look at it later um just to refer back to uh yeah what you were just saying right yeah and those those um that data I'm talking about I do now are available on all three of those uh company's websites that you've uh that you've said those those daily and weekly reports uh they're they're all there and and yeah not not uh on a daily basis some of the other historicals uh I'll just go through a few examples of of why uh you know a visual really of why risk management is uh is a necessary or not necessary tool but I think an advantageous tool for looking at at managing margins um this is the longest dated chart that I could get which is I'm not not well this is not in microns but that dates back um longer than Jody uh happily informed everyone I've been in the wool industry um so that's that's almost uh oh it's 42 years of data and you can see the peaks and troughs that we've had over time um we'll go through a few others um if we look at a shorter timeframe this last decade then you can see 18 microns has gone through the best part of a thousand cents in that time um that's just a chart on connects all those those finer microns and you can see the movement is is in a pattern which which we spoke about earlier where there was only one uh micron that was uh uh hedgeable from the SFE and the reason behind that is you'll see that that that the price movements are uh for wool in in uh concert with each other until you break them down so you actually it all looks quite regular but if you break it down what we've discussed in a few minutes uh because we haven't got a lot of time about basis between the microns and how that can be used but that's why there's hedging the underlying product is more important than getting the basis absolutely right uh having said that we now have a variety of products which can which can eliminate some of that uh that basis the data we're talking about is is from a historical point of view how to look at it this is what's called a percentile chart um and it just gives you a reflection over the last i've cut it back to two years because i think if we go back further some of these numbers uh this is the move the upward movement so even in this short time frame you'll see that we're currently sitting on some of these these uh microns or all of them except for 30 microns in the 85 percentile or higher which means that for 85 percent of the time prices have been lower than this over these the last two years and if we will look at this uh over a decade period then you find that the majority of the of the marinos are now sitting still in their 95 percentile band for the last decade but i think that's that we need to reflect on you know the last two years more importantly because that's where we've set things but it goes to show that even in that period that there is considerable downside from here to get even the average price of the last two years for 18 microns it's it's 250 sets under here and when we get to a basis chart uh you can see that's over or just over 400 sets from the from the average on 21 microns which is really very significant and if we look at uh just some prices without the the visuals the 21 microns the average over the uh the last eight years is 1270 cents with the low of of just under 900 and a high of uh 19 that's actually not correct the high was 1938 oh that's uh yeah so that didn't change that last six months it broke that previous high so we are talking about a volatile commodity and something that that we need to address uh as uh as growers if in principle we're happy to accept the pricing of the work that we do for 12 months for one single day on that sale day or now i know there's multiple occasions people sell across the year with with uh with more than yearly shearing but the the principle is that we should be looking at pricing uh you know the work done over the year on more than one occasion that's just a clip of the of the uh indicative forward grid you'll notice that's still in quite severe backwardation and a lot of that's been on the back of of where where we've travelled especially on the finer microns uh where it's come back over the last uh few weeks so now if we just talk about what are the the key i think are the key drivers in trying to to develop a strategy and they're different for every enterprise and but they need to relate to the cost of production risk appetite and the impact if any on the cost of financing because that's what the banks we're talking to are now looking at at that volatility especially at these levels and you know uh they want to move risk around and are happy to price financing based on some strategy of risk minimization we're actually getting close to time so i'll run through these fairly fairly quickly they're just the type of strategies and this is really just textbook examples of of what happens in other commodities and what what strategies are about whether they're survival adaptive control or hedging strategies um i spoke about basis and i'd just like to explain that it refers to the difference in the product that's being hedged to the underlying contract so when we had the sfv contract if you were 19 micron wool grower you're hedging 21 uh the basis was a difference between those two and that chart we showed before that they do move in line but they actually do shift out when you break them apart in the case of wool it's the difference between your clip and the underlying mpg that you're going to hedge with and for the export of the type they're delivering against that mpg so the you don't they the export doesn't live to china on 21 micron the mpg delivers a type 55 and for a grower the clip will might be around 21 microns it won't be exact but it'll be a relative or basis to that and in most cases it's best to minimize that basis and therefore hedge to that nearest mpg but sometimes important to look at at basis uh to see if you might get some strategic advantage now this will give you an idea of what that that basis can can look like this is just between two of the finer microns and you'll see in 2011 that basis got to near enough 500 cents and we almost got back that again so that means the difference between an 18 micron wool and a 19 micron wool is 500 cents so it was fairly important at that stage to be uh hedging your closer up to your production as you could whereas down in the lower section over a couple of years especially in in sort of 2014 when that basis got very very low then an 18 micron wool grower would be far better off hedging 19 microns when the basis is is almost nothing if that basis is out there in the forward market then it's better to to hedge the broader micron because more likely than not it will shift up from that basis not not down uh it did get close to zero but never touched zero um and we'll see that in also in 21 microns where yeah that basis again got down to sort of 20 or 30 cents against 21 so at that stage it would have been best to do 21 against 18 instead of that whereas at a peak in 2011 it got to a thousand cents so uh and again 21s you 19 to 21s you'll see that it has moved violently but it is now heading back in in the other direction close to concluding so i could have a few questions um the ongoing key of course and all of this is is education and uh just to to sort of put it in in broad terms um from the selling side wool breakers that are participating in the rhyman market represent around 90 of the volume that goes through auction so that they are very active but probably only half of those brokers are are a very active participants on the exporting side the same thing around 75 percent exporters represent about 75 percent of the wool shift but the majority is only probably traded by about 25 percent so we need education on both sides of that and the real killer for for wool unlike grains cotton is that only about two percent of the underlying clip is is hedged and i think jd asked the the i've asked the question about you know what is a normal strategy well that's probably closer to 30 for an individual grower so if you look at that uh then individual growers we're probably looking at at only about one percent of of individual growers or less using the contract because the guys they're using are hedging around about 20 to 30 percent of their clip and liquidity for everyone is the key to delivering accurate and and fair forward pricing and i always like to finish with uh the same mission statement um we need to look at valuing certainty uh which is more important than than the fear of lost opportunity because none of us can predict what the future is going to be thanks right well thanks very much mike is there any uh any further questions while we have mike's valuable time if you want to yet just drop them down that in that question box and i can certainly pass on to him um also worth mentioning that the we invited the brokers to provide the informations in that handout section so absolutely download them and have a look and i suggest if you want any further information to to contact your broker directly but yes if there's any other questions if they would like to come in fairly quickly um we're we're reaching the end of our our session time and we're always very conscious of of not going over people's time again just a reminder that we will be sending out a recording of this a link to the recording that you can listen to it at your leisure so we yes we highly recommend that you do that especially if there are items or bits that you missed or um if like me your line speed tops out in and out a bit you can at least then go back and reflect on all the great advice that mike gave us i will on on finishing up just firstly thank mike for his very precious time especially seeing we've called him back from easter at barren bay to do this which is very kind of him to to give us his time um and along with with mark and jody of course we would like to on behalf of persia and awr sheet connect and natural resources say our lands like to thank you all for attending we hope you've really enjoyed it at the end of the session there will be a a couple of questions that we'd love you to answer just makes it easier for us to know what type of topics you're looking at next time and we found that these webinars are just getting more and more popular so we find it an excellent tool for for passing on information to a wide audience and so if there's nothing more and we've got a couple of comments coming in mike about the fact that it's a yep been a great session and most most valued so that's fantastic so anyway so thank you very much again for for logging on and attending and we look forward to having you again at our next webinar thanks very much