IS THERE A FUTURE FOR SALMON FUTURES? AN ANALYSIS OF THE PROSPECTS OF A POTENTIAL FUTURES MARKET FOR SALMON

Abstract

Many futures contracts for food commodities have been introduced; however, most of them have been withdrawn from the market due to poor liquidity. In this article, various known success factors for futures contracts are discussed with regards to a proposed futures contract for salmon. Criteria from the literature are used. The principal conclusion is that a salmon contract might have difficulty surviving for a long period of time. Alternative means to manage the price risk in the salmon industry are proposed.

Keywords:

• aquaculture
• contract design
• futures
• risk management
• salmon

ACKNOWLEDGMENTS

Thanks to Henry Bryant, Steinar Ekern, Brian Hardaker, Gudbrand Lien, Søren Martens, Atle Marøen, Ragnar Tveterås, and two anonymous reviewers for valuable comments and discussions.

Notes

Source: USDA, FAO and different industry reports.

Source: Statistics Norway and Datastream.

Source: Rausser & Bryant, 2005.

Source: Discussion in this article.

The Financial Supervisory Authority of Norway has mentioned this as an important risk factor for Norwegian banks–see e.g., their risk outlook for the financial markets in Norway for 2003, < http://www.kredittilsynet.no/archive/stab_pdf/01/01/10504055.pdf>

The theoretical idea is not new—Vassdal (1995) provided a good discussion of the issue – the new aspect is that companies are now working on the actual implementation of a futures contract.

For good reviews of commodity futures markets and how they work, see Carter (1999) and Garcia & Leuthold (2004).

Leland (1996) notes that derivatives thus should be held only by investors differing from the average in terms of risk aversion, expectations, or hedging needs.

As prices vary, both over time and from market to market, the quoted average prices are estimates. Hence, the market value figures will be inaccurate, but should at least give an idea about relative sizes. Volatilities are based on weekly cash trade prices on the exchange with the most volume where available, otherwise on weekly published price estimates.

Amundsen & Singh (1992) mention the “rule of thumb” from NYMEX, that new contracts should be based on a commodity with at least 10% volatility in demand and supply, and 20% volatility in prices.

In addition to being larger commodities, it is worth noting that the introduction of both Nordpool and Imarex, the Nordic futures markets for electricity and shipping, probably were successful due to the large and/or increasing spot market activity around the introductions.

Smaller lot sizes might also be an advantage for small producers, who could face challenges, for instance if the lot size was larger than their whole production for a given period.

See Cita & Lien (1992) for a more thorough discussion of the challenges related to finding the most representative spot price index.

Including the failure of the shrimp contract—the only other seafood contract traded so far.

In a discussion of the Imarex market for freight derivatives, Skjetne (2005) pointed out that the use of indexed representative spot prices probably was one of the reasons why the earlier BIFFEX market for freight futures ceased to exist. While correlation between different underlying price series included in an index is substantially higher for salmon than for freight, attention should be paid to this problem here too.

The matrix shows correlation between salmon spot prices and futures prices of the other commodities, as these futures prices would be the alternative for hedging salmon price risk. The table shows correlations between logarithmic changes in prices. Bold numbers are significantly (> 99%) different from 0. For salmon, the official weekly export price series from Statistics Norway are used. For the other commodities, the weekly futures prices are used (the price series from the most active market if the commodity is traded in several market places) collected from Datastream. Each series consists of 299 observations, from 2000 to 2005.

See for instance Donath et al. (2000) for a study of consumer preferences and willingness to pay for eco-labelled seafood.

Contract success is subjective—a contract is deemed to “maybe” be a success if is has failed in large markets but is traded in smaller volumes other places, or if it has survived with small, but stable trade. The potato market is the exception to this—with so many attempts to establish a contract in large markets, it must be considered a failure even if it is traded in low volumes in smaller markets.

The futures contract is for cheddar cheese, but the volume is for white full cow-milk cheese combined, as these were the only data available. However, one might assume that prices of the different kinds of full-milk cheese are highly correlated and hence allow for use of the same futures contract, so the total market size should be a good measure for the contract's chances of success.

This is based on average export prices from Statistics Norway. As prices for different sizes and qualities are not perfectly correlated (in fact sometimes negatively correlated, see discussion in part three), the volatility for any one specific size and quality is likely to be slightly higher than this.