Managing Price Risk in Local Food Reserves: Analysing the prospects for a stabilisation fund in Mali and Niger | Margin (Finance) | Profit (Accounting)

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Local food reserves can contribute to food security strategies and have the potential to empower communities. These collective initiatives are set up and owned by small-scale producers with the objective of increasing the availability and access to food, or of increasing income by managing the food-price cycle. But the rate of failure among local food reserves is high, largely as a result of climate and price risks, coupled with challenges linked to their design, planning and management This research report analyses the possibility of developing a stabilisation fund as an effective price risk management tool to help local food reserves overcome their vulnerability to price cycle inversions. Four scenarios were considered and modelled on the basis of price data in a series of 12 cereal markets in Mali and Niger over a 15-year time span. The report concludes that the type of stabilisation fund outlined could represent a viable way of managing price risk in countries where the option of using market-based tools to tackle price risk is not available.
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  OXFAM RESEARCH REPORTS JU LY  2013 MANAGING PRICE RISK IN LOCAL FOOD RESERVES  Analysing the prospects for a stabilisation fund in Mali and Niger CREDA–UPC–IRTA This research paper analyses the possibility of developing a stabilisation fund as an effective price risk management tool designed to strengthen local food reserves by reducing their vulnerability to price cycle inversions. Four hypothetical scenarios were considered and modelled on the basis of the price data collected in 12 cereal markets from Mali and Niger over a 15-year time span. The main conclusion to be drawn is that the type of stabilisation fund outlined in this research paper could effectively represent a viable solution for price risk management in countries where the option of using market-based tools to tackle price risk is not available. Oxfam Research Reports  are written to share research results, to contribute to public debate and to invite feedback on development and humanitarian policy and practice. They do not necessarily reflect Oxfam policy positions. The views expressed are those of the author and not necessarily those of Oxfam.   www.oxfam.org  2 Managing price risk in local food reserves CONTENTS 1   Introduction...............................................................................................................3   2   Local food reserves and price risk............................................................................4   3    Assessing the prospects for the establishment of a stabilisation fund.....................6   4   Findings..................................................................................................................10   5   Conclusions and recommendations.......................................................................13   Bibliography..................................................................................................................15   Notes............................................................................................................................15    ANNEX.........................................................................................................................16   INDEX OF TABLES Table 1: Selected markets where LFR buy and sell.......................................................7 Table 2: Market combinations (production and consumption markets) and distance between markets............................................................................................................8 Table 3: Main characteristics of the four scenarios developed.......................................9 Table 4: Minimum wages, nominal and real (in CFA francs)..........................................9 Table 5: LFR operating costs in Niger..........................................................................10 Table 6 Storage facility margins per scenario (average 1995-2011)............................16 Table 7 Storage facility margin variability per scenario, coefficient of variation per market and scenario.....................................................................................................17 Table 8 Storage facility economic results for 50 tons of storage capacity and operating costs.............................................................................................................................18 Table 9 Margins in terms of number of wages and years with margins less than 3 minimum wages. Surplus zones. Scenarios 1 to 4.......................................................19 Table 10 Margins in terms of number of wages and years with margins less than 3 minimum wages. Precarious balance zones. Scenarios 1 to 4....................................19 Table 11 SF profits in legal minimum wages. Results by scenario..............................20 INDEX OF CHARTS Chart 1: SF profits per scenario: Maize, Loulouni   #$   Chart 2 SF profits per scenario: Millet-Macina-Loulouni #$   Chart 3 SF profits per scenario: Maize M’Pessoba – Loulouni ##   Chart 4 SF profits per scenario: Millet-Maradi ##   Chart 5 SF profits per scenario: Millet-Macina-Djenné #%   Chart 6 SF profits per scenario: Millet-Maradi – Filingué #%   Chart 7 SF profits per scenario: Millet-Magaria- Filingué #&   Chart 8 SF profits per scenario: Millet-Macina-Gao #&   Chart 9 SF profits per scenario: Maize, Loulouni-Gao #'   Chart 10 SF profits per scenario: Maize, M’Pessoba-Gao #'   Chart 11 SF profits per scenario: Millet, Maradi-Tillabéri #(   Chart 12 SF profits per scenario: Magaria-Tillabéri #(     Managing price risk in local food reserves 3 1 INTRODUCTION Local Food Reserves (LFR) are formal or informal collective initiatives set up and owned by small producers with the objective of increasing availability and access to food (food security reserves), or of increasing income by buying grain from producers when prices are low and selling it when prices are more attractive (commercial local food reserves). Although their fundamental objectives differ, both types of reserves ultimately try to improve the conditions of producers by managing the price cycle. Local food reserves can contribute to food security in several ways (from mitigating the effects of price hikes to improving income and protecting livelihoods and assets). Numerous civil society organisations and small producer federations promote the creation of local food reserves, recognising their contribution to food security strategies and their potential to empower communities and decrease their dependence on external structures. Oxfam has promoted the development of local food reserves for more than ten years with the dual objective of increasing the income of grain producers (in surplus zones) and increasing food security (in surplus and deficit zones). Despite their potential as effective food security instruments, the rate of failure among LFR is high, largely as a result of a combination of climate and price risks, coupled with challenges linked to their design, planning and management (Oxfam, 2012). Price risk remains the most complex factor affecting the vulnerability of LFR and the least studied. For the purposes of this paper, price risk is defined as the probability of a local food reserve purchasing grain at a price above its selling price. The question of how often this situation occurs has received growing attention in recent years. Preliminary research carried out prior to this study showed that LFR had a probability of losing out as a result of lower prices during the lean season (“ price cycle inversion” ) as high as 25% (Oxfam, 2012) . Given the low financial capacity of LFR, it has been estimated that two years of price cycle inversion (or even as little as one year in certain cases) could lead LFR to bankruptcy. In developed countries, the possibility of using market-based tools for farmers or cooperatives to manage price risk has been evolving over several decades. Price insurance coverage is widespread in developed financial markets, but less so in developing countries, where it rarely serves small farmers. Several reasons account for this limited coverage 1 . ã  The lack of commodity exchanges limits the availability of price information. ã  The lack of use of grades and standards limits the possibility of establishing long-distance contracts both for buying and selling. ã  Government interventions in markets affect prices and discourage financial institutions to provide price insurance. In developing countries, the few documented cases of price insurance systems for cooperatives that exist have focused on cash crops, given the lower odds of government interventions in this realm. Price insurance markets are still underdeveloped and most projects have not progressed beyond the pilot phase. In West Africa, the possibility of working with adequate price insurance coverage is also limited by the absence of large financial institutions with the capacity to provide the required backing to this type of initiative.  4 Managing price risk in local food reserves In the absence of appropriate price risk management tools, LFR can resort to two main mechanisms in order to protect themselves against price risk: ã   Profit savings : Saving money during the profitable years in order to cover losses during the years affected by inverted price cycles. ã    Year-round sales : Lowering risk by selling grain during the whole year instead of selling it during the lean season. This research paper reviews these two mechanisms by analysing 4 hypothetical scenarios: the first one consists of selling all production during the lean the season (at the end of the crop year, just before harvest). In contrast, different sale allocations over time are considered in scenarios 2-4. The two mechanisms are analyzed as follows: Profit savings : This first mechanism is based on preventive measures that could in principle allow compensation between negative and positive years in all four scenarios . Under this mechanism, LFR accumulate savings during the years with a positive balance and use these savings to cover the years with a negative balance. In order for this to be possible, the number and quantity of savings during positive years would have to offset the negative balance years. The conclusions of this research report suggest that under the specific circumstances considered, the establishment of a stabilisation fund 2  would be viable. This stabilisation fund would be set up in a federation of cooperatives with the aim of limiting the damage caused by the inversion of price cycles.  Year-round sales : Assessing the potential effectiveness of this first mechanism requires measuring both the price risk and the profits of selling during the whole year versus the price risk borne and profits obtained when sales are limited to the lean season . Scenarios 2, 3 and 4, described later, measure this relationship. The conclusions show that risk in year-round sales is lower than selling at the end of the season, but profits are also lower. 2 LOCAL FOOD RESERVES AND PRICE RISK For the purposes of this paper, price risk is defined as the probability of a local food reserve purchasing grain at a price above its selling price .   It is important to distinguish price risk from price variation. The latter is necessary in order to cover changing maintenance, storage and transport costs, since if the price is not higher at the end of the season than at the beginning, no trader will be willing to store. Price variation between seasons is also necessary in order to give signals to farmers to invest more or less in a crop, according to its abundance or scarcity in the market. This difference in price across different moments in time is known as temporal arbitrage. The same logic applies to price variation between different locations, since if the price is not higher far from local markets, there will be no incentive for traders to move grain to deficit areas. These differences in price across geographic locations are known as spatial arbitrage, which constitutes a key challenge for cereal banks. In the case of cereals, price risk is not the same for producers than for intermediaries or local food reserves. For producers, price risk means that sudden changes in input prices or drops in cereal prices can compromise crop profitability. If they have enough cash to retain the harvest for a few months (or they belong to a cereal bank), the price risk is then the same as that borne by the intermediary or the LFR (i.e. to have lower prices around the lean season than during the
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