Revised methodology applied in the determination of location differentials for 2012/2013 maize marketing season

CHRIS STURGESS, DIRECTOR: COMMODITY DERIVATIVES, JOHANNESBURG STOCK EXCHANGE (JSE) AND RAPHAEL KARUAIHE, JSE

The resistance around the use of location differential rates (LDR’s) has been in the market place for many years with an independent study undertaken by the National Agricultural Marketing Council (NAMC) in 2009, confirming the impact to the various market participants should differentials be removed.

A number of recommendations were also made in the report in order to improve the transparency of the cash market basis premiums. The continued use of location differential rates was again discussed in 2011 amongst the Advisory Committee.

Following extensive consultative meetings of the JSE Agricultural Advisory Committee which consists of various agricultural market organisations and commodity derivatives members, the majority of participants confirmed their support for the trading of futures contracts establishing the price from a single reference point. This then implies the continued use of location differentials to each registered delivery point from Randfontein.

The JSE together with the National Agricultural Marketing Council (NAMC) and Agricultural Advisory Committee did resolve to further investigate any improvements that can be made to the process of determining location differentials, particularly the transparency thereof on an annual basis.

This resolution resulted in a series of workshops being conducted to establish a more robust calculation process for the location differential rates. The outcome of these workshops resulted in more formulabased location differential rates that were driven off the actual distance of the respective silo to Randfontein.

This article presents the revised approach to determining location differential rates as it was applied to the 2012/2013 crop season for both white and yellow maize. The results are appended at the end of this article.

New approach

As per previous years, the JSE extended an open invitation to all market participants via a market notice to contribute both road and rail tariffs directly to the exchange. In addition to this, registered silo owners were approached to contribute rail versus road out-loading information.

Additionally, road transporters were requested to submit to the JSE their actual budgets relating to annual kilometres travelled, fixed and variable cost components. The information was used to determine aggregate rand per kilometre (RPK) figures for each silo location to Randfontein.

Although collecting this level of detail from road transport companies is new, in principle, collecting accurate road rates has always remained the objective when determining location differential rates.

Following further discussions it was agreed to move from a rand-per-kilometre (RPK) figure to a rand-per-ton (RPT) using the below formula, as this best replicated how transporters currently priced and quoted in the industry:
RPT = Distance*RLF*RPK
            Payload

Where: Distance is the distance in kilometres to Randfontein;
            RLF is the return load factor;
            RPK is in rand per km; and
            Payload is in tons.

Thus the road rates in rand-per-ton (RPT) for all silo locations were then calculated using the new formula:

• Distances to Randfontein from each silo were aggregated from submissions by an independent logistics entity and the transport industry.
• A RLF of 2, which implies that one leg of the trip is empty, was applied to all delivery points up to and including 400 km’s from Randfontein. This issue of return loads was discussed at length at the workshop since a number of the long distance routes see limited return load activity. The JSE reached an agreement that this principle will be ironed out for future updates via the Agricultural Advisory Committee and at this point is comfortable with the information provided to continue on the proposed sliding scale. The following sliding scale was introduced for the RLF for the maize calculations as illustrated below:

  Distance	RLF
  <401 km	2
  401 - 425 km	1,9
  426 - 450 km	1,8
  451 - 475 km	1,7
  476 - 500 km	1,6
  >500 km	1,5

• The RPK rate was calculated by the JSE after aggregating all the information provided by the road transporters, this therefore is an indication of actual road costs. Based on this information, the cost per kilometre varied depending on the distance travelled; as can be seen, the rates for the very short distances are high and then gradually ease off and flatline after a certain distance. The rates are as follows:
  

  Distance	RPK (R/km)
  0 - 15 km	80,31
  16 - 25 km	53,54
  26 - 50 km	26,77
  51 - 75 km	18,07
  76 - 100 km	16,35
  101 - 125 km	15,76
  126 - 150 km	15,49
  151 - 175 km	15,00
  176 - 200 km	14,94
  201 - 225 km	14,78
  226 - 250 km	14,74
  251 - 275 km	14,03
  276 - 300 km	13,71
  301 - 325 km	13,71
  326 - 350 km	13,61
  351 - 375 km	12,70
  >375 km	12,53

• Although the JSE aimed to ensure the location differential rates calculation is all formula based, there was an anomaly in terms of the Western Cape delivery points. If this was calculated purely on road rates, as a number of delivery points suggested, and even if guaranteed return loads were factored in, this would not reflect current transport supply and demand factors and so for the Western Cape delivery points, the JSE completed an independent survey to understand actual road tariffs applicable at this point in time. Based on this information it was decided to move this rate to R400/ton from the current R410/ton.
• The payload agreed at the workshop, although this could vary per type of road truck used, was 34 tons.

An example of the road rate based on RPT calculation is as follows:
Location = Brits
Distance = 97 km
RLF = 2
RPK = R16,35/km
Payload = 34
RPT(Brits) = 97*2*16,35 = R93,29/ton
                        34

In addition to the calculated RPT rates, actual rail rates for the previous season were received and adjusted by 9,5% as published by Transnet to reflect the cost for the new marketing season. Therefore, the most recent rail increase was factored into the calculations.

Based on the calculated RPT road rates and actual rail rates available, finally the rail-road out-loading ratios as supplied by the registered silo owners, were then referenced per individual silo using the same formula as in the past:
Final LDR = (Road rate*Road out-loading ratio) + (Rail rate*Rail outloading ratio)

By refining the process and determining a RPT road rate, the industry is able to, on a more transparent basis; understand the road portion of the location differential rates final number. This process will also ensure, going forward, that there is a consistent adjustment across all registered silos where in the past the JSE did not always receive comprehensive road rates across all delivery points which impacted the resulting averages calculated. Going forward, this new approach, although dependent on contributions by road transporters, allows for a more accurate distribution across all registered points since it will be driven off the distance to Randfontein. The final 2012/2013 location differential rates for all 198 silo locations for maize, are available on our web page.

Conclusion

In summary, across the 198 maize delivery points, the average location differential increase is R15/ton or 8,47%. Please note that there are individual increases whilst others have decreased from last year’s rates. The JSE has spent a significant amount of time reviewing and reconfirming all the adjustments based on the improved methodology and is confident following this year’s alignments, that we should not see such large variations across delivery points going forward since the road distance together with a RPT, will drive actual road costs.

The remaining factor that could potentially result in greater variations, is the rail versus road out-loading ratio. This year already the JSE made use of a two year average for the out-loading ratio to provide a smoother effect. Although the rail:road ratio is applied per each individual silo, the average across all delivery points for the two years is 20% rail and 80% road. The JSE will continue to consult silo owners with the objective in the future to also provide the individual out-loading ratios per silo to the market in general so that replicating the JSE location differential rates calculations would be easily possible.

Members and clients are again reminded that the published location differentials are indicative of transport costs for product from the registered silo to Randfontein, which is the basis for the standardised futures contract. It is impossible that this rate will be 100% accurate throughout the year, as transport components change. Throughout each marketing season the basis value at each silo, created through supply and demand, must be considered before making physical delivery onto the exchange. Through further refinements of the Safex silo receipt auction functionality, the exchange aims to improve transparency to the basis trade for each silo based on product delivered in completion of a futures contract.

In proposing the adjusted maize location differential rates, although the JSE has spent a significant amount of effort to move to a more calculated methodology, this has only been possible thanks to the invaluable commitment of a number of road transporters who supported the bigger picture and contributed individual information directly to the JSE who could then aggregate this to determine the RPK rates table.

In addition to these respected companies, the NAMC, Grain SA and selected traders, all actively contributed during the workshops in order to be able to propose the improved methodology. The JSE also values the accurate contributions made by the silo owners in terms of the rail versus road out-loading ratios as well as the actual rail rates provided by market participants. Finally, recognition also goes to the Agricultural Advisory Committee who have provided guidance in the past and where the above exception principles will be finalised going forward.

This improved methodology will also be applied to calculating the wheat and sunflower seed differentials henceforth.

The JSE has commenced testing software that will allow for the trading of Safex silo receipts. This functionality will provide all registered market participants with an opportunity to offer physical grain in silos at a requested premium per ton whilst buyers will be able to bid premiums in required silos. This will create a transparent platform whereby physical stock holders and buyers will be able to transact basis premiums on a guaranteed trading platform. The existing trading rules of the JSE derivatives market will oversee these transactions providing additional regulation to the market place. Following extensive testing, this new functionality is expected to be launched in August this year.

For additional information regarding the products traded, visit www.jse.co.za/commodities or feel free to email commodities@jse.co.za with your questions. Alternatively the authors of this article, Chris Sturgess and Raphael Karuaihe, can be contact at (011) 520-7535.