Sri Lanka tea industry mulls futures market

MAY 23, 2007 (LBO) – Sri Lanka’s tea industry and the Securities and Exchange Commission are considering introducing a tea futures market as part of efforts to develop the island’s capital markets and provide an opportunity for tea producers to hedge risks.

“It’s a bet on what tea prices will do ” so the producer can hedge his risk” de Mel said. The tea industry and the market regulators have been studying the tea futures market proposal which has won the support of the Asian Development Bank.

The SEC is considering setting up a commodities exchange not just for tea but for other commodities as well.

The industry believes a futures market will help stabilize the tea market, which now experiences peaks and troughs as quality changes with changing weather patterns.

The tea market’s fluctuations make it difficult for producers like Regional Plantations Companies to budget for their costs, explained Nissanka de Mel, finance director at Asia Siyaka Commodities.

“The tea market is cyclical because production is not static. We have two monsoons and because of the rainfall pattern, as in all agriculture, there are peaks in production.”

This trend is particularly felt in high grown teas which have distinct quality seasons depending on the monsoons, during which prices peak.

Low grown teas, which now make up over half the crop, do not have a quality season. But quality tends to drop when there is a lot of crop as factories become hard-pressed to deal with the bigger volumes.

The tea futures market is being envisaged for the three main elevations ” low, medium and high grown teas.

A study done by the ADB found that a futures market could be developed in tea because the Ceylon tea industry has price records classified according to estates and elevations going back over a century.

A futures market is where a standardized contract is traded on a futures exchange, to buy or sell a certain underlying instrument or product at a certain date in the future, at a specified price.

It allows producers of the underlying product, such as tea, to hedge the risk of future price changes, by selling the futures contract to speculators who seek to make a profit by predicting market changes.

Allowing producers to sell futures contracts for their commodities helps them ensure guaranteed prices and better plan for the future.

“Futures markets are really not linked to physical quantities. There is an overall link, but not on each transaction,” de Mel said.

“Futures take out the uncertainty in the market and helps ensure price predictability. It helps take out the fluctuations that exist in the actual physical plane. They allow you to know your income without uncertainty.”

Resistance to idea arose owing to misconceptions in the market place that futures contracts are linked to physical quantities