Onion prices keep popping up in the news once in a while for their skyrocketing prices. Mostly, this happens because of poor storage facilities, crop damage, too much or too little rainfall, delay in logistics and transportation, high demand for onions during festive seasons, shortage of supply, and many other factors that take place. To curb the shortage, India often bans the export of onions. This ban causes a rise in onion prices globally as India is the third-largest exporter of onion in the world. This volatility in onion prices proves to be catastrophic for the farmers many times. There are no risk management mechanisms against which farmers hedge themselves.
There used to be a tool in the United States to hedge the risk, which was made illegal in the year 1958. The ‘Onion Futures Act’ banned the dealing in onion derivatives, which could be used to hedge the risks associated with it.
What is the Onion Futures Act?
In the early 50s in the US, onions were traded in the open market alongside the Chicago Mercantile Exchange, where onion derivatives or onion future contracts were traded.
A derivative is a security which traces its value from an underlying asset. As an example, NIFTY Futures derive their value from the underlying asset which is NIFTY itself. A ‘futures contract’ is a contract where a person agrees to buy/sell something in the future at a predetermined price and time. You can find index, stock, and commodity futures on your broker’s terminal.
A futures contract allows a person to hedge or offset the risk involved. In this case, the product was onion and the risks associated were droughts, floods, changes in supply, and demand which could lead to a huge rise or fall in onion prices.
So let’s get into the story. Two gentlemen; Vincent Kosuga and Sam Siegel, were onion farmers who also traded in onion derivatives. Onion derivatives was a hot product in 1950. They made up for 20% of Chicago Mercantile Exchange’s trades.
In early 1955, Kosuga and Siegel bought enough onion and onion futures to control close to 90% of Chicago’s onion market. This meant that they had a higher bargaining power and could set the price very very high. A million pounds of onions were shipped to Chicago and stored at facilities. By late 1955, Kosuga and Siegel had hoarded 14,000 tonnes of onions. They had these onions stored at storage facilities all across the country to prevent suspicion. The shortage of supply caused the prices to increase.
They profited in two ways:
Firstly, Kosuga and Siegel threatened the other small traders to buy onions from them stating that if they didn’t comply they would flood the market with onions and drive the price down. They profited from this since traders were buying onions from them, that too at a high price.
Secondly, Kosuga and Siegel bought short-positions on onion derivatives beforehand. When you hold a short position, you benefit from the fall in the price of the underlying stock or product, in this case, it was onions. What they did with these short-positions made them millionaires.
Kosuga and Siegel dumped the onions in the market and there was an excess supply. This caused futures traders to think that there was an excess supply of onions, they too started holding short positions which further drove down onion prices. Onion prices sunk from $2.75 a bag (23 Kg) to 10 cents a bag. At one point the onions were cheaper than the bags in which they were packed. However, since Kosuga and Siegel had held a short-position on onion futures, they benefitted massively from the fall in onion prices. They made millions of dollars.
Then-Congressman Gerald Ford of Michigan sponsored a bill called the ‘Onion Futures Act’, which banned futures trading on onions. President Dwight D. Eisenhower signed the bill in August 1958. The bill was very unpopular amongst traders. E.B. Harris, the president of the Chicago Mercantile Exchange, lobbied hard against the bill. The Chicago Mercantile Exchange also filed a lawsuit against the act, but the ban stood.
Does India Need Onion Derivatives?
Every time there is a certain spike in onion prices, the government invokes restrictive measures like a stock limit or an export ban. This has failed to resolve the agony that a farmer has faced for centuries, the uncertainty of prices. Such spikes and dips in prices affect both the consumer as well as the farmer. If a farmer enters into a futures contract, then he/she will surely get the amount per unit as promised in the contract after a successful yield. This is already being implemented in the form of contract farming, where corporates like McDonald’s and Reliance get into agreements with farmers before yield season.
Futures can be the future for farmers. MCX and NCDEX are the two primary commodity exchanges that allow you to trade in commodity derivatives. Commodities such as Cotton, Guar Seeds, Wheat, Maize, Turmeric, Castor, and many other commodities can be traded on these platforms. These exchanges also allow for physical delivery of the commodities. Farmers can get connected through these platforms. NCDEX has onboarded close to 258 Farmer-Producer Organizations(FPOs) which represent close to 5,23,000 farmers and MCX has onboarded close to 78 such FPOs.
When a farmer gets into a futures contract, he sets a fixed ‘lock-in’ price for his crops. The futures market gives a farmer two pros- Price Discovery and Risk Management. As for Risk Management, it means that there is no possibility that his ‘selling’ price will fall in the future. This is called ‘hedging’ the risk. The risk of price changes gets transferred to speculators who are willing to accept the risk in hope of making a profit out of it. As far as price discovery is concerned, the futures market reflects the price expectation of buyers and sellers in the future, this allows the farmer to estimate the selling price and plan the harvest or sowing accordingly.
Onion Futures in India
India’s Agricultural Economy is liberalized with three agricultural bills passed in late September 2020. This allows farmers to become entrepreneurs. This gives them great flexibility in making decisions that best suit their economic interests along with risks. Onion derivatives were planned by NCDEX thrice. Once in 2003, another in 2006 and 2013. The proposition however didn’t pass through despite getting a go-ahead from the FMC or Forward Markets Commission.
Onions have been the lead topic of dozens of political campaigns throughout the country. Considering the lack of education amongst farmers, onion derivatives might seem like a scam to them and might become the centre of another political stir. Farmers must be imparted financial knowledge to elevate their economic situation.