Drought Hedge Costs GNC $70M on bumper crop. Financial Review...

Drought Hedge Costs GNC $70M on bumper crop. Financial Review article follows:-

GrainCorp'smove to take out costly production-based crop insurance just as the east coastdrought was about to break will force it to pay $70 million to insurer Aon onthe back of a bumper winter crop

The downside of theproduction-based insurance derivative, which followed a bitter $3.3 billionbattle to privatise GrainCorp, is that it limits the company’scapacity to cash in on big harvests.

In a sign of how farming fortuneshave turned around since a widespread break in drought, GrainCorp received $58million from Aon after last year’s dismal east coast winter harvest.

GrainCorp chief executive RobertSpurway wasn’t on the scene when the insurance deal was signed, but says hewould have no hesitation agreeing to the same terms today.

“Theproduct I think is still an excellent product. It is unique as we understand inthe world and what is really good about it is that when we pay out we are wellinto an export task and the margin we are able to make from that export volumemore than covers the cost of the crop production contract,” he said.

“It is good protection, it isworking as we’d expect it to.”

Crop production estimatesreleased overnight by official forecaster ABARES show grain production in NSW,Victoria and Queensland bouncing back to a combined 24.4 million tonnes.

Payoutcapped

NSW is leading the way withharvest tipped to produce 14.8 million tonnes, up by more than 300 per centfrom just 3.34 million tonnes last year.

Under its deal with Aon,GrainCorp receives up to $80 million a year in insurance top-ups when the grainharvest in Queensland, NSW and Victoria falls below a 15.3 million tonnethreshold.

In years when production tops19.3 million tonnes, GrainCorp instead pays up to $70 million to the insurer.

The payout amounts are calculatedat a rate of $15 a tonne and both GrainCorp’s and Aon’s payouts are capped at$270 million over the 10-year term of the insurance derivative.

Mr Spurway said it was good tosee NSW farmers smiling again but they needed the favourable conditions to lastfor the next couple of months and into harvest.

In the wake of two consecutivehorror harvests that sank exports, GrainCorp has been gearing up to resumeshipments from its seven port terminals and is hiring about 3000 casual workersin regional areas to help handle a big crop.

Australia is on track to produce47.9 million tonnes of grain, its biggest crop since a record-breaking 56.67tonnes in 2016-17.

The latest ABARES forecast is up8 per cent since June and 20 per cent above the 10-year average for Australiangrain production.

Wheat production is tipped toreach 28.9 million tonnes, up 91 per cent from last year.

Less thanperfect

Barley growers hit by tradecrippling Chinese import tariffs are set to increase production by 25 per centto 11.2 million tonnes.

ABARES has also forecast a 47 percent jump in canola production to 3.4 million tonnes.

Wilsons Advisory head of researchJames Ferrier said the GrainCorp insurance derivative served its purpose ofsmoothing out seasonal lumps and bumps in earnings to an extent but was a lessthan perfect hedge.

Mr Ferrier said the payout to Aonwas based on the ABARES production numbers and not how much grain the companyactually received into its vast storage and handling network.

“GrainCorp market share is stilla variable that shareholders are fully exposed to,” he said.

Mr Ferrier said that after twoyears of severe drought, there were a lot of unknowns around what farmers mightdo in terms of storing grain on-farm or selling into rival supply chains.

“It is unclear where domesticdemand has settled, whether for (livestock) feed or food, and how many farmerswill look to sell and monetise their crop and to what extent it is stored onfarm,” he said.

Overseasdemand

Analysis by TheAustralian Financial Review at the time the insurance derivative wasannounced showed that if it had been in place for the previous decade,GrainCorp would have made net payments of $107.86 million to Aon as well aspaying about $100 million in annual base fees.

The Aon deal mirrored aspects of anaborted takeover offer from Tony Shepherd and Chris Craddock-led Long-Term Asset Partners (LTAP) launched late in 2018. LTAP enlisted Allianz as major insurer to smooth out earnings.

Mr Spurway said the insurancesafety net was an important part of setting up GrainCorp for success after 12months of restructuring that has included the demerger of its lessseasonally-volatile malting arm to create ASX-listed United Malt.

With the United States, the UKand France set to produce below average wheat crops, Mr Spurway said there weresigns the world would need Australia’s big crop.

“We are certainly seeing gooddemand and forward orders for product,” he said.

GrainCorp is committed to payingfarmers within 48 hours of receiving their grain and has beefed up its digitalplatform for contactless delivery at the request of Victorian growers.

Mr Spurway said grower feedbackindicated they were well set to get their crops off despite COVID-19 with themain concerns around Victoria’s border farming communities.

“Certainly those in border communitiesare looking for support from governments to allow movement of goods andpeople,” he said.

“That is slowly happening. We’dlike to see it happen more quickly but like us I think most growers areprepared and planning ahead.”