Tariffs may threaten pricing

An analyst warns that tariffs and subsidies could throw a wrench into the commodity futures market

Analysts see no simple solution to the price-distorting effects of tariffs and subsidies on the futures market, but farmers are warned that the problem will likely somehow work its way back to them. Photo by Rômulo Queiroz/Pexels

SASKATOON — Tariffs and subsidies could undermine pricing mechanisms for many Canadian agricultural commodities, says an analyst.

Most Canadian agricultural commodities currently face zero tariffs into the U.S. market, according to a recent policy note released by Agri-Food Economic Systems.

However, there is the looming threat that U.S. president Donald Trump may reinstate his 25 per cent tariff against Mexican and Canadian goods once his 90-day suspension expires July 8.

If that happens, it will undermine local commodity pricing in Canada.

“It could make historical basis charts and relationships used by traders in merchandizing and hedging all but irrelevant,” said report author Al Mussell.

Pricing of major grains, oilseeds, cattle and hogs in Canada are largely based on U.S. futures prices adjusted for currency exchange rates and local freight, elevation and handling costs, which is collectively referred to as the basis.

The assumption is that the United States and Canada are essentially one market, but that is not the case when tariffs and subsidies are in place.

“Tariffs add noise or interrupt this kind of price correlation,” said Mussell.

“It introduces a whole new dimension into the basis.”

The problem is that the existing components of the basis are in Canadian dollars and are fixed costs that are unrelated to the price of the commodity.

That is not the case with tariffs, which would be in U.S. dollars and are a percentage of the price.

“I don’t know how you would mesh the two of them together,” he said.

“We don’t have a lot of precedent to work with in terms of how on earth this would all get factored in.”

And it’s not just tariffs between the U.S. and Canada that matter.

Access to third-country markets must also be equivalent for the U.S. and Canada for the pricing system to work properly, and that is not always the case. For instance, U.S. pork faces a 57 per cent tariff into the Chinese market compared to Canada’s 37 per cent.

It’s a similar situation for soybeans where China is applying a 23 per cent tariff on U.S. product and three per cent on Canadian.

“How can U.S. futures markets capture that additional value owing solely to Canadian origin and the differential Chinese tariff treatment?” said Mussell.

Subsidies are another issue to consider.

The U.S. trade war with China could trigger a second round of the Market Facilitation Program, which delivered $23 billion in direct payments to U.S. farmers during the previous trade war in 2018 and 2019.

Those subsidies distorted the pricing relationship between Canada and the U.S. because the farm price effects of lost sales to the Chinese market were cushioned by the subsidies.

Mussell doesn’t know what to do about the price-distorting effects of tariffs and subsidies, but he thinks it will somehow work its way back to farmers.

“Be prepared for the possibility of more (price) risk,” he said.

“Maybe we need to get geared up and thinking about how we’re going to make this work.”

One idea is to broaden the ICE Futures Canada offerings beyond canola to include other crops and livestock. However, those contracts would likely suffer from low liquidity and a lack of financial critical mass.

Traders could use other agricultural futures markets such as the Dalian in China or the Euronext in Europe.

However, those are not realistic options either because there is no ability to deliver against those contracts and they wouldn’t be as efficient as Chicago or Minneapolis, which can handle settlements in cents or even fractions of cents.

About the author

Sean Pratt has been working at The Western Producer since 1993 after graduating from the University of Regina’s School of Journalism. Sean also has a Bachelor of Commerce degree from the University of Saskatchewan and worked in a bank for a few years before switching careers. Sean primarily writes markets and policy stories about the grain industry and has attended more than 100 conferences over the past three decades. He has received awards from the Canadian Farm Writers Federation, North American Agricultural Journalists and the American Agricultural Editors Association.