To cope with a sudden spike in wheat prices, the world’s biggest importing nation is considering an unusual tactic: price hedging.
Egypt, which relies on subsidized wheat to feed millions of people, is in the early stages of discussing a plan to hedge against price increases, according to Finance Minister Mohamed Maait. The country is paying more for imports after severe droughts in Europe and Australia ruined crops, with benchmark wheat futures in Chicago reaching a three-year high earlier this year.
While the plan is in the beginning stages, it would be a dramatic development for the wheat market. It’s common for the private sector to hedge commodity purchases, but the tactic is rare among countries. The most notable example is Mexico, which has run a hedging program for its oil exports for nearly 20 years.
“It’s a sign that future wheat volatility is being taken very seriously by big buyers,” said Charles Clack, an analyst at Rabobank International in London. “I wouldn’t necessarily say its a big deal for global prices, but it’s quite a shift in Egyptian risk strategy.”
Egypt will buy 12.5 million metric tons of wheat in the 2018-19 season, according to estimates from the U.S. Department of Agriculture. The World Bank and the International Monetary Fund had been encouraging emerging nations to hedge their exposure to commodities markets, in part on the positive experience on Mexico.
At current wheat prices and freight costs, Cairo would spend this year about $3 billion buying the cereal. Insuring the expected wheat import needs of Egypt over the next year through the options market could cost roughly $150 million in fees, according to Bloomberg News estimates based on current prices.
Egypt was already talking to at least one bank about the potential for wheat price hedging, but was still in the early stages of that plan, according to an official, who spoke on condition of anonymity. The country announced several weeks ago that it was seeking to protect itself against sudden increases in the price of crude oil and was negotiating with global banks.
Read: Egypt Said to Choose Citi, JP Morgan for Oil Price Hedging Plan
“Egypt probably got reminded this year that supply is not infinite and that producers can falter on the supply side,” said Rory Deverell, a senior commodity risk manager at INTL FCStone Ltd. “This move suggests Egypt is trying a new model.”
Sovereign hedges for commodities can be very expensive for large deals. Mexico spends regularly about $1 billion in fees with Wall Street banks to lock-in energy prices. Smaller countries with a relatively small volumes to cover can get cheap deals, however. Uruguay bought insurance against rising oil prices for approximately half of its import needs in 2016, spending $15.7 million.
Sovereign hedging also has political risk if the market moves against the country. Ecuador, an oil exporter, hedged its crude sales in 1993 through a deal with Goldman Sachs Group Inc. The losses triggered a political storm and the nation never tried again.