12. Other Related Information

Risk Hedging Procedure Against Sugar Price Volatility in the World
Market

Thailand has the capability to produce sugar more than domestic
consumptions, some of remaining sugar were exported. Ratios of domestic
consumption to exportation vary each year by year --approximately from
20:80 to 40:60--depending on yearly amounts of sugar cane crushed. Then,
Thailand becomes the second largest sugar exporter after Brazil. Revenue
of sugar producers in Thailand is partially based on the world market
sugar prices and fixed domestic sugar prices, regulated by government.

In terms of world sugar price, the policies supporting and protecting
benefits of farmers, and food security policies regulate importing
countries to issue measures for regulating and restricting sugar
importation. These policies, issued by international government sectors,
affect sugar demand in the world market. Factors related to climate
uncertainty such as flooding, droughts, or severe cold in countries
where sugar is produced and consumed, limited number of exporting
countries, and any other events affecting the world market sugar supply
also affect the world sugar prices. Furthermore, in the past 2 – 3
years, significant increase in investment by foreign funds has
heightened fluctuation of sugar prices in the world market; prices are
much higher or lower than fundamental factors. Sugar prices are
especially volatile in years when consumption demand is close to or
greater than the amount of sugar produced. Table 12.1: World Sugar
Prices in the Past 10 Years demonstrates volatility of sugar prices.

Table 12.1: World Sugar Prices in the Past 10 Years

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Due to the fact that revenue of sugar producers in Thailand is partially
based on the world sugar prices, which fluctuate significantly, the
company's operating results will be affected when sugar prices in the
world market drop drastically. To prevent the risk posed by sugar price
volatility in the world market, the risk hedging procedure has been
established with the use of risk management mechanisms and tools in the
forms of futures contracts. Prices are based on those at futures markets
in New York (NYBOT#11 – Raw Sugar) and London (LD#5 – Refined Sugar).
Details are as follows:

Case 1: Normal business transactions in trading export sugar (without
risk hedging)

A buyer and seller agree on a sugar price based on the market price.
Once reaching an agreement, the changed world market price does not
affect the agreed price and accounting recorded value. The seller
records the price as agreed with the buyer, for instance:

In case of sugar price increase in futures market

Day 1: Sugar futures price is at 600 USD / ton :

The buyer and seller agree on a transaction of sugar at the market price
of 600 USD + premium 100 USD

Day 2: Sugar futures price increases to 800 USD / ton :

The seller delivers the sugar. The buyer pays 600 USD + 100 USD premium
= 700 USD

Accounting Record: The company income generated from sugar sale is 700
USD.

Note: Premiums of sugar are based on types of sugar, delivery sites,
delivery time, delivery terms, etc.

In case of sugar price decrease in futures market

Day 1: Sugar futures price is at 600 USD / ton :

The buyer and seller agree on a transaction of sugar at the market price
of 600 USD + premium 100 USD.

Day 2: Sugar futures price decreases to 400 USD / ton :

The seller delivers the sugar. The buyer pays 600 USD + 100 USD premium
= 700 USD.

Accounting Record: The company's income generated from sugar sale is 700
USD.

It can be seen that prices that buyers receive depend on the time that
buyers and sellers agree to make transactions. This becomes problematic
when the world sugar prices are high. Sellers are interested in selling,
while buyers are not willing to buy due to high prices. When the world
sugar prices are low, buyers are willing to buy. Sellers, however,
consider the prices too low and are not so willing to sell. Sellers and
buyers are unable to agree on prices. This method would only work if
sugar prices in the world market were not volatile. High volatility of
sugar price causes the sellers and/or buyers losing the opportunities to
trade at their own satisfied prices.

Case 2: Adopting risk hedging procedure for sugar price in form of sugar
future contracts

During a period when the world sugar prices are highly volatile, to
prevent losing opportunities to sell at satisfied prices, sugar
producers adopt risk hedging procedure in form of "sugar futures
contracts" which their price are based on world sugar price. With this
futures contracts, contracts are not settled by sugar delivery, but by
cash settlement which paying the difference between the sugar price
fixed on the day the contracts are made and the sugar price on the day
the contracts are settled (unwinded). The risk hedging procedure may be
carried out directly at sugar futures market through a broker or
alternatively, through a financial institution as a counterparty.
Examples are as follows:

In case of sugar price decrease in futures market

Day 1: Sugar futures price is at 600 USD / ton :

The seller is satisfied with the price at this level, but no interest
from any buyer. Buyers expect the price to decrease. The seller entered
into a contract with a financial institution fixing the sugar futures
price at 600 USD.

Day 2: Sugar futures price decreases to 400 USD / ton :

A buyer is interested in buying. The seller sells sugar at the agreed
market price of 400 USD + 100 USD premium = 500 USD. At the same time,
the seller closes or unwinds the futures contract by buying back the
contract at the market price of 400 USD/ton (sold at 600 USD while
bought back at 400 USD), resulting in 200 USD gain.

From this example, the seller's actual income from the sugar sale is 500
USD + 200 USD gain from entering into the sugar futures contract = 700
USD. The amount equals the guaranteed price of 600 USD + 100 USD premium
= 700 USD.

Accounting Record: The company generates income from sugar sale at 500
USD (which is lower than the guaranteed price of 700 USD). The 200 USD
gain from entering into the sugar futures contract is recorded as other
income.

In case of sugar price increase in futures market

Day 1: Sugar futures price is at 600 USD/ton :

The seller is satisfied with the price at this level, but receives no
interest from any buyer. Buyers expect the price to decrease. The seller
enters into a contract with a financial institution fixing the sugar
futures price at 600 USD.

Day 2: Sugar futures price increases to 800 USD/ton :

A buyer needs sugar for use, resulting in buying at a high price. The
seller sells sugar at the agreed market price of 800 USD + 100 USD
premium = 900 USD. At the same time, the seller closes or unwinds the
futures contract by buying back the contract at the market price of 800
USD/ton, resulting in 200 USD loss (sold at 600 USD while bought back at
800 USD).

In this example, the seller's actual income from the sugar sale is 900
USD + -200 USD loss from entering into the sugar futures contract = 700
USD. The amount equals the guaranteed price of 600 USD + 100 USD premium
= 700 USD.

Accounting Record: The company generates income from sugar sale at 900
USD (which is higher than the guaranteed price of 700 USD). The -200 USD
from entering into the sugar futures contract is recorded as a loss.

In all the cases, the company has the net income of 700 USD (excluding a
commission paid to the financial institution). Methods of producing
accounting records are, however, different. For the regular transaction,
(no risk management involved), the company records 700 USD as income
from sale. The concerns with this type of transaction is that at the
time there may not be any buyer willing to buy, or the seller may not be
willing to sell. Adopting a risk hedging tool of sugar futures
contracts, if the market is in a downturn, the company will record
income from the sugar sale at 500 USD, and 200 USD gain from entering
into the sugar futures contract will be recorded as other income.
However, during an upturn in the market, the company will record 900 USD
as income from sale and -200 USD loss from entering into the sugar
futures contract.

In conclusion, entering into sugar futures contracts enable (1) buyers
and sellers to trade at prices considered satisfactory by both parties
without the need to wait for prices to reach the levels that buyers and
sellers can agree on; and (2) the net revenue will be equal to fixed
prices. If the market is experiencing a down turn, actual income from
sugar sales will be low, but will be offset by gain from entering into
sugar futures contracts. During an upturn, however, actual income from
sugar sale will be high, while there is loss from entering into sugar
futures contracts.

Important Concerns

1. The times of recording actual sales may be different from those of
recording gain/loss from entering into sugar futures contracts.
Accounting policies of some companies, for example, record income from
actual sales when sugar is delivered to customers. Gain/loss from
entering into sugar futures contracts is recorded upon contract closure
or unwinded. It is possible that companies will realize gain/loss from
entering into sugar futures contracts before recording sales, resulting
in a discrepancy between the two records produced at different periods.
This outcome will be experienced significantly by companies that report
their operating results in quarterly basis.

2. Adopting a risk hedging procedure for sugar price volatility in form
of sugar futures contracts can insure the company against the sugar
price risk on existing sugar volume and also sugar volume estimated to
be produced in the future. Amounts hedged under sugar future contracts
vary according to sugar production estimated to be produced in the
future. However, amounts of sugar produced depend on quantities of cane
crushed largely affected by climate, vast cultivation areas, and a lot
of farmers. As a result, inaccuracy of estimation of sugar cane crops
may be rather high.

When estimation of sugar cane crops are too high, sugar futures
contracts have been made according to the estimates and later the actual
outputs do not match up with the estimates, the contracts become
oversold. If the sugar future price is in an upturn, there will be
actual loss from sugar futures contracts made. This is due to the fact
that there is no actual sale at a high price to offset. In contrast,
when the sugar market price is experiencing a downturn, there will be
actual gain from sugar futures contracts made.