Last June, just as Ontario’s corn crop was starting to be visible from the laneway, the Chicago Board of Trade posted its first December 2012 corn futures contracts. Overnight, growers could sell corn they wouldn’t harvest for almost four years.
The question is, should you sell that far out?
Grain buyers report that more farmers are pre-selling more crop, but they’re staying within limits.
“Farmers are definitely looking out further when marketing their crops,” says Gerry Groot, grain marketer for Hensall District Co-op in Hensall, Ont. “Some producers are now trying to lock in profitable prices a year or two in advance.”
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Hensall District Co-op is a diversified farmer-owned co-operative that sells farm inputs and buys feed grains for its two feed mills. Hensall also buys wheat, corn, soybeans and edible beans for commercial and export sale.
The co-op offers flat cash-pricing for those who simply want a cash price, but producers wanting to price grain for future delivery are able to forward contract, use basis contracting, and even rent storage for their grain for later sale.
Still, Hensall doesn’t offer the more complex pricing tools such as hedge-to-arrive contracts or minimum price contracts. And it doesn’t sell contracts more than two years out.
Groot has a one word explanation: volatility.
Locking in a profitable price on a portion of this year’s or next year’s crop is smart marketing, Groot says.
But the same argument doesn’t apply to selling three or four years out, he says. It’s just too risky.
The problem, says Groot, is that input prices can be just as volatile as crop prices. That makes saying a price today will be profitable in 2012 little more than a guess.
Ed Usset, grain marketing specialist at the University of Minnesota and author of GRAIN MARKETING IS SIMPLE, IT’S JUST NOT EASY, suggests a grower should start marketing the crop about a year and a half before the crop is harvested.
But there’s a big difference between starting to market and starting to sell. What Usset is recommending, he says, is for growers to start laying out their marketing plan for the crop, and to start watching for pricing opportunities.
If prices look profitable, locking in a return on a portion of the crop you’ll harvest in 18 months can make sense. Even then, however, it’s wise to be cautious. Usset recommends pricing no more than 30 per cent of your expected crop when you’re between a year and a year and a half out.
“Pricing two or three years ahead is too aggressive” says Usset. “You have to know your input costs, especially fuel, fertilizer, pesticides, and rents in order to lock in a profit. It is impossible to lock in some of these costs more than a year in advance.”
“Production costs and pricing of your production must be tied together,” Usset insists.
Besides, says Usset, politics can change too. If you’re more than a year and a half out, it’s impossible to predict what may happen to safety nets or other government programs that can have a huge impact on prices and on cropping decisions.
If the yield isn’t there
In contrast to Usset and Groot, farmers usually cite weather and production concerns when they explain why they’re reluctant to do more forward pricing.
Sometimes, in fact, weather is a dominant concern, especially on farms that are especially vulnerable to frost and severe drought.
In many areas, however, crop failures are rare, Groot says. And while quality can be a concern, most contracts allow for a quality discount.
Usset addresses production worries by suggesting you link the maximum number of bushels from your current crop that you ever price pre-harvest to your insurance coverage.
As indicated, Usset also says that if you’re looking to price some crop two years out, never sell more than 30 per cent.
Growers who rely on crop insurance to offset sales must remember crop insurance coverage and costs can change year to year, and this is another reason Usset suggests not going out more than a year and a half.
What if prices go up?
Many growers also avoid forward pricing because no one wants to miss better prices that may come along after you’ve locked in. Melvin Brees, market extension associate with the Food and Agricultural Policy Research Institute at Missouri State University, reminds growers no one can know how high — or how low — prices will go.
“It is unlikely that you can sell at the market high because no one knows what that might be or when it may occur,” Brees says. “Growers should try to lock in profitable prices rather than worry about getting the highest price.”
Brees suggests a strategy of incremental sales, especially in a rising market. Instead of pre-harvest pricing all your estimated crop in one transaction, sell percentages of your expected production over a period of time.
Growers who use futures and options markets to price grain must also be aware of the potential of significant margin calls to maintain their market position, especially when prices are volatile. Brees says it is very important for your banker to understand what you are doing when pricing grain pre-harvest, so
Pre-Pricing Toolbox
Pricing before a crop is harvested allows growers to lock in profitable prices. Growers can also take advantage of seasonal price trends. For example, the highest average prices tend to be in April, May, and June. Following is a list of market strategies growers might be able to use to pre harvest price their crops.
Deferred delivery contract: a promise to deliver a specific amount and grade of grain to a buyer by a certain date for a specified price at time of delivery.
Basis contract: a promise to deliver a specific tonnage of crop at a certain basis above or below a certain futures price. The futures price must also be locked in before price risk is eliminated.
Futures hedge: a sale of a futures contract equivalent to estimated production.
Hedge-to-arrive: a contract with a company for delivery of your estimated production. The company then sells futures for this amount. While futures price is established, basis is not.
Strategies with limited pre-harvest pricing potential include:
Options: producers can use put and call options to profit from expected price movement, to create a price range, or to reduce risks when locking in a price position.
Target pricing contracts: a promise to deliver a specific amount of grain if the targeted price is reached. If the price is reached within the predetermined time period, the contract automatically becomes binding. If price is not reached the contract becomes null and void.
credit is available to cover margin calls if they are required.
Growers must also remember margin call costs, as well as that the costs to acquire the futures or options are real costs which must be deducted to determine the true price you receive for your grain.
Canadian growers wishing to use futures or options markets for price determination are limited to trading on U. S. exchanges for some grains and contracts. This means exchange rates get added to the mix, and in these economic times, these currency risks can be very real.
On top of all that, growers who forward contract must also be aware of the possibility of the failure of the company they are contracting with. While not as serious as when grain has already been delivered but not priced, an unfilled delivery contract with a bankrupt grain buyer can lead to legal hassles.
Why it works for buyers too
Forward pricing of grain not only works for farmers, but for end users of the grains as well. Feedlots, mills, crushers and other end users need a steady supply of grain. Forward contracts are one way for buyers to ensure they can keep their plants running. However, they too face increased risks the farther out those contracts are extended.
Terra Grain Fuels, operator of the new ethanol facility at Belle Plain, Sask., initially offered growers one-or two-year fixed-price delivery contracts. Now, price volatility has forced the company to drop the two-year contract.
“Most farmers wanted an act of God clause in the two-year contract,” explains Dale Williamson, grain merchant for Terra Grain Fuels. Simply put, the farmers felt the production risks were just too high two years out, Williamson says. “But as an end user we still need delivery of the amount of contracted grain and the risk for us to replace grain that was contracted but not delivered was too high. So we are only offering one year contracts now.”
Based on the experts, the farmers probably made the right choice.
Locking in profits through pre-harvest pricing is a sound business strategy. Most marketing experts agree that farmers can and should be looking out up to 15 months pre-harvest for profitable pricing opportunities.
However, pricing beyond 15 months greatly increases risks. Input costs, new production problems, insurance costs and potential returns, government policy, and world economic conditions are all factors which you have no control over but which can seriously impact your costs and returns.
If you cannot know and control your costs, there is no way you can lock in a profit! CG
