In my experience, most farmers will not price grains six months prior to seeding because it seems too risky — they’re concerned about delivery risk. How can you reduce or eliminate delivery risk so that, if prices are profitable early in the year, you’re not afraid to price some or most of your crop and lock in a profit? Here are some strategies.
You can use a futures hedging strategy to establish a floor futures price. This doesn’t require a delivery commitment so you’re free from delivery risk, but there is a cost, including potential margin calls. This allows you to wait until closer to harvest before you price any grain for delivery — reducing your risk of having to buy back a contract if you can’t deliver because of a production or quality wreck.
Put and call options
You can use a put option strategy, which does the same thing as a futures hedge — it sets a floor futures price. The difference is that you pay an upfront premium for the option and there is no risk of a margin call. Options contracts are used by farmers more often than futures hedges. The premium you pay for an options contract will likely be more expensive than that for a futures contract.
At some time you still have to contract your grain for delivery. Using a call option, you can do that and still reduce your delivery risk, so you feel comfortable forward pricing grain early in the year.
Let’s say a grain company offers an attractive basis on a deferred delivery contract early in the year for fall delivery, and you’re concerned about delivery risk. You can buy a call option for the same number of tonnes you pre-priced. A call option, an option to buy a set amount of grain at a certain price, would protect you if you were unable to meet your contract obligations due to a production wreck.
If the futures prices rise between when you sign the contract and when you have to buy back the contract, the value of your call option will have increased by the same amount as the increase in the futures. Your contract buy-back costs will be covered by selling your call option, other than other than administration costs.
If futures prices fall between when you sign the contract and when you have to buy back the contract, you’ve secured a good price for delivery and gotten some cash flow. The call option was insurance against delivery risk.
Barley and pulse crops
The contracts out there for malt barley and pulse crops range from basic production contracts with no pre-pricing requirements and no Act of God clauses to production contracts with full Act of God clauses and a requirement to pre-price 50 per cent of production.
The best contract for your farm depends on the risk you want to take on.
Signing a production contract means you are at least in the door, so to speak. If you grow a quality product you will be able to move some and maybe all of it through this contract.
You may be required to pre-price a portion of your anticipated production. But with the Act of God clause, if you end up not producing a quality product you are released from the contract with no buyback penalty or costs.
Some pulse buyers may give you the option to take an Act of God clause. If you take it, they’ll offer you a lower price to offset the risk they take on. You need to decide if you’re willing to take that risk.
Pulse crops and malt barley bids are derived on a sale-by-sale basis. Companies make sales to end users and then post bid prices. Quite often the first price offerings for the coming year are merely an incentive to get producers to commit to seeding that crop in the spring, to ensure that supplies will be available to meet the companies’ demand. Often those early offers can be some of the best prices for the year. They usually don’t last long, as the companies are only willing to take on so much pre-priced risk heading into a year of many unknowns.
Using these types of strategies can help you lock in profits with little to no risk, early in the year. Locking in profits is never a bad thing.
Using these strategies will help you develop a better and more disciplined approach to marketing based on your cost of production, breakeven numbers and cash flow needs. Overall, you’ll see an improvement in your overall pricing results.