Now that your crop’s in the bin, find out how to get a price for it that will keep you sleeping well at night
Harvest is done. Now what’s the next thing you should be focusing on, marketing wise?
The grain is in the bin and you still have some of it unpriced. When should you price it? How can you better protect yourself price wise if futures values continue to erode?
The current situation
First you need to evaluate the world and/or local markets and try to understand where the supply is, where the demand is, which is greater and where you fit into the picture.
You need to know the quality of your grain, so you know if it will meet market demand. Is your quality above average? For example do you have high protein wheat that may allow you to extract an additional premium out of the market? If your quality is only average or below average you may need to look for ways to improve it by blending, which means negotiating with a grain company to take your grain.
With this year’s wheat crop being larger than average and the majority of it average quality (No. 1 or No. 2, low protein) there is a lot of grain that needs to move. That means those who wait to sell could be waiting six to eight months to deliver their grain.
Logistically, our transportation system cannot handle a crop of this year’s volume in 12 months so some of it will end up staying on farm. You need to figure out how much, if any, grain you are willing to store until next year. If that’s not an option, you need to look at marketing your grain sooner than later to ensure it will move before next harvest.
As mentioned in my previous column, this is where watching futures spreads and basis levels will tell you what buyers and grain companies want for grain and when they need it. Spreads and basis levels will incent you to deliver now or hold your grain and deliver at a later date.
Cash flow needs
Next, you need to review your cash flow needs to ensure you are selling grain at the appropriate time. Let’s say you need cash for year end, either to pay some bills or pre-purchase fertilizer for year end tax benefits.
Preparing to sell grain months in advance of when you need the cash allows you more time to watch the markets to extract the best price possible. The trick is to match your cash flow need with their need for grain so that you can get the best futures value, the best spread and the narrowest basis.
Let’s say it’s July and you need cash for December, so you’re watching futures prices closely for Nov./Dec. delivery. For this example we are referring to either canola or wheat, as those are the crops where you have the ability to use options contracts.
Futures are up and the basis is historically narrow, so you will net out a nice per acre profit based on your fixed cost and an average yield. You decide you want to protect that profit and — as every farmer is an eternal optimist — you believe markets will go higher. What is your best pricing risk management strategy?
If the basis is what you consider narrow, lock that in. That establishes your delivery period. Now, as for the futures, you have a couple of choices:
1. Lock in the futures and then purchase a call option so that if the futures go higher you will extract that additional value from the market with the option.
2. Buy a put option and leave the futures unpriced for now. This allows you to follow the market and limit your downside risk. The put option will protect you if the futures values falls below your strike price and it also allows you to watch the futures markets for an extended period of time so that if the futures do go higher you can lock it in when you want.
Now, what if you consider the basis too wide in July, but the futures value is still attractive?
You need to deliver grain in November to get cash to meet your December cash flow needs, and the only way you can do that is by locking in a basis or a futures contract with the company to secure a delivery period. If the basis is too wide, don’t lock it in (you must lock in the futures to establish a delivery period). Now that you have locked in the futures you can give yourself some additional pricing flexibility by buying a call option to give you the potential to capture any upward movement in the futures prices. The key is “what does the option cost?” and “what do you think there is for upward movement potential in the futures over the life of the option contract?” Does it make sense to spend the money to buy the option, or are you better off to keep that premium money in your pocket and be happy with the price you locked in?
That is always the question that is the hardest to answer: What will the markets do?
The better question to ask yourself is: “Are you happy with the price you locked in?”
If you do purchase the option contract, can you live with the price you have locked in minus the premium cost for the option contract as your minimum price if the markets don’t move and your option expires worthless?
The difference between greed and risk management is what are you willing to spend to protect yourself and establish a floor price as opposed to letting it ride and see where the markets will go. There is a cost to establishing a pricing comfort level (floor price) but there is also a lot less risk for you, which should help you sleep better at night. †