What do we consider cash grains? These are grains that do not have an active futures or options contract trading that you can use to offset pricing and delivery risk. These include durum, malt barley, feed barley, flax, peas, and all other special crops.
What can you do to reduce your pricing and delivery risk if you decide to pre-price cash grains prior to harvest?
Unless your production contract with a grain buyer includes an Act of God (AoG) clause.
A production contract is a commitment to deliver all or a portion of your production of a specific crop to a grain company. Your commitment helps the company know how much volume they’ll have on hand, so they can pre-sell it. But what does it do for you?
The AoG clause is a rare and wonderful thing. It provides an incentive for you to sign a production contract with a grain company.
The terms of an AoG clause will vary with every company and every type of grain. Generally, they offer farmers the ability to lock in a price on a specific tonnage or percentage of anticipated production before harvest. If you experience a production loss (like hail or drought, for example) the grain company, after verifying your production loss, will not hold you responsible to deliver the tonnes you pre-priced.
In essence, the company has given you the ability to pre-price some of your grain with no delivery or pricing buyback risk if you’re short production at delivery time. That is about as risk free a pre-pricing contract as you will find.
Don’t assume that all production contracts will include an AoG clause, Ask before you sign. Try to negotiate one in to the contract if it is not there.
Why are AoG clauses rare?
Only a few grain companies offer AoG clauses. These clauses are rare because grain companies offering AoG clauses are taking on all of the risk if you can’t deliver the tonnes you contracted. They can’t offset this risk by hedging because there are no valid futures markets for them to hedge on.
For example, if you locked in a price on some peas and the grain company pre-sold them to a buyer, then you got hailed out and couldn’t deliver the peas, the grain company has to find other peas to replace yours. But now, the price of peas has gone up above the price the grain company pre-sold them for — the grain company ends up losing money on this transaction.
That is why most AoG clauses limit the maximum percentage or tonnage that they cover — to reduce the company’s total price exposure and risk. Only a few companies offer a 100 per cent AoG clause.
You could ask your grain company rep to do a production contract with a specific number of acres or tonnes of production of a specific crop if they will provide you with some pricing protection with an AoG clause. This would guarantee them tonnage and give you some price protection. This is what I would consider a good working relationship.
If markets for cash grains and specialty crops are going to continue to grow, grain buyers need to start offering contracts that will give farmers incentive to grow these crops without shouldering all of the risk themselves.
No Act of god clause?
If you don’t have a production contract with an AoG clause and you pre-price some of your cash grains, you’re facing greater pricing and delivery risk. You can’t offset any of your risk with a hedge or options contract like you could with canola, wheat or oats. If you’re short of production and cannot deliver against your contract, you’ll have to find grain to fill your contract or buy out your contract, whichever is easier or cheaper.
There are only a small number of acres of specialty crops like lentils, mustard and chickpeas, and these are usually grown in a fairly concentrated area. A major drought or hailstorm could easily wipe out a good portion of the total production real fast. If this happens, and you have to buy out your contract, the cost could be astronomical depending of course on how prices react to the situation.
Due to this additional risk related to pre-pricing cash grains it is often advised that you focus your pre-pricing strategies on grains that offer hedging or options contracts (canola, wheat and oats). If you need cash in the fall you can pre-price those grains more aggressively (protecting yourself with a hedge or options contract). Then you can wait until you have your cash grains in the bin before you sell them. This will eliminate your delivery risk.
Having said that, there is nothing wrong with pre-pricing some tonnes of cash grains, if you do it strategically.
The likelihood of getting 100 per cent hailed or droughted out is on average rather low. If you were to pre-price 10 or 15 per cent of your anticipated crop because the price is good, there shouldn’t be too much concern that you won’t be able to come up with enough tonnes at harvest to meet your contractual obligation.
It’s all about taking advantage of good prices when they’re available, without putting yourself in an overly risky situation.
Be safe this spring. Spread your risk around among different grains, and use different contract types to your advantage to reduce your risk. †