Volatility may curtail multi-year contracts

(Resource News International) — The price volatility that has crept into the Canadian ag industry may have long-term implications for multi-year contracts, with farmers less willing to sign onto agreements that look attractive one season and inadequate the next, an agricultural analyst said.

Ron Frost, a marketing specialist with Pike Management Group in Calgary, said significant shifts in both crop and fertilizer prices are making it difficult for farmers to manage their risk through multi-year contracts.

That has been the experience of some farmers in Western Canada who signed multi-year feed wheat contracts with ethanol plants at prices near $4 per bushel, only to watch input costs rise drastically and erode their profit, Frost said. When many of the contracts were signed, cash bids for feed wheat were in

the $3.50 a bushel range.

“From the plants’ point of view, it was a very business-savvy thing to do. From a farmer perspective, the contracts offered slightly improved prospects from some of the prices we saw in previous years when you’d be lucky to get anything that would allow you to break even. They scrambled to grab the contracts.”

For the next couple of years however, producers locked in at $4 a bushel will have a tough time making ends meet.

“We’re getting indications that by next spring we could be facing phosphate prices that are well in excess of $2,000 per tonne. There have even been some guesses that we might be looking at phosphate prices of $3,000 per tonne, compared to current price level of $1,200 to $1,400 per tonne,” Frost said.

That being the case, he said, it’s easy to understand why some farmers say their contracts need to be re-negotiated.

Failing that, growers may be forced to significantly reduce their fertilizer applications, thus lowering their yields and the amount of feed wheat available for delivery to the plants, Frost explained.

Some farmers have also inquired about ways to end their contracts altogether, but Frost doesn’t believe many producers will follow through on that, seeing as how agriculture is still largely a sector in which a contract is seen as binding.

Looking ahead, Frost predicts producers will be more hesitant when it comes to entering into multi-year contracts.

“I think the current volatile environment is a problem that will have bigger implications for multi-year production contracts. Lessons will have been learned from situations like this and both parties (producer and end-user) may re-think how they enter into them in the future,” he said.

Another scenario is that end-users, such as ethanol plants, will be eager to sign longer-term contracts while producers hold back.

“In the next year or two some contracts are going to be offered as multi-year contracts and quite frankly at $7, $8 or even $9 per bushel as opposed to $4, it will be the other side that is grabbing onto them,” Frost said.

“It will probably be the producers that have the leg up and it will be the ethanol plants that are sitting there facing red ink. Multi-year contracts in extremely volatile markets are a difficult thing to manage on both sides.”

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