Marketing grain can be very difficult because of all the ways you can position. This is especially true under the current farm policy and also because you can store the grain indefinitely. When prices are trending higher, it seems like the good news will continue forever. When prices turn lower, it's hard to sell corn and soybeans today for a price a lot lower than yesterday's.
Knowing which market alternative to use and when can make pulling the trigger much easier. In this article I'll describe six of the most common marketing methods and the benefits and disadvantages of each.
Sell cash. All of the grain you grow is eventually consumed on the farm or sold into the cash market. When the grain is sold to a local elevator, grain broker, terminal or processor you establish four key criteria:
* Quality. The grain must meet standard government grade and have a minimum of foreign material and acceptable moisture content.
* Location of delivery. Usually, where you sell is where you deliver; however, some elevators will buy the grain for delivery at a terminal, feed company or processor. Others will pick up the grain on the farm.
* Time. When is the grain to be delivered for a cash sale? It is usually assumed that it will be for delivery within two weeks. At times when the Mississippi River is freezing up in late November or early December, the date you can have it delivered by is very important.
* Price. Cash prices are established by deducting the basis from the nearby futures contract. Futures and basis levels change often in the course of a day. Once you have made the cash sale you have locked in the futures price and basis and eliminated that risk. In volatile markets, having your offers to sell at a specific price level will often make youmore money than waiting to see where prices are on the close.
Forward contract. With this option you agree to the quantity, location, time of delivery and price. The advantage of forward contracts is that you eliminate both the futures and the basis risk. The disadvantage is that you often are forced to sell new-crop on a very wide basis.
At times, producers use forward contracts because the later delivery offers a much better basis than is available in the cash market. Selling ahead for river opening is a favorite merchandising method on both the Illinois and Mississippi rivers.
Hedge. When you hedge your grain, you usually sell a futures contract that specifies the following: a specific quantity (usually 1,000 or 5,000 bu), a specific delivery location (terminals along the Illinois River), a time period (the contract month that you choose to hedge into) and the price that you lock in. Hedging offers these advantages:
* You're usually able to lock in a better basis by hedging new-crop sales than by making forward contracts.
* You have a lot more flexibility to deliver to the location offering the best cash bid at the time you select to deliver. You have the flexibility to lift out of the hedge or roll it ahead. The major disadvantage is the margin calls you may have to make if prices move higher.
Basis contract. In a basis contract you lock in a price that is so many cents over or under a specific futures contract price.
For example, you could lock in a basis of 21 cents under the July Chicago Board of Trade soybean futures contract during June or July for delivery to river terminals on the upper Mississippi. The ultimate sale price is then totally dependent on what the CBOT July futures do between when you enter into the contract and when you establish the futures price by July 1. You have eliminated the basis risk but still have to deliver to the specified location in the specified time period, and you have to lock in the futures price prior to first notice day.
This may be a good alternative to consider if dry conditions continue into this spring and summer and the river levels stay low.
Minimum price contract. There are as many types of these as there are elevators in the Midwest. Most commonly, here's how a minimum price contract works: A farmer makes a cash sale, but isn't satisfied with the price or feels that the market may continue to move higher. The elevator manager then buys a call option for the farmer and deducts the cost of the call premium from the farmer's check. The producer has eliminated all futures and basis risk, but could still gain from a major rally in the futures market after he has entered into this contract.
It sounds complicated and it is, and that's one of the disadvantages. One of the key advantages is that, if prices move substantially lower after you've entered into the contract, you will have made a good cash sale, even if you lose the value of the call. It also allows producers to stop commercial storage charges and take 80-90% of the sale price to the bank.
Delayed price contract. In a delayed price (DP) contract you deliver the grain to the elevator, but choose to lock in the price later. The reason most producers enter into a DP contract is that they don't have any new-crop storage and the elevator is full. If they want to haul it in, it'll have to go on DP. Most DP agreements have a minimum service fee of 8-12 cents/bu, then a 3 cents/month fee after 60-90 days.
There are at least two disadvantages to this contract. First, you are taking all of the risk, both futures and basis. Second, the money you pay in fees is used by someone else after your grain is sold. A DP contract is your worst alternative. If you're willing to hedge or forward contract, either one is almost always a better alternative than a DP contract.
With the current Freedom to Farm policy, entering into a DP contract can also make it impossible to collect loan deficiency payments because you have given up beneficial interest in the grain. A DP contract usually results in a DP - disappointed producer.
A question often comes up when farmers talk about forward contracts or new-crop hedges: What happens when you can't deliver on a forward contract? Elevators handle this differently. Usually, if you can't deliver the grain you have contracted because of an Act of God disaster, and you let the elevator manager know right away, you can offset the contract and write out a check or get a check back, depending on what the market has done.
In 1993, the year of the great Midwestern flood, we had several customers who didn't grow enough to deliver against the 50% they had contracted. The contracts were rolled ahead to the fall of 1994, when they delivered $2.30 cash corn when the cash market was at $1.70. I have never worked with a producer who was unable to work out a reasonable agreement when an honest production shortfall made delivery impossible.
Farmers always have two risks, production and marketing. If you're too concerned with the production risk, you may ignore the price risk.
Farmers who study marketing know they will rarely get high prices and a narrow basis at the same time. But if they understand their alternatives and use discipline and patience, they can usually get what they want.