MARKETING ALTERNATIVES FOR GEORGIA FARMERS

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MARKETING ALTERNATIVES FOR GEORGIA FARMERS

• TRI-CO. YOUNG FARMER ORGANIZATION

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INTRODUCTION

• GOVERNMENT POLICY CHANGE
• Strict regulations to market oriented system
• Greater risk exposure (wild swings since 1972)
• What to produce
• How much to produce
• When, Where, How to establish a price

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INCREASED IMPORTANCE OF FOREIGN MARKETS

• Changes in value of the dollar
• Global weather
• Political situations
• Exports
• Global economies

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GEORGIA PRODUCERS MUST UTILIZE PRODUCTION AND
MARKETING PRACTICES

• Reduce risk
• Increase probability of selling crops at a
  profitable price

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PLANNING AHEAD

• Production practices greatly improved
• Marketing receives too little attention
• Production and marketing go hand in hand in
  creating a successful farming operation
• Effective marketing requires planning ahead
• Where you want to go and how to get there

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PRICE OBJECTIVE

• Where you want to go the sale of crops at a
  profitable price (Price Objective)
• Be high enough to cover costs of production plus
  provide a reasonable return for risk and effort
• Price objectives will be different for each farm

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HOW SHOULD PRICE OBJECTIVES BE DETERMINED?

• Dont know the exact cost of production
• Use previous farm history
• Crop enterprise budgets

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MARKETING STRATEGIES

• No one strategy is best for everyone every year
  Must evaluate farm situation
• Ability to handle risk is key element
• Risk The chance or probability of a loss or an
  otherwise unfavorable outcome

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TWO TYPES OF RISK

• Production risk
• Low yields, high production costs
• Price risk
• Unfavorable market prices

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MARKETING ALTERNATIVES ALLOW FOR PRICING UP TO
ONE YEAR PRIOR TO HARVEST AND MORE THAN ONE YEAR
AFTER HARVEST

• Marketing may include pricing portions of the
  crop over a period of time using more than one
  market alternative
• Reduces risk but requires more attention to
  market situations

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MARKETING STRATEGIES

• Four things must occur for a legal transaction
• Goods must be delivered from seller to buyer
• Price must be agreed upon
• Transfer of legal title must occur
• Payment must be made from buyer to seller
• All create possibility of marketing alternatives

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FORWARD PRICING ALTERNATIVES

• Price of the commodity is established prior to
  delivery to the cash market buyer
• Available for a year or more prior to the actual
  harvest and may be used after harvest

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DELIVERY PRICING ALTERNATIVE

• Price determined at the time of delivery to buyer
• Take place at harvest or out of storage

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DELAYED PRICING ALTERNATIVE

• Pricing determined at sometime after delivery to
  the buyer

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FLOOR PRICING ALTERNATIVES

• Minimum price is established for the commodity
  but allows for receipt of upside price movements
• Commodity options
• Government loans

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FORWARD PRICING ALTERNATIVES

• Hedging in the Futures Market
• Very complex and sophisticated marketing
  alternative
• Better know what you are doing
• Knowledge of futures market is needed to
  understand how prices are established for farmers

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FUTURES MARKETS

• The markets are where prices are established for
  the future delivery of commodities
• Prices determined by traders making public bids
  and offers on the trading floor
• Contracts to deliver or receive a specified
  quantity and quality of a commodity at a
  specified price, place, and time in the future

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CONTRACT OBLIGATIONS

• Can meet the obligation of a contract by making
  an opposite or offsetting transaction in the same
  delivery month.
• Sell one November soybean contract Get out of
  the contract by buying one November contract
  before the maturity date (near the twentieth of
  the month)
• Use futures markets to shift price risk to
  someone else not an actual sale and delivery of
  the crop (before the maturity date)

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PRICE RELATIONSHIPS

• Local and futures prices generally move in the
  same direction but will not usually be the same
  amount
• Georgia prices tend to be higher than Iowa prices

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BASIS

• The difference between local cash price and the
  futures market price
• Reasonably predictable
• When to use futures market Trade risk of
  predicting cash price for the lesser risk of
  predicting the basis

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TWO DISTINCT GROUPS OF FUTURES MARKET PARTICIPANTS

• Hedgers
• Use futures markets to establish a price of a
  commodity which will be delivered in the future
• Very few farmers hedge but most grain elevators,
  feed mills, etc. hedge

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Speculators

• Do not wish to receive or deliver the actual cash
  commodity
• Buy and sell futures solely to profit from price
  changes
• Are important to make the futures market work
• Assumes price risk and allows for easy entrance
  and exit from the market

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THE HEDGING PROCESS

• Determine price objective
• Large enough to cover your estimated costs of
  production including profit and storage costs if
  appropriate
• Localize the quoted futures price
• Select appropriate futures contract month
• Find most recent price quote for futures contract
  month
• Adjust for local market basis

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HEDGING PROCESS CONTINUED

• Deduct the costs of using the futures market
• Broker commission fee (1 cent per bushel)
• Interest on margin account
• Good faith money (5 10 of value of contract
  Returned when end contracts
• Annual interest fee (12 for 6 mos.)
• Total of about .05 per bushel

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HEDGING PROCESS CONT

• Make a decision
• Execute the hedge
• Hire a broker
• Deliver an order to sell contract at or above
  target price
• When harvesting crop, sell at local cash market,
  and deliver an order to buy a contract

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TWO TYPES OF HEDGES

• Production hedge Forward price growing crop or
  crop yet to be planted
• Storage hedge price on stored crops which locks
  in return to storage

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HEDGE EXAMPLE 1

• HANDOUT
• WHEN PRICES DECREASE AT HARVEST

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HEDGE EXAMPLE 2

• HANDOUT
• WHEN PRICES INCREASE AT HARVEST

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CASH FORWARD CONTRACTS

• AGREEMENT BETWEEN A SELLER AND A BUYER FOR A
  SPECIFIED QUANTITY AND QUALITY OF A CROP AT A
  SPECIFIED PRICE AND DELIVERY PERIOD
• MAIN FACTOR USED BY BUYER IN SETTING A CASH
  CONTRACT BID PRICE IS THE CURRENT FUTURES PRICE
  FOR THE MONTH NEAREST THE DELIVERY DATE (NOT
  BEFORE)

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FORWARD CONTRACTS CONT

• Buyer usually hedges the purchase in the futures
  market or immediately sells to another buyer
• Advantages
• Shift price risk to buyer
• Disadvantage
• If fail to produce may have to buy to meet
  commitment

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DELIVERY PRICING

• Cash sale at harvest
• Cash sale out of storage
• Disadvantage
• Lost opportunity cost
• May have to take what you can get for a price at
  the time

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DELAYED PRICING

• Price Later Contracts
• Commodity is delivered, title changes hands, the
  seller may accept the price offered by the buyer
  or any given day within some time period
• Buyer usually hedges purchase to secure price

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DELAYED PRICING CONT

• Basis Contracts
• Commodity is delivered
• Title changes hands
• Seller selects a futures market contract month
  near the date of expected sales upon which the
  price will be based
• Buyer assigns a basis to the futures contract
• Seller agrees to price the contract before the
  futures contract matures

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Basis Contract Cont

• Advantage
• Buyer often makes a partial payment
• Disadvantage
• Seller gives up any opportunity for basis
  appreciation

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FLOOR PRICING ALTERNATIVES

• Establish a minimum price for a crop while
  retaining the ability to capture upside price
  movements
• Two Methods
• Government Loan Program
• Commodity Options

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GOVERNMENT LOAN PROGRAM

• Non-recourse loans by USDA through Commodity
  Credit Corporation (CCC)
• Stored crop is collateral
• Generally 9 months in duration
• Loans sometimes extend 3-5 years through Farmer
  Owned Reserve
• Sec. Of Agriculture sets loan rates provides a
  floor price

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GOVERNMENT LOAN CONT

• Grower has the option of selling the crop and
  repaying the loan plus interest or forfeiting the
  crop to the CCC in lieu of loan repayment
• At a minimum the grower should receive the loan
  rate less storage costs

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COMMODITY OPTIONS

• Provides an opportunity, but not an obligation,
  to sell or buy a commodity at a certain price

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COMMODITY OPTIONS CONT

• Purchaser pays a premium (like insurance) to put
  a floor on selling price or a cap on a buying
  price of a commodity

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There are two kinds of options

• PUTS
• Gives you the right, but not the obligation to go
  short, or sell, a futures contract upon
  expiration.
• Puts gain value as prices fall and are primarily
  used for planting strategies by hedgers
• Most hedgers close out their contracts and do not
  convert them to actual futures contracts
• If you bought a put in the spring and it gained
  value because prices fell, you would sell a put
  at the same strike price to exit your position.
  Profit would be the difference to be added to the
  cash price you received

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SECOND KIND OF OPTION

• CALLS
• Gives you the right, but not the obligation to go
  long, or buy, a futures contract upon expiration.
• Calls gain value as the market rises and are
  primarily used for harvest strategies by hedgers
• Allow for profit from upward price movement after
  the sale of the commodity
• If your call option gained in value you would
  offset your position by selling a call at the
  same strike price. If prices went down, let
  option expire

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COMMODITY OPTIONS
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STRIKE PRICE

• The price at which you want your level of
  coverage
• Out of the money not earning money yet and the
  premium is less expensive
• At the money at the current selling price and
  will earn money when the market moves. The
  premium is average
• In the money option is already earning money
  and the premium is most expensive

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DETERMINING WHAT STRIKE PRICE TO CHOOSE

• Know your cost of production
• Determine how much risk you can afford to take
• Determine how much premium you can afford to pay

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Strike Price Premium Price Floor
Option Cost X Contract Size Premium
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