ECON 339X:

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ECON 339X Agricultural Marketing

Chad Hart Assistant Professor/Grain
Markets Specialist chart_at_iastate.edu 515-294-9911
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Todays Topic

• HW 1,
• Contracting Grain,
• New Generation Grain Contracts

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Options
Buy a put
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Options
Sell a put
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Options
Buy a call
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Options
Sell a call
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Crop Insurance ACRE
7. a) 3.90/bu (75 200 bu/acre 122
bu/acre) - 6.52/acre 7. b) 75 200 bu/acre
4.20/bu 122 bu/acre 4.20/bu -
13.93/acre 8. a) ACRE Rev. Guar. 90
3.83/bu 171 bu/acre ACRE Farm Rev.
Trigger 3.83/bu 171 bu/acre
13.93/acre 8. b) Needed to check both triggers,
but ACRE payment rate is based on state level
revenues
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Contracting

• Basic Hedge-to-Arrive
• Basis
• Deferred Price
• Minimum Price
• New Generation
• Automated Pricing
• Managed Hedging
• Combination

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Hedge-to-Arrive

• Allows producer to lock futures price, but leaves
  the basis open
• Basis is determined at a later date, prior to
  delivery on the contract
• So the producer still faces basis risk and
  production risk (must produce enough crop to
  cover the contract)
• The buyer takes on the futures price risk

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Hedge-to-Arrive

• Why might you use it?
• Think basis will strengthen before delivery
• For the producer, the gain/loss on the contract
  is due to basis moves
• Available in roll and non-roll varieties

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Basis Contract

• Also known as a fix price later contract
• Allows producer to lock in basis level, but
  leaves futures price open
• Producer still faces futures price risk and
  production risk
• Buyer takes on basis risk

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Basis Contract

• Why might you use it?
• Expect higher futures prices, but possibly weaker
  basis
• Example
• On July 1, producer sells 5,000 bushels of corn
  for November delivery at 20 cents under December
  futures.
• On Nov. 1, Dec. futures set the futures price

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Deferred Price Contract

• Also known as no price established contract
• Allows producer to deliver crop without setting
  sales price
• Buyer takes delivery and charges fee for allowing
  price deferral
• Producer still faces all price risk and
  production risk (if contract is set before
  delivery)

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Deferred Price Contract

• Producer also faces counterparty risk
• If buyer files for bankruptcy, the producer
  becomes an unsecured creditor
• Why would you use it?
• Believe market prices are on the rise
• Takes care of storage
• Allows producer to lock prices at a later time
• Producer benefits from higher prices and stronger
  basis, but risks lower prices and weaker basis

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Minimum Price Contract

• Allows producer to establish a minimum price in
  exchange for a service fee and the cost of an
  option
• The final price is set later at the choice of the
  producer
• If prices are below the minimum price, the
  producer gets the minimum price
• If prices are above the minimum price, the
  producer captures a higher price

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Minimum Price Contract

• Removes downside price risk (below minimum price)
  and allows upside potential (after adjusting for
  fees)
• Producer looking price increases to offset fees
• Provides some predictability in pricing, can be
  set to be cash-flow needs

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New Generation Contracts

• Ever evolving set of contracts established to
  assist producers and users in marketing crops
• Structured to overcome marketing challenges
• Inability to follow through on marketings
• Marketing decisions triggered by emotion
• Complexities and costs of marketing tools

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New Generation Contracts

• Often broken into three categories
• Automated pricing
• Managed hedging
• Combination contracts
• Offered by several companies, each with its own
  twist on the contract
• I will highlight some available contracts (for
  illustrative purposes only, not an endorsement

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New Generation Contracts

• The contract follow predetermined pricing rules
• Often sold in set bushel increments, like futures
  and options, with a specified delivery period
• Some have exit clauses (depending on price)

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Automated Pricing

• In its purest form, basically locks in an average
  price by marketing equal amounts of grain each
  period within a set time
• Could be daily or weekly
• Some contracts allow producers to pick the
  pricing period
• Can be combined with other pricing approaches
  (minimum price, etc.)

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Automated Pricing

• Examples
• Decision Commodities Index Pricing
• E-Markets Market Index Forward
• Cargill PacerPro
• CGB Equalizer Classic
• Variations
• CGB Equalizer Traditional
• Cargill PacerPro Ultra
• E-Markets Seasonal Index Forward

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Automated Pricing
Pricing period Jan. to Mar. 2009 on Nov.
2009 soybean futures
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Automated Pricing

• Advantages
• Automates marketing decision, frees up producer
  time
• Removes concerns about additional costs (margin
  calls)
• Can be set to capture average price when seasonal
  highs are usually hit

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Managed Hedging

• Automated contracts that implement pricing based
  on recommendations from market analysts
• Example
• Cargill MarketPros
• Producers can choose to follow CargillPros or
  Kluis Commodities recommendations

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Managed Hedging

• Has many of the same advantages as automated
  pricing
• Results are dependent on the performance of the
  market analysts
• Often has higher fees than automated pricing
• Automated pricing 3-5 cents/bushel
• Managed hedging 10-15 cents/bushel

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Combination Contracts

• Extend or combine mechanisms from various
  contracts
• Averaging pricing
• Minimum pricing
• Pricing based on market movements
• Opt-out clauses if prices fall significantly
• Come in many varieties, so producers can find one
  to fit their needs

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Cargill DiversiMax

• Price is set by formula
• 75 of the price is determined by the average
  daily high futures price during a specified
  pricing period
• 25 of the price is determined by the highest
  price observed during the pricing period
• Can be linked to a commitment to market
  additional grain (the commitment reduces the fee
  charged)

Source http//www.cargillpropricing.com/contracts
.html
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Decision Commodities

• Accelerator Pricing
• Markets bushels when prices exceed a floor price,
  but marketed quantities depend on price level
• For example,

If the Nov. 2009 soybean price is Then we market
lt 8.00 0 bushels per day
8.00 to 8.50 100 bushels per day
8.50 to 9.00 250 bushels per day
gt 9.00 500 bushels per day
Source http//decisioncommodities.com/products/
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Decision Commodities

• Topper Pricing
• Markets bushels when prices exceed a floor price
  on days where prices have jumped sharply
• Example Markets bushels when prices exceed
  3.50/bushel on days where prices have increased
  by at least 15 cents/bushel
• Takes immediate advantage of market rallies

Source http//decisioncommodities.com/products/
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Decision Commodities
Source http//decisioncommodities.com/products/
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Decision Commodities
Source http//decisioncommodities.com/products/
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FC Stone

• Accumulator Contract
• Versions for producers and consumers
• Key parameters
• Accumulator price price grain is sold (or
  bought) at
• Knockout price price that terminates the
  contract
• Weekly bushel sales commitment
• Has acceleration function if price move beyond
  accumulator price

Source http//www.fcstone.com/content/agriculture
/origtools.aspx
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FC Stone Accumulator
Quantity marketed doubles
Normal quantity marketed
Contract ends
Source http//www.fcstone.com/content/agriculture
/origtools.aspx
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FC Stone Consumer Accumulator
Contract ends
Normal quantity bought
Quantity bought doubles
Source http//www.fcstone.com/content/agriculture
/origtools.aspx
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Class web sitehttp//www.econ.iastate.edu/classe
s/econ339/hart-lawrence/