ECON 339X: Agricultural Marketing

1. ECON 339X: Agricultural Marketing Chad Hart Assistant Professor chart@iastate.edu 515-294-9911 John Lawrence Professor jdlaw@iastate.edu 515-294-7801

2. Today’s Topic “New Generation” Contracts

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

4. 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

5. 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

6. 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

7. 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

8. 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)

9. 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

10. 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

11. 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

12. 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

13. 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

14. 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)

15. 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.)

16. Automated Pricing • Examples • AgriVisor – Index Pricing • E-Markets – Market Index Forward • Cargill – PacerPro • CGB – Equalizer Classic • Variations • CGB – Equalizer Traditional • Cargill – PacerPro Ultra • E-Markets – Seasonal Index Forward

17. Automated Pricing Pricing period: Jan. to Mar. 2011 on Nov. 2011 soybean futures

18. 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

19. 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

20. 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

21. 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

22. 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

23. AgriVisor • Accelerator Pricing • Markets bushels when prices exceed a floor price, but marketed quantities depend on price level • For example, Source: http://www.agrivisor.com/Services/CrossoverSolutions.aspx

24. AgriVisor • Topper Pricing • Markets bushels when prices exceed a floor price on days where prices have jumped sharply • Example: Markets bushels when prices exceed $13.00/bushel on days where prices have increased by at least 15 cents/bushel • Takes immediate advantage of market rallies Source: http://www.agrivisor.com/Services/CrossoverSolutions.aspx

25. AgriVisor Source: http://www.agrivisor.com/Services/CrossoverSolutions.aspx

26. AgriVisor Source: http://www.agrivisor.com/Services/CrossoverSolutions.aspx

27. 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.intlfcstone.com/commodities/grains/Pages/OriginationTools.aspx

28. FC Stone – Accumulator Quantity marketed doubles Normal quantity marketed Contract ends Source: http://www.intlfcstone.com/commodities/grains/Pages/OriginationTools.aspx

29. FC Stone – Consumer Accumulator Contract ends Normal quantity bought Quantity bought doubles Source: http://www.intlfcstone.com/commodities/grains/Pages/OriginationTools.aspx

30. Class web site: http://www.econ.iastate.edu/~chart/Classes/econ339/Spring2011/