ECON 339X: Agricultural Marketing

1. ECON 339X: Agricultural Marketing Chad Hart Assistant Professor/Grain Markets Specialist chart@iastate.edu 515-294-9911

2. HW #1, Contracting Grain, & New Generation Grain Contracts Today’s Topic

3. Options Buy a put

4. Options Sell a put

5. Options Buy a call

6. Options Sell a call

7. 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

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

9. 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

10. 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

11. 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

12. 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

13. 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)

14. 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

15. 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

16. 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

17. 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

18. 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

19. 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)

20. 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.)

21. 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

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

23. 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

24. 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

25. 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

26. 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

27. 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

28. Decision Commodities • Accelerator Pricing • Markets bushels when prices exceed a floor price, but marketed quantities depend on price level • For example, Source: http://decisioncommodities.com/products/

29. 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/

30. Decision Commodities Source: http://decisioncommodities.com/products/

31. Decision Commodities Source: http://decisioncommodities.com/products/

32. 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

33. FC Stone – Accumulator Quantity marketed doubles Normal quantity marketed Contract ends Source: http://www.fcstone.com/content/agriculture/origtools.aspx

34. FC Stone – Consumer Accumulator Contract ends Normal quantity bought Quantity bought doubles Source: http://www.fcstone.com/content/agriculture/origtools.aspx

35. Class web site:http://www.econ.iastate.edu/classes/econ339/hart-lawrence/