Grain Marketing in the BioFuels Era: Session 4: Marketing Strategies: February 12

1. Grain Marketing in the BioFuels Era:Session 4: Marketing Strategies: February 12 Ethanol

2. Characteristics of price patterns in the BioFuels Era

5. Market Opportunity-Bull Strategy • Price later (wait for a big event) • No government programs • Consider selling at harvest-replace with long futures/calls • Smaller returns for storage Opportunity Government Support Line

6. How BioFuels Era Impacts Prices and Marketing Level of crop prices rise Relationship of crop prices change Volatility of crop prices increases Government programs: Limited importance Risk Exposure--$ of Exposure grow Cyclical Uncertainties as Boom/Bust Odds Grow Coordination of linkage between growers and end users

7. Opportunity Exposure

8. Ethanol’s Growth? Vulnerable Unlimited • Lower Energy Prices • Policy • Federal Subsidy • State: • MTBE Restrictions • State RFS • Much Higher Corn Prices • Higher food prices • Technology-cheaper energy sources 25 by 25 U.S. Gasoline use is about 140 billion gallons per year. Ethanol has about 70% of the energy of gasoline.

9. Predicting Price Direction Everyone is interested, but the success rate is not encouraging

10. Random Walk Model • What? Successive price changes in futures are independent and thus past prices are not a reliable indicator of future prices • And: Information tends to flow to the market in a random nature. Thus the odds of prices being up or down tomorrow are equally likely.

11. Efficient Market Hypothesis • At any given point in time, the marketplace incorporates all of the information available, and quickly and accurately formulates price. • Assumes: • A large number of market participants • Participants who are well informed • Participants are profit maximizers

12. Conclusions From Random Walk and Efficient Market Hypothesis • Futures Prices are not predictable • Futures Markets should not have predictable trends • Futures Markets should not have seasonality • A trader should not be able to profit from trend following or seasonality of price movement • It is difficult to make speculative profits in futures trading from price prediction

13. Hurt: Hog Price Forecast Errors

14. USDA :Average % Miss on Crop Size: 1981 to 2005 Crops For May 2007: This is Plus or Minus 1.2 billion bushels

15. Support for these Theories • Past studies show in any given year for small speculators about 75% lose money, ie. There are 3 times more losers than winners • This means that over 90% of small specs would be net losers after 2 years • AgMas: Project tracks corn and soybean recommendations from Ag advisories show little net gain from advisory information in total…see examples

16. Rejection of these Theories • Empirical evidence suggest there is seasonality of futures when the last 10-15 years are observed on average--Maybe • Some people do make money speculating in futures—Does not reject Theories • Some advisory firms did substantially exceed the average in pricing corn and soybeans (AgMas)—Does not reject Theories

17. Some Relaxation of Theories • While information is random, that information sometimes has a trending nature to it. For example; • Weather trends • USDA supply and demand reports • Economic trends (Favorable economic trends) • News trends (Asian Financial Crisis) • Livestock production cycles

18. Risk premiums may have to be paid, giving rise to seasonality • Buyer of futures perceive greater risk in the spring and early summer for crops therefore will pay greater futures prices to • Shift risk of upside from themselves to a speculator • At harvest, short hedge pressure tends to drive futures to their lowest seasonal price. • At harvest, buyer feels little need to pay “risk premium”

19. Purdue Conclusions on Speculation • Beating futures markets at price speculation is difficult. • At any trading price, the odds of prices going higher or lower is about 50/50. • Limit your speculative positions to acceptable levels. • Always look for the best pricing strategy, but also diversify them. • If you have a speculative objective also have a speculative “Ouch” point. • Markets have NO concern for you or your family, they can destroy your business if allowed. • The returns to non-speculative types of marketing knowledge have higher odds of success than speculation. • “Stick to your knitting.” Returns for your time in other farm management decisions are generally more profitable over time than market speculation

20. Optimum Pricing Strategies

21. Overview • What drives the pricing decision (criteria)? • Conceptual framework to consider in establishing your strategies. • Pricing clues from the past: • Pre-harvest pricing • Harvest-pricing • Post-harvest pricing (storage returns)

22. Decisions In Pricing • What drives the pricing decision? • Timing based decisions. • Outlook • Fundamental indicators • Technical indicators • Use an analyst, or marketing service • Cost of production thresholds • Cash flow needs • Emotion--- Not Generally Recommended

23. Strategy Concepts • Routine strategy, or discretionary decisions • Portfolio approach to marketing: • Portion that is passive marketing • Portion that is active • Decision weighting: • Concentrate marketing strategies • Diversify marketing strategies.

24. Pricing Clues From Past Patterns • For Pre-harvest pricing: • Do new crop futures tend to have a seasonal pattern? • Do new crop cash bids tend to follow this pattern? • For Post-harvest prices: • Do they tend to follow a pattern? • Do they increase enough to cover storage costs? • On-farm • Off-farm (commercial).

25. About a 20 cent historic premium for pricing in the mid-Feb to early-June period versus harvest

26. About a 35 cent historic advantage for pricing in the mid-March to late-June time period versus harvest

27. New Crop Forward Pricing Window

28. Pre-Harvest Pricing 1. Research on pricing strategies on both corn and soybeans shows that pre-harvest pricing tends to help increase the mean returns versus selling at harvest and also reduces the variability of prices received over time. 2. The reason is new crop futures for both corn and beans have tended to be higher in mid-February to early-June period than at harvest. Thus, on average, pricing some new crop in this time period has given higher average prices in the past. 3. The price variability of new crop futures also tends to be less in the mid-February to early-June time period than at harvest.

29. Pre-Harvest Pricing • Pricing strategies that tend to work well in the Pre-harvest period include: • Forward cash contracting • Selling futures to hedge • Buying put options, and • Selling cash on a forward contract and also buying new crop call options (this is called a synthetic put)

30. Hurt/Weitrich Study SoybeansHarvest Price = $6.04 This study was for 1975 to 1988. The spring highs tend to come earlier in more recent years.

31. Be more aggressive at pre-harvest pricing Have a stronger tendency to use forward cash contracting Still need to follow the volume guidelines outlined next Want to leave open the storage decision until later in the summer/fall Tend to avoid forward cash contracting for harvest delivery, but May forward cash contract for delivery out of storage, or In the spring, sell futures or buy puts which allow you to make the storage decision later in the summer/fall May tend to sell Nov/Dec futures in the spring and then roll to March after futures spreads widen in the summer or fall. Further Guidelines Related to Storage Without Storage With On-farm Storage

32. Pre-Harvest Pricing Volumes • Generally pricing too large of volume in pre-harvest is considered risky until yields are known. • The first 25% can often be priced with a forward cash contract, generally without concern for ultimate yields. • The portion from 25% to 50% of expected conservative yields might be priced: • Once yields are more certain into the late spring or summer • With options • Or forward priced after buying out-of-the money calls to protect against upside price movements

33. Pre-Harvest Pricing • Above 50% of the expected conservative yield • Should not be done until yields are more certain • Should be done with options only • Remain unpriced and buy puts • Puts establish a futures floor price, but • Do not establish a final price, in the case of rising futures • Do not commit bushels to be delivered in case of short crop yields • Forward cash contract, and also buy out-of-the-money call options to cover potential futures price increases

34. Pre-Harvest Pricing • Should be more aggressive and start pricing new crop earlier in years following a short production year. • In 1995 there was a short corn crop due to low yields • Begin to price the 1996 crop as early as the fall of 1995 and into the spring of 1996. • Generally you also want to be more aggressive at pricing larger volumes, although still use options once you are moving above the 25% to 50% of conservative production estimates.

36. Pricing At Harvest • Should generally be avoided with some exceptions: • When futures price spreads are inverted and the market carry is small or negative. • When prices are viewed as high. • When income tax management favors selling in the harvest calendar year. • When storage is not available, or commercial storage costs exceed the estimated price gains (carry) offered by the market. • When a landlord or tenant is not willing to consider other alternatives. • When cash flow needs demand pricing at harvest

37. Pricing at Harvest • Even if you price at harvest: • Consider bids for later time delivery • Calculate the storage costs • Evaluate whether a positive return can be gained from storing and pricing for a later delivery period. • Also, always look for any premiums for early harvest delivery that you may be able to earn.

38. Post Harvest Pricing • Basis normally appreciates sharply at the conclusion of harvest. • Expect to see 15 to 20 cents per bushel gain, or more, in the three or four weeks immediately after harvest. • Beans: • Cash prices of beans tend to rise until early-December, but tend to be flat to slightly downward into March. • Then beans tend to have final increase into spring • The best pricing window for beans is often the 30 to 60 days after harvest or into March to mid-May. • Those who want to continue to speculate on beans might then consider doing so with futures or options.

39. Post Harvest Pricing • Corn: • Corn prices have a tendency to continue to rise into the spring period because there is no major Southern Hemisphere competitive crops. • The odds of receiving a positive net return to corn storage into the spring are higher for corn than beans, especially on-farm storage. • Commercial, off-farm storage over time has been about a breakeven situation • Storage into the late spring and summer generally does not cover storage costs, so • Either sell the cash grain and buy call options for potential upside gain, or • Store with the grain priced for summer delivery.

45. Review • There are many aspects to establishing a pricing decision. • Pre-harvest pricing somewhat before or during planting has tended to increase average prices versus harvest pricing. • Post-harvest pricing has tended to provide positive storage returns for: • Short term storage on beans either on-farm or in off-farm storage, and for • Storage into the spring for on-farm corn storage only. • There is much variation from year to year, thus • There is a need to “read” the market signals each year, and • Make some adjustment in pricing strategy. • Diversification in a marketing program has its merits

46. In the End • When all the research is concluded, remember no one knows for sure what the “optimum” pricing strategy will be for next year. • The odds of most producers “beating the market” at price speculation are relatively low. • Always know for sure how much risk you can and are willing to take in the market. • “Stick to your knitting.” Do your best job of pricing, but remember returns can often be higher for time spent in production and general farm management. • Diversify, because no one does know for sure what will happen.

47. The Ten Step Marketing Plan (CMS Disk 2, Unit 7)

48. What Is a Marketing Plan? An orderly procedure to attempt to achieve specific pricing objectives that meet the farm’s overall goals.

49. The First Step 1. Define Your Pricing Objectives • Highest price? • Sell above average yearly price? • Net price above yearly average price? • Price above the midpoint of the price range? • Price in the highest 1/3 of the price range? • Price at a profit? • Price to meet cash flow? • Reduce or minimize price uncertainty…risk?

50. Suggested Objectives • Use a strategy that allows you to increase prices 2% to 5% above the average yearly price received by farmers in your area, adjusted for storage costs. • Implement a strategy that will allow you to generate prices 5% to 10% above the average harvest cash prices after you net out all costs of marketing including storage cost, commissions, options premiums, etc. (Except in short production years, or when futures price spreads are inverted at harvest).