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Agricultural Hedging Strategies for Producers and Processors

Learn how short and long hedging protect against price fluctuations for soybean and corn producers and processors. Understand futures contracts, basis, and hedging outcomes for effective risk management.

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Agricultural Hedging Strategies for Producers and Processors

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  1. ECON 337: Agricultural Marketing Lee Schulz Assistant Professor lschulz@iastate.edu 515-294-3356 Chad Hart Associate Professor chart@iastate.edu 515-294-9911

  2. Short Hedgers • Producers with a commodity to sell at some point in the future • Are hurt by a price decline • Sell the futures contract initially • Buy the futures contract (offset) when they sell the physical commodity

  3. Short Hedge Example • A soybean producer will have 25,000 bushels to sell in November • The short hedge is to protect the producer from falling prices between now and November • Since the farmer is producing the soybeans, they are considered long in soybeans

  4. Short Hedge Example • To create an equal and opposite position, the producer would sell 5 November soybean futures contracts • Each contract is for 5,000 bushels • The farmer would short the futures, opposite their long from production • As prices increase (decline), the futures position loses (gains) value

  5. Short Hedge Expected Price • Expected price = Futures prices when I place the hedge + Expected basis at delivery – Broker commission

  6. Short Hedge Example • As of Jan. 16, ($ per bushel) Nov. 2015 soybean futures $ 9.76 Historical basis for Nov. $-0.30 Rough commission on trade $-0.01 Expected price $ 9.45 • Come November, the producer is ready to sell soybeans • Prices could be higher or lower • Basis could be narrower or wider than the historical average

  7. Prices Went Up, Hist. Basis • In November, buy back futures at $10.50 per bushel ($ per bushel) Nov. 2015 soybean futures $10.50 Actual basis for Nov. $-0.30 Local cash price $10.20 Net value from futures $-0.75 ($9.76 - $10.50 - $0.01) Net price $ 9.45

  8. Prices Went Down, Hist. Basis • In November, buy back futures at $8.00 per bushel ($ per bushel) Nov. 2015 soybean futures $ 8.00 Actual basis for Nov. $-0.30 Local cash price $ 7.70 Net value from futures $ 1.75 ($9.76 - $8.00 - $0.01) Net price $ 9.45

  9. Short Hedge Graph Hedging Nov. 2015 Soybeans @ $9.76

  10. Prices Went Down, Basis Change • In November, buy back futures at $8.00 per bushel ($ per bushel) Nov. 2015 soybean futures $ 8.00 Actual basis for Nov. $-0.10 Local cash price $ 7.90 Net value from futures $ 1.75 ($9.76 - $8.00 - $0.01) Net price $ 9.65 • Basis narrowed, net price improved

  11. Long Hedgers • Processors or feeders that plan to buy a commodity in the future • Are hurt by a price increase • Buy the futures initially • Sellthe futures contract (offset) when they buy the physical commodity

  12. Long Hedge Example • An ethanol plant will buy 50,000 bushels of corn in December • The long hedge is to protect the ethanol plant from rising corn prices between now and December • Since the plant is using the corn, they are considered short in corn

  13. Long Hedge Example • To create an equal and opposite position, the plant manager would buy 10 December corn futures contracts • Each contract is for 5,000 bushels • The plant manager would long the futures, opposite their short from usage • As prices increase (decline), the futures position gains (loses) value

  14. Long Hedge Expected Price • Expected price = Futures prices when I place the hedge + Expected basis at delivery + Broker commission

  15. Long Hedge Example • As of Jan. 16, ($ per bushel) Dec. 2015 corn futures $ 4.15 Historical basis for Dec. $ -0.25 Rough commission on trade $+0.01 Expected local net price $ 3.91 • Come December, the plant manager is ready to buy corn to process into ethanol • Prices could be higher or lower • Basis could be narrower or wider than the historical average

  16. Prices Went Up, Hist. Basis • In December, sell back futures at $5.00 per bushel ($ per bushel) Dec. 2015 corn futures $ 5.00 Actual basis for Dec. $-0.25 Local cash price $ 4.75 Less net value from futures $-0.84 -($5.00 - $4.15 - $0.01) Net cost of corn $ 3.91 • Futures gained in value, reducing net cost of corn to the plant

  17. Prices Went Down, Hist. Basis • In December, sell back futures at $3.00 per bushel ($ per bushel) Dec. 2015 corn futures $ 3.00 Actual basis for Dec. $ -0.25 Local cash price $ 2.75 Less net value from futures $+1.16 -($3.00 - $4.15 - $0.01) Net cost of corn $ 3.91 • Futures lost value, increasing net cost of corn

  18. Long Hedge Graph Hedging Dec. 2015 Corn @ $4.15

  19. Prices Went Down, Basis Change • In December, sell back futures at $3.00 per bushel ($ per bushel) Dec. 2014 corn futures $ 3.00 Actual basis for Dec. $ -0.10 Local cash price $ 2.90 Less net value from futures $+1.16 -($3.00 - $4.15 - $0.01) Net cost of corn $ 4.06 • Basis narrowed, net cost of corn increased

  20. Hedging Results • In a hedge the net price will differ from expected price only by the amount that the actual basis differs from the expected basis. • So basis estimation is critical to successful hedging. • Narrowing basis, good for short hedgers, bad for long hedgers • Widening basis, bad for short hedgers, good for long hedgers

  21. Class web site: http://www.econ.iastate.edu/~chart/Classes/econ337/Spring2015/ Have a great weekend!

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