Buying out of Grain Contracts Is Never Fun
It flat out sucks to be forced to buy out of forward contracts/HTAs when faced with a short crop.
If you have the ability to predict commodity prices and/or weather you’ll never face this scenario. I know I certainly don’t have that ability!
For our US followers, RP crop insurance (without Harvest Price Exclusion) greatly cushions the blow of having it happen.
As you know, nothing is a certainty when it comes to grain marketing. But historically the commodity markets tend to offer premium pricing opportunities during the growing season.
See the seasonal chart below from the guys at White Commercial Corporation.
As we’ve seen the last few years, this risk premium can come out of the market very fast….sending profitable prices well below your cost of production in a matter of a few days.
Knowing that no one has a grain marketing crystal ball, I like making sales on rallies both pre-harvest and post-harvest at prices that work for your cash flow (using average yields).
Very few businesses lock in all of their expenses before locking in the per unit price component of their revenue. I prefer to have some revenue certainty and that involves forward sales/hedges.
When making pre-harvest sales, you are doing so without knowing your final yield. This has obvious risks. If you choose to be proactive in your grain marketing (making pre-harvest sales), this yield uncertainty can lead you to a situation where you get oversold.
I should add that you don’t have to forward sell. It’s your business, you can do whatever you want. You could simply sell all your grain post-harvest but I’d argue that you’d want a significant working capital buffer (50-100+% of revenue) to do this.
I simply don’t think it’s prudent to lock in the majority of your farm’s expenses and “let it ride” on the revenue side of your equation.
Enough about that…..
Hypothetical situation: Let’s assume you’re a spring wheat farmer. Knowing the weather is hard to predict, you contract some of your 2017 production as prices reached multi-year highs a few weeks ago only to see your rain chances disappear. A 1988-style drought sets in….
While crop insurance shouldn’t be used as a primary grain marketing tool (see this blog post), it’s very important if you choose to forward sell or hedge your production.
Coming up short on your HTAs looks like a certainty……
Don’t panic, let’s look at this objectively.
Click the image below to watch a video where I walk through the math and point out the main variable that impacts your bottom line in a short crop scenario (your sales price vs. break even at an APH yield).
Two warnings: 1) there are a lot of assumptions that vary tremendously from farm-to-farm and 2) it’s an 18-minute video (sorry for being long-winded…..it’s a complex topic).
To be clear, every farm is different when evaluating this type of situation. Local basis, APHs, coverage levels all play key roles in the math.
In my experience, the best thing to do when presented with a situation like this is to have a meeting with your farm’s key partners (banker, crop insurance agent, grain buyer) and conduct some scenario analysis with your farm’s numbers.
And the end of the day, you need to make an objective and numbers-based decision. There is no perfect path to guaranteed profitability.
Disclaimer: All examples given are strictly hypothetical and neither the information, nor any opinion expressed, constitutes a solicitation to market commodities, to buy or sell futures, or options on futures. Past performance and results are not indicative of, nor do they guarantee, future performance. Commodity marketing has inherent risks. Trading and/or crop insurances and/or marketing decisions, as well as any gains or losses thereof, are the sole responsibility of the commodity owner, producer, and/or account holder. Market Wise Ag. Services, LLC, it’s principals and employees, Harvest Profit, Inc. and Midwest Hedging, LLC assume no liability for any use of any information contained herein.
Passionate about farm finances, software, and assets that produce cash flow (oil wells/farmland/rentals). U of MN grad.
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