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

“New Generation” Contracts Basic Hedge-to-Arrive Basis Deferred Price Minimum Price New Generation Automated Pricing Managed Hedging Combination

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

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

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

Basis Contract Why might you use it? Example 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

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)

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

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

Minimum Price Contract Removes downside price risk (below minimum price) and allows upside potential (after adjusting for fees) Producer looking for price increases to offset fees Provides some predictability in pricing, can be set to be cash-flow needs

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

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)

New Generation Contracts The contract follows 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)

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.)

Automated Pricing Examples Variations AgriVisor – Insight and Crossover Solutions Cargill – Pacer CGB – Equalizer Min-Max Variations CGB – Strategic Portfolio

Automated Pricing Pricing period: Apr. to June 2016 on Nov. 2016 soybean futures

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

Managed Hedging Automated contracts that implement pricing based on recommendations from market analysts Examples Cargill – ProPricing Producers can choose to follow Cargill recommendations AgriVisor – Insight Producers can choose to follow AgriVisor, Doane, or ProFarmer recommendations

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

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

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

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

Accumulator Contracts – 2010’s 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

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

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

Class web site: http://www2.econ.iastate.edu/faculty/hart/Classes/econ337/Spring2019/