Types of Grain/Oilseed Contracts by: Joe Parcell PIE Agricultural Contracting

Why a Grain/Oilseed Contract? 4 Change in farm policy 4 Increased global market risks 4 Price risk (uncertainty) 4 The neighbor did it

Types of Contracts 4 Production –quality 4 Marketing (traditional contracts) –Fixed price –Basis –Deferred price –Hedge-to-arrive –Minimum price

Production Contracts 4 High Oleic Soybean Contract –Bailment Clause regarding “intellectual property” rights issue –A. Can’t sell to a third party –B. No access by third party –C. Can’t keep and seed –D. Can’t use crop as collateral

Production Contracts 4 High Oleic Soybean Contract –General Terms Acreage specification Purchasing seed specification Basically says you will pay a technology fee

Production Contracts 4 High Oleic Soybean Contract –Delivery Where to sell seed Buyer’s call between December 1998 and April, 1999 –Price risk issues One week notice

Production Contracts 4 High Oleic Soybean Contract –Quality Specifications Moisture13% max Splits20% max Total damaged2% max Heat damaged0.3% max Foreign material1% max Contamination12% max –No Premium if outside the limits –Specify variety you plant

Soybeans of other types ??

Production Contracts 4 High Oleic Soybean Contract –Pricing and Grower Compensation Compensation –Elevator cash price on day of delivery - which someone else sets –Premium scale »Less than 75% Oleic$0.00 per bu. »75% Oleic or greater$0.65 per bu. –Additional incentives for using optimum crop protection chemicals

Production Contracts 4 Optimum - MFA High-oil Contract –Oil Premium Changed between end of December and now Response to profitability issue???????? –Delivery window Now have delivery window –This makes risk management much easier –Look at further out months

Marketing Contracts 4 Fixed Price –This type of contract, also known as a “flat price” contract, transfers all price risk and opportunity from the seller to the buyer on the date of the trade. 4 EXAMPLE On July 1, a producer sells for November delivery and establishes a flat price of $2.30/bushel. Source: USDA, RMA

Marketing Contracts 4 Forward Price –The price being offered by the futures market for future delivery 4 EXAMPLE On July 1, a producer prices harvest production in the December futures contract Source: USDA, RMA

Marketing Contracts 4 Deferred Price –This type of contract, also known as a “no price established” contract, provides the seller the opportunity to deliver and transfer ownership on the contract date, but without a sales price. 4 EXAMPLE On November 1, a producer delivers to the local elevator and enters into a deferred price contract. On January 1, the producer prices the contract at the current elevator bid, less the delayed price charge. Source: USDA, RMA

Marketing Contracts 4 Hedge-to-arrive –This type of contract is the basis of a contract; it permits the seller to set the futures level on the contract date, but the basis level is determined by the seller at a later date. 4 EXAMPLE On July 1, a producer agrees to sell a specified quantity for November delivery. The futures price is set at $2.50/bushel per the December contract on the CBOT. The basis level remains open, to be set by the seller at some later date. Source: USDA, RMA

Marketing Contracts 4 Basis –Is also known as a “fixed price later” contract. This type of contract transfers the basis risk and opportunity form the seller to the buyer on the date of the contract. 4 EXAMPLE On July 1, a producer agrees to sell a specified quantity for November delivery at $0.20 December (the November 1 cash price less $0.20) Source: USDA, RMA

Risk to Seller and Buyer Source: USDA, RMA

Risk Exposure w/ Various Contracts source: Wisner

When Will Contract Perform Well 4 Fixed price –n/a 4 Deferred price –Perform well if markets rise following the contract date. 4 Hedge-to-Arrive –When cash and futures converge toward contract expiration 4 Basis –If futures price increases Source: USDA, RMA

When Will Contract Perform Poor 4 Fixed price –n/a 4 Deferred price –Perform poorly if markets drop following the contract date. 4 Hedge-to-Arrive –When cash and futures diverge toward contract expiration, i.e., basis widens 4 Basis –If market price decreases Source: USDA, RMA

Scenarios for Selected Market Alternatives source: Wisner Expected Change UP StrengthenWeaken Down Basis Futures 1. Store and wait 2. Delayed price contract 3. Minimum price contract 1. Basis contract 2. Sell cash and buy futures or buy call option 3. Minimum price contract 1. Cash sales now 2. Forward Contract 1. Hedge 2. Hedge-to-Arrive 3. Buy put option