Many parts of the United States saw their crops, especially corn, devastated by drought in 2012. In other locations the damage was much less severe, but we saw reduced yields that coupled with the increase in futures prices triggered a crop insurance payment. In the cases of significant reductions in yield, farmers who typically forward-priced a portion of their crop prior to harvest found themselves in the predicament of having sold or hedged more grain than they ended up harvesting.
If planting is delayed and if producers change their cropping plans resulting in fewer corn acres on their farm, they could see significant reductions in the amount of corn being produced. Growers who have already forward-priced any significant amount of production may end up having sold more corn than they end up producing. Farmers who find themselves or expect to find themselves in this position need to approach managing their marketing positions in a thoughtful and well-planned manner.
The first thing that farmers need to do is to review their current marketing actions.
1.) What contracts were utilized?
- Cash forward
- Futures fixed or Hedge-to-arrive
- Futures and/or options contracts
2.) What amounts of grain (especially corn) have been hedged or forward-priced with elevator contracts?
3.) At what price have each of the contracts been set?
4.) What are the terms of the elevator contracts?
- Cash forward: Delivery obligated contract. There normally is not a non-delivery clause in this contract. Sellers (farmers) are expected to deliver grain, and if unable, they must find grain to fill the contract.
- Futures fixed or hedge-to-arrive contracts: These are also normally considered delivery obligated contracts. However, in many cases there is a buy back clause in the contract that will outline the circumstances that allow for non-delivery and the cost to exit from the contract.
- Futures and option on futures contracts: These contracts can simply be bought back or sold to offset the futures contract or the option on futures positions. The difference between the sales price (the initial price set with the futures hedge) and the price upon offsetting or buying back the contract will result in either a gain if the buy-back price is lower than the original sale price or a loss if the buy-back price is higher.
5.) Crop insurance considerations
It is important to realize that to minimize risk, any of the contracts that can be offset or bought out, should be offset during the harvest price discovery period for revenue-based crop insurance. The price discovery period for crops commonly grown in our region is during the month of October. If producers panic and lift the positions prior to that time, and the price decreases during the price discovery period, losses will be increased.
In many cases a combination of the previously mentioned contracts will have been used by growers to price their crops. If that is the case, then the lowest cost exit strategy or strategies need to be implemented.
Keep in mind that communication with grain buyers, brokers and lenders is important so everyone who may be impacted by these situations will be informed of the consequences of non-delivery of contracted grain. Also, unnecessary risk can be avoided by waiting until the harvest price discovery period is in process before contracts are bought back.
For more information on managing agricultural businesses, visit www.extension.umn.edu/AgBusiness
Any use of this article must include the byline or following credit line:
Bret Oelke is an agricultural business management educator with University of Minnesota Extension.
Media Contact: Catherine Dehdashti, U of M Extension, (612) 625-0237, firstname.lastname@example.org