ECON 337: Agricultural Marketing Chad Hart Assistant Professor chart@iastate.edu 515-294-9911 Econ 337, Spring 2012 Today’s Topic “New Generation” Contracts Econ 337, Spring 2012 Contracting Basic Hedge-to-Arrive Basis Deferred Price Minimum Price New Generation Automated Pricing Managed Hedging Combination Econ 337, Spring 2012 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 Econ 337, Spring 2012 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 Econ 337, Spring 2012 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 Econ 337, Spring 2012 Basis Contract Why might you use it? 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 Econ 337, Spring 2012 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) Econ 337, Spring 2012 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 Econ 337, Spring 2012 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 Econ 337, Spring 2012 Minimum Price Contract Removes downside price risk (below minimum price) and allows upside potential (after adjusting for fees) Producer looking price increases to offset fees Provides some predictability in pricing, can be set to be cash-flow needs Econ 337, Spring 2012 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 Econ 337, Spring 2012 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 Econ 337, Spring 2012 New Generation Contracts The contract follow 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) Econ 337, Spring 2012 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.) Econ 337, Spring 2012 Automated Pricing Examples AgriVisor – Index E-Markets – Market Index Forward Cargill – PacerPro CGB – Equalizer Classic Variations CGB – Equalizer Traditional Cargill – PacerPro Ultra E-Markets – Seasonal Index Forward Econ 337, Spring 2012 Automated Pricing $14.00 Price ($ per bu.) $13.50 Pricing period: Jan. to Mar. 2012 on Nov. 2012 soybean futures $13.00 $12.50 $12.00 1/ 3/ 20 1 1/ 10 2 /2 1/ 012 17 /2 1/ 012 24 /2 1/ 012 31 /2 01 2 2/ 7/ 20 1 2/ 14 2 /2 2/ 012 21 /2 2/ 012 28 /2 0 3/ 12 6/ 2 3/ 012 13 /2 3/ 012 20 /2 3/ 012 27 /2 01 2 $11.50 Futures Econ 337, Spring 2012 Automated Pricing 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 Econ 337, Spring 2012 Managed Hedging Automated contracts that implement pricing based on recommendations from market analysts Example Cargill – MarketPros Producers can choose to follow CargillPros or Kluis Commodities recommendations Econ 337, Spring 2012 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 Econ 337, Spring 2012 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 Econ 337, Spring 2012 Cargill – DiversiPro Price is set by formula 75% of the price is determined by the average daily high futures price during a specified pricing period 25% of the price is determined by the highest price observed during the pricing period Can be linked to a commitment to market additional grain (the commitment reduces the fee charged) Source: http://www.cargillpropricing.com/contracts.html Econ 337, Spring 2012 AgriVisor Accelerator Pricing Markets bushels when prices exceed a floor price, but marketed quantities depend on price level For example, If the Nov. 2012 soybean Then we market price is < $12.00 0 bushels per day $12.00 to $13.00 100 bushels per day $13.00 to $14.00 250 bushels per day > $14.00 500 bushels per day Econ 337, Spring 2012 Source: http://www.agrivisor.com/Services/CrossoverSolutions.aspx AgriVisor Topper Pricing Markets bushels when prices exceed a floor price on days where prices have jumped sharply Example: Markets bushels when prices exceed $13.00/bushel on days where prices have increased by at least 15 cents/bushel Takes immediate advantage of market rallies Econ 337, Spring 2012 Source: http://www.agrivisor.com/Services/CrossoverSolutions.aspx AgriVisor Econ 337, Spring 2012 Source: http://www.agrivisor.com/Services/CrossoverSolutions.aspx AgriVisor Econ 337, Spring 2012 Source: http://www.agrivisor.com/Services/CrossoverSolutions.aspx FC Stone Accumulator Contract 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 Econ 337, Spring 2012 Source: http://www.intlfcstone.com/commodities/grains/Pages/OriginationTools.aspx FC Stone – Accumulator Quantity marketed doubles Normal quantity marketed Contract ends Econ 337, Spring 2012 Source: http://www.intlfcstone.com/commodities/grains/Pages/OriginationTools.aspx FC Stone – Consumer Accumulator Contract ends Normal quantity bought Quantity bought doubles Econ 337, Spring 2012 Source: http://www.intlfcstone.com/commodities/grains/Pages/OriginationTools.aspx Class web site: http://www.econ.iastate.edu/~chart/Classes/econ337/ Spring2012/ Have a great weekend! Econ 337, Spring 2012