Cash market pricing tools, part 2

iStock/Getty Images aerial view of grain bin overhead top down view
Forward contracts are an important pricing tool every producer should know how to use.

Last month we covered the most basic of cash pricing tools: making a cash grain sale and holding unpriced grain in storage. This month I want to discuss forward contracts, an important pricing tool that every producer should have in their toolbox.

A forward contract is a cash sale in which a seller agrees to deliver a commodity to a buyer at some point in the future. With a forward contract, your price at delivery is known - basis and futures are set in the price. The only unknowns are quality discounts. Forward contracts are used to price grain before harvest, or to price grain held in storage after harvest.

Unlike a standardized futures contract, all terms of a forward contract are negotiated. For example, the contract can be for any bushel amount, not 5,000-bu. increments. You can amble into your local elevator in January with the desire to price two truckloads (1,800 bushels) of new-crop soybeans, and there is a good chance they will write the contract. Another plus is no worries with brokerage fees, margin accounts, or margin calls.

All of this makes the forward contract very easy to use.

Institutional risk

There is institutional risk in forward contracting - the risk that your buyer goes broke before they can fulfill their end of the contract (BTW, your elevator has the same concern about you). The Verasun story from 2009 is a high-profile example of institutional risk. Verasun was a major producer of ethanol with plants in the Upper Midwest. With prices soaring in 2008, many producers forward contracted with Verasun for 2009 delivery. Early in the year, Verasun declared bankruptcy and, poof, the contracts were no more.

Fortunately, stories like Verasun are rare. There is, however, one common concern with forward contracts: the difficulty of getting a fair basis in forward bids. The evidence is mostly anecdotal, but I do have a record of forward bids for Sleepy Eye, MN (and what a great name for a town). The table shows basis data only—the actual cash and futures prices are not important. It may be just one market, but I think it represents bids in much of the Corn Belt.

The record speaks for itself—the basis for corn was stronger at harvest versus five months earlier in 16 of the last 20 years. Since 2000, the basis for new-crop corn averaged 9 cents better at harvest than the basis bid in early May. Would you like that in plain language? Since 2000, if you used a forward contract (instead of selling futures and setting the basis at harvest) in early May to price corn, you left 9 cents/bu. on the table. The data history available to me indicates that the basis challenge in soybeans and wheat is not as one-sided. Either way the onus is on you to know your local basis and understand whether or not a forward contract presents a good opportunity to price grain.

Speaking of good opportunities, I cannot help but note that Dec’21 corn futures and Nov’21 soybean futures are up 10% and 15%, respectively, from early August lows. The opportunity to price next year’s crop should, at the very least, be on your radar. A simple forward contract could be the right way to get it done.

Sleepy Eye, MN New Crop Corn Basis, 2000-2019

Year

early May

early October

change

2000

(0.60)

(0.54)

0.05

2001

(0.55)

(0.48)

0.07

2002

(0.49)

(0.33)

0.16

2003

(0.46)

(0.34)

0.12

2004

(0.37)

(0.31)

0.06

2005

(0.41)

(0.56)

(0.15)

2006

(0.57)

(0.51)

0.06

2007

(0.54)

(0.33)

0.21

2008

(0.61)

(0.50)

0.11

2009

(0.55)

(0.41)

0.14

2010

(0.48)

(0.69)

(0.21)

2011

(0.73)

(0.40)

0.33

2012

(0.50)

(0.25)

0.25

2013

(0.50)

(0.35)

0.15

2014

(0.54)

(0.45)

0.09

2015

(0.50)

(0.53)

(0.03)

2016

(0.56)

(0.46)

0.10

2017

(0.58)

(0.66)

(0.08)

2018

(0.62)

(0.55)

0.07

2019

(0.55)

(0.30)

0.25

Average

(0.54)

(0.45)

0.09

Graphic source: John Woodford is a retired farm business management consultant and a serious student of his local Sleepy Eye market. He keeps great records! All figures are in $/bushel. Early May figures represent the new crop corn bid in early May, less December futures. Early October figures represent the harvest price of corn, less December futures.
 

Want more?

Want to learn more? Here are past columns.
Edward Usset is a Grain Market Economist at the University of Minnesota, and author of the book “Grain Marketing is Simple (it’s just not easy).” You can reach him at usset001@umn.edu
The opinions of the author are not necessarily those of Farm Futures or Farm Progress. 
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