April 1, 2012
HTAs can be a marketing tool that offers the benefits of hedging without threat of a margin call. But many think first of the hedge-to-arrive fiascoes in the mid-1990s. They are among a range of forward contracts offered by grain elevators, ethanol plants and other grain buyers, says Melvin Brees, University of Missouri Food and Agricultural Policy Research Institute(FAPRI) economist. They provide you a guaranteed futures price and the freedom to set the basis at any time before delivery. In return, growers are obligated to deliver the contracted bushels.
“The attractive thing is they work like a straight hedge, except farmers don’t have to go into the futures market,” Brees says. “There are no margin calls because the buyer assumes the risk and covers his end of the contract by offsetting it with futures.
“But there’s a tradeoff for everything. Farmers are committed to delivery. That’s why crop insurance is so important (in the event a crop can’t be produced for delivery).”
How they work: Basically, a grower determines if his local elevator or other grain buyer offers an HTA. When the corn or soybean futures market offers an attractive price to the grower, he then contracts to deliver a set number of bushels based on that futures price.
However, he may set the basis (the difference between the future and local cash price) at any time prior to delivery or at delivery. Once the basis is set, the final contract price is the locked-in futures price plus or minus the basis level.
For example, in mid-March, December 2012 corn futures were about $5.65/bu. A fictitious grower in central Illinois likes the price. He decides to “hedge” about 20%, or 200 acres of his expected production from 1,000 acres of corn.
His average yield is about 180 bu. That 180 bu. x 200 acres is about 36,000 bu. of production, which would equal about seven 5,000-bu. futures contracts. However, it can be included in a single HTA if the elevator agrees to it.
However, the grower doesn’t like the current basis of about 60¢ under. He holds off on locking in the basis in hopes the corn supply tightens and the basis level improves to 30¢ under. He then establishes the basis.
He has a guaranteed contract of $5.65 minus the 30¢ basis, or $5.35/bu. for 36,000 bu. If the futures price decreases to $4.65, he is hedged against the loss. But if it increases to $6.65, he is still locked into the $5.65 rate (which was an attractive place to start).
Additional HTAs may be taken to cover additional bushels, depending on his risk management requirements.
“HTAs are good for farmers in that they can often be used for any number of bushels, not just a standard 5,000-bu. contract,” Brees says. “They are also an opportunity to separate pricing from merchandising. You can capture a futures price, then merchandise in the cash market to set a better basis.”
HTA troubles
Many HTAs enable growers to roll the contracts into a more distant delivery period, for a fee, if basis levels are poor or there is a problem with delivery.
Multi-year rolling burned many growers and elevators in 1995-1997. A drought caused corn to hit $5, nearly unheard of back then. Growers booked multi years of production through HTAs. Then the market plunged, putting huge obligations on grain handlers and growers. State and federal lawsuits erupted. Some went to prison.
“That debacle caused HTAs to get a bad name,” Brees says. “Some elevators now give them different names, such as ‘no-basis-established (NBE)’ or ‘futures-only’ contracts.
“However, HTAs can be good marketing tools. It’s just important that growers have crop insurance in place in the event they can’t make enough of a crop to cover the contracted bushels required for delivery.”
For more on HTAs and other marketing tools, check with your Extension crop marketing specialists or your local grain buyers.
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