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Have You 'Rebalanced' Your Grain Contracts?

Have You 'Rebalanced' Your Grain Contracts?

NDSU economist warns that late spring may require changes to deals that require physical delivery of grain.

Frayne Olson, NDSU Extension crops marketing economist, says many marketing plans may have to be revised because spring planting has been delayed.

The first step: Compare the number of bushels or pounds already forward priced or contracted with the revised planting intentions. For example, assume that the original marketing plan for crop A is to forward price two-thirds (67 percent) of the expected 2011 production by May 1 through incremental sales, and that this plan has been implemented. However, if 15 percent of the intended acres are shifted to an alternative crop, the forward pricing strategy for crop A now covers approximately 82% of the expected production.

"This is not necessarily a bad plan," Olson says. It simply means that the strategy used to market the remaining production may need to be changed to adapt to the smaller unpriced production level. It means that the marketing strategy for the alternative crop also may need to be adjusted because of the increased acreage and associated production.

A more problematic situation is when acreage adjustments and/or prevented-planting creates a situation where expected production is less than the the amount already forward priced. The easiest adjustments are those that involve shifting "futures only" or "options only" contract positions, which are not tied to the physical delivery of the crop. Existing futures or options positions can be retraded at any time to rebalance expected production with forward pricing strategies.

However, contracts that require physical delivery, such as forward price, futures fixed or production contracts, take more time and effort to adjust. If contract commitments exceed expected production, farmers need to contact the elevator or processor that wrote the contract as soon as possible to begin working on adjustments.

Opening and maintaining lines of communication between the buyer and seller is the most important thing that can be done, Olson says. Most buyers are able to adjust to changing conditions if they are given enough advance warning and can determine the extent of the problems. The most difficult situation for the buyers, which leaves them very little flexibility, is when they do not learn about a production or delivery shortfall until harvest.

A common question asked is how to modify an existing forward contract or production contract if cropping plans change dramatically due to poor weather. The broad answer is that the parties who signed the contract need to discuss the situation as soon as possible, outline potential adjustments and determine what makes most sense for all of the parties, Olson says.

"The specific solution can vary greatly and will depend upon the structure of the current contract, crop involved and how many other farmers in the area have the same problem. A buyer typically has more flexibility to work with a single farmer having a contract issue than if the problem is widespread throughout the buyer's trade area. This is because grain elevators and processors normally have re-contracted or resold the crop, or products made from the crop, to their domestic and/or international customers. Small shortfalls in deliveries can be covered with additional purchases in the spot market, but large shortfalls can be difficult to replace economically."

Some of the possible contract modifications could include changing the location of the fields and updating the legal descriptions in the contract, buying out of the contract shortfall, using existing inventory to fill the contract shortfall, purchasing production from another farmer to fill the shortfall, shifting the contract production to another farmer, shifting the contract production into next year or invoking an "act of God" clause if available.

Many production contracts for smaller market or specialty crops include an act of God clause that releases the farmer from contract shortfalls due to drought, hail, insects, diseases or flooding. The specific terms of an act of God clause varies greatly among industries and across buyers. Many act of God clauses require the farmer to notify the buyer in writing as soon as possible after an adverse event occurs. Typically, notification must be made within 14 days. If notice is not given, the act of God clause does not apply.

"This again shows that opening the lines of communication between buyer and seller as soon as possible is very important," Olson says.

Source: NDSU Ag Communications

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