Grain Marketing in the BioFuels Era: Session 3: Local Cash Market: February 5

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Grain Marketing in the BioFuels EraSession 3
Local Cash Market February 5
Ethanol
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Three Dimensions of Price

• 1. Flat price, cash price, or spot price
• 2. Futures
• 3. Basis

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What is Basis?

• Local Cash Price
• - Nearby Futures Price
• Nearby Local BASIS

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Basis Terminology
When Cash gt Futures, we say the the basis
is over. Cash lt Futures, we say the basis
is under.
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Basis Example 1 (Under)

• On June 20th
• Columbus Indiana wheat price 3.50
• Nearby July futures price 4.00
• Basis -
  .50
• Columbus cash wheat is 50 cents UNDER the July
  Futures

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Basis Example 2 (Over)

• On January 25th
• Evansville Indiana Corn price 3.15
• Nearby March futures price 3.00
• Basis
  .15
• Evansville cash corn is 15 cents OVER the March
  Futures

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Basis Movement

• .30
• .20
• .10
• 0
• -.10
• -.20
• -.30

WEAKEN Less positive or More negative
STRENGTHEN More positive or Less negative
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Futures and basis pricing can occur at separate
times

• Date May Futures Basis Cash
• March 20th 2.90 -.05 2.85
• March 30th 2.70 .03 2.73
• April 5th 2.96 -.08 2.88
• Best Cash Price 2.88
• Best Futures 2.96 Worst Futures 2.70
• Best Basis .03 Worst Basis -.08
• Best Price 2.99 Worst Price 2.62

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What Affects the Level of the Basis?

• Storage costs between current time and futures
  delivery period.
• Interest
• Bin costs
• Distance to futures market (transportation)
• Handling costs and elevator margin
• Quality differences
• Supply and demand in
• International market affects futures price) vs.
• Local markets (affects local price)

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Meaning of Local Basis
The local basis is a good measure of the supply
and demand conditions in your local market. A
strong basis means that demand is strong relative
to available supply. A strong basis often means
its a good time to consider pricing some grain,
either cash pricing or at least consider pricing
basis.
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Seasonality of Crop Prices!Whats Seasonality
In?-Futures-Basis-Cash Prices
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Whats the Marketing Year? Accounting period
for a Marketing Year 1. Corn is September
1- August 30 2. Soybeans is Sept.1
August 30 3. Wheat is June 1 to May 31
Question What is the 06/07 Marketing Year for
Corn and Soybeans??
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Constructing Nearby Basis Charts
--------------------Futures Month-----------------
--
Sept
Aug
Nov
Jan
March
May
July
Strengthening Basis
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Basis Seasonality!
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Evansville Area
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Evansville Area
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Futures Seasonality!
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Cash Price Seasonality!
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BioFuels Era
Short crops tend to 1. Peak earlier 2. Have less
return to storage 3. Have more vulnerability to
price declines the next summer
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Record Price Year
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Cash Contract Alternatives at Elevators

• Spot
• Cash Forward Contract
• Basis Contract
• Hedge-to-Arrive
• Min/Max Price Contracts
• Delayed Pricing Contract

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Making decisions about which pricing alternative
to use is based upon

• (Current levels of futures and basis
• (Anticipated direction of futures and basis
• (Knowledge of pricing alternatives
• (Risk bearing ability and
• ( Marketing goals

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If anticipated direction is as follows, use these
simplified guidelines

• Futures Basis What should be done???
• Up Up Do no pricing-wait for improvement
• Up Down Sell Basis - Basis Contract
• Down Up Sell Futures-Hedge with
  futures or options
• Down Down Sell cash now!

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Types of Cash Pricing Contracts in Grain Industry?

• 1. Spot Sale
• 2. Cash Forward Contract- Negotiate the bushels,
  delivery time, and price for delivery in a
  forward time period!
• 3. Basis Contract- Elevator buys the basis only,
  bushels are established, delivery date can be
  negotiated. If delivery is for immediate
  shipment, an advance payment of 70 to 80 is
  often made.

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Continued

• 4. Hedge-to-Arrive (HTA), or Futures Only-
  Elevator sells futures for the customer. No
  basis is established. A final pricing date will
  be determined. Producer often has the option to
  Aroll_at_ the futures to a later period. Elevator
  pays all margin calls. THESE contracts created
  problems in 1996 when futures went very high, and
  producers argued they were not aware of their
  short futures positions.

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Continued

• 5. Minimum/Maximum Price Contracts Elevator
  attaches one or more option positions to a cash
  contract. Elevator deducts the premium costs and
  a service fee from the price the producer
  receives. If futures prices change sufficiently,
  producer can receive gains from options position,
  but not less than the minimum, nor more than
  maximum.

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Producer forward cash contracts 3,000 bu. in
spring, and elevator manager also buys a call
contract
Establish Minimum Futures Basis is Priced
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Producer forward cash contracts 3,000 bu. in
spring, and elevator manager also buys a call
contract
Producer has a cash forward contract to deliver
3,000 bushels of beans in the fall _at_6.00. The
elevator manager also buys a 6.25 put for their
account, and deducts the .22 of costs. Producer
has a minimum futures price and has priced the
basis.
In the fall, if Futures 8.00
4.00 Basis -.10 -.30 Cash
Price 7.90 3.70 Minimum 5.78
5.78 Gain Call 1.75 0.0 Final
7.53 5.78
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Min/Max Alternatives

• To do at the elevator, the options must be
  attached to a cash contract (CFTC rule).
• This is an example of a Minimum price contract
• Can also do maximum price by selling a call,or
• Min/Max by buying a put and selling a call

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Continued

• 6. Delayed Pricing Contacts- Producer delivers
  grain, but does not price it (not futures or
  basis). Title to grain passes to elevator.
  Producer has the right to price the grain at the
  elevators board price up to a negotiated time
  period. Farmer is a general creditor of the
  elevator which may create financial losses if the
  elevator fails.

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What about New Crop Pricing?The 07/08 Crops

• Prices lows tend to occur at harvest time
• There is often a favorable new-crop pricing
  window in the March to Mid-May prior to planting.
• This tends to be about 20 to 25 cents per bushel
  for both corn and soybeans
• Roughly 25 to 35 of the time prices go higher
  by harvest.
• Poor spring and/or summer weather
• Major change in demand
• Consider pricing 25 to 35 of expected
  production in the spring pricing window.

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Elevators Have Responded to this predominance of
a March to May spring price premium time window.
New Generation Pricing Contracts In March to May
Forward Price Window -Average Daily Price in
March to May Window -Average Price with a
producer defined floor price -Price with a
producer defined weighting system in the time
window -Price in a producer defined time
window -Price in a time window, but use a moving
average or RSI technical system to determine
when to price -Let an analyst make the decision
of when to price
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Now What?????

• Watch futures markets
• What are current price levels
• Are prices generally going up/down/sideway
• Watch basis levels weekly
• Get historic basis records from your elevator
  manager
• Begin a weekly record of nearby futures and cash
  prices
• Which direction are futures and basis going
• What would be the best pricing alternatives if
  price continue as they are now
• Talk with others about markets.
• Get motivated to keep learning .

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Web SitesPurdue Outlook http//www.agecon.purdu
e.edu/extension/prices/index.asp
Purdue/Illinois Weekly Letter
http//www.farmdoc.uiuc.edu/marketing/newsletters.
html Futures Price Quotes www.gptc.comFutures
Charts http//www.futuresource.com/ Futures
Commentary http//cbot.com/cbot/pub/page/0,3181,9
63,00.html Cash Prices and basis
http//www.incorn.org/ go to Local Cash
Grain
Bids
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Will the future be specific attribute-identity
preserved marketing?
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Industry Implications

• Greater crop production specialization
• Specific-attribute genetics
• Oil yields
• Starch yields
• Nutritional value-animals
• Movement to monocultures for specific end users?
• Compressed planting and harvest windows
• Machinery capacity at planting and harvest
• GPS/Monitoring systems/Auto steer
• Human capacity at planting and harvest
• Grain handling capacity

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Industry Implications

• Greater link between seed industry and final
  market
• Contracts may become the norm
• What do contracts offer ethanol plants?
• Supply assurance
• Coordinate delivery/logistics

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Assignments

• Exercise comparing cash market strategies

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Readings for Feb 12th Market Strategies

• Under Pricing Strategies tab
• Market Efficiency and Marketing to Enhance
  Income of Crop Producers
• Do You Need a Market Advisory Service?
• Pre-harvest new-crop corn and soybean pricing
  strategies show incentives for using options
  markets

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Questions

• To email in questions, either give them to your
  host or send them to Corinne Alexander
• cealexan_at_purdue.edu