"You mean to tell me that with corn futures at $7, I can’t sell you the bushels today because I might have to sell them to you months from now at $4.80? What kind of a deal did you get me into, anyway?”
Imagine a producer sitting in your office during the height of a bull market, demanding an answer to that question. Most managers would rather be outside loading a train in January than face that farmer. Now think about the grain marketing strategies you offer your producer customers, and why you offer those strategies. Do they expose your business to hidden risks?
Originating grain is always a challenge. You have competing interests: Your business has to make money and you need volume at a good operating margin to accomplish that. But customer satisfaction is also a priority. When you’re wearing your “farm advisor” hat, customers often want a higher price, or want the flexibility to capture a higher price if futures move higher. Other customers want to sell grain to you, but want you to offer the same strategies ‘the other guy’ offers, or something they heard about at an advisory meeting. Elevator managers can be unsure which hat to wear.
Define objectives and parameters for your origination program:
- Is volume more important than the margin on your purchases, or the quality of those purchases? Identify which crop years you will allow farmers to sell for.
- Set a maximum percentage of production you will allow a farmer to contract with you.
- Identify how you will decide which farmers will be allowed to use more sophisticated strategies.
- List the variables of a farm-marketing strategy and the strategies that go along with that profile. For example:
- futures price not finalized
- basis not finalized
- sets a futures floor but not a ceiling
- sets a futures floor and a ceiling but leaves open a “window” of price opportunity
- pays the farmer a premium for his/her grain but with an obligation to sell additional bushels if futures are at or above a specific level at a future point in time.
- Quantify the potential risks of each strategy in various market scenarios, both to your business and to your producer-customer.
- Next, identify which strategies you will offer, and ones you will not offer.
- Review your advertising and promotional materials for all strategies to see it’s clear and not misleading.
- Determine who within your organization is sufficiently trained and knowledgeable enough to buy grain using the more-advanced strategies.
Country elevators aren’t grain companies
Let’s face it — elevators just don’t have the same resources that large companies have. Their balance sheets and credit lines are a fraction of a grain company’s. Elevators don’t have a legal staff, or sophisticated market-modeling software to analyze risks and outcomes. Elevators don’t typically have a separate staff to manage producer marketing programs. That’s not a problem unless you’re trying to compete on the same playing field. Further, an elevator’s accounting staff may not recognize how to properly “mark to market” advanced contracts to ensure accurate financial reports.
Global grain(s) consumption continues its upward trend despite rising prices. The crop losses in 2010 brought to the forefront again how tight global inventories are and the potential consequences of widespread production failure. High prices do come and go, and it’s possible prices will retreat in 2011 if global production soars. But ag commodity prices currently reflect the ongoing concerns.
High prices = higher risks
High prices and volatile markets can pose unusual risks for country elevators and small grain businesses. High prices mean your working capital and credit line won’t go as far, for example:
Rising prices mean margin calls on short futures hedges. Some credit lines are structured so that the bank will only finance part of the margin calls on forward contracts, forcing the elevator to finance the rest from working capital. Counterparty contract risk on forward purchases rises with the market. A farmer who was thrilled to sell $4 corn for 2011 crop may be less than eager to deliver the corn if prices rise to $7.