Econ 338c Review 4/26/07

Time needed to complete Corn Planings U.S. About 24 days with perfect weather – Likely completion date: around May 30 – Days beyond optimum: about 21 days – Yield impact: about 0.4% decrease/day after 5/10? Iowa About 18 days with perfect weather –Likely completion date: around May 22 – Potential % of crop planted after May 10: 60% Yield impact?

First & 2 First & 4th nd Sessions Big picture of global marketing system --Participants --Merchandising & arbitrage --5 Main economic-marketing functions --Sources of global competition --Some major trends—especially bio-energy --Price discovery mechanisms: futuresmkts. Marketing from a farmer perspective --Price-sensitive govt. payments --Importance of knowing farm finances --Basis: determining geographical price variations, analyzing marketing opportunities

Major Marketing Functions Providing time utility Providing form utility Providing space utility Financing Price/value discovery

Key work area for Grain Merchandisers

te.edu/soybeanrust/ Sources of information and rust location map:

Overview of Grain Marketing World futures markets (Price Discovery) –Chicago:corn, soft red wheat, soybeans, oats –Kansas City: hard red winter wheat –Minneapolis: hard spring and hard white wheat, Corn & Soybean cash index markets –Tokyo: GMO & non-GMO soybeans, corn –Various other futures markets: Brazil, Argentina, China, Europe –Foreign exchange futures

Capacity: 137% of 2006 Crop Iowa Corn Processing Plants, Current & Planned, 2/16/07 71 Potential Iowa Plants 11 Just across IA Borders

Cost, Price & Yield

Major elements in producer grain marketing External: world & govt. (need outlook info) Historical record of price & farm yields Farm financial needs Pricing tools: new & old contracts Production risk-control tools Trigger pulling mechanism: Exit Plan Evaluation: relative to market, producer costs & goals

Cash-Flow Risk Ratio: Percent of the crop required to be sold to cover cash-flow costs Formula for computation: Cash-flow break-even price divided by selling price

Net-Worth Risk Ratio The maximum dollars per acre which can be lost in any one year before a predetermined percentage of the equity is lost.

Calculating Net-Worth Risk Ratio Max. dollars of net worth to be placed at risk divided by number of acres = Max.$ that can be risked per acre To compute max. loss per bu. : divide $/A. by normal yld. = $/bu. that can be risked for pre- determined loss of equity

Govt. Payments Loan Deficiency Pmts: Market Sensitive LDP is Positive if Posted County Price is Below Loan Rate: LDP = LR-PCP Counter Cyclical Pmts: Market Sensitive CCP Paid if higher of $2.35-LR or $2.35- U.S. Mktg. Year Avg. Price if positive Direct Payment: Not Market Sensitive

Storage Economics Costs to store on & off farm Seasonality of prices Harvest basis & carrying charge Timing and amount of cash-flow needs

8-MonthStorage $2.90 Corn Shrinkage below 15% Extra drying Extra handling Interest (8%) Storage charge Quality deterioration & storage shrink Total costs On-farm Off-farm $0.073 (to 13%) $ (Fixed cost) $0.331 $0.425

8-MonthStorage $7.00 Soybeans Extra handling Interest (8%) Storage charge Quality deterioration & storage shrink Total costs On-farm Off-farm (Fixed cost) $0.425 $0.564

Traditional Grain Contracts Forward Contract Hedge to Arrive Minimum Price Basis contract Delayed Payment contract Price later contract Premium offer contract

If harvest Basis is strong Market says sell now If weak: Signals to store & hedge or use hta contract

Traditional Grain Contracts Forward contract: locks in price level, basis, spreads Hedge to Arrive: does not lock in Basis Basis Contract: locks in basis but not price Price Later contract: doesn’t lock in either one (You lose ownership— cash out LDP first)

Traditional Grain Contracts Premium offer contract Typically involves sale of options & farmer potential sale commitment in next season

Credit-Sale Contracts Ownership is transferred to elevator Protection of warehouse receipts is not available In case of elevator bankruptcy, farmer becomes just another creditor Warehouse receipts give 1 st claim on assets in bankruptcy

Credit-Sale Contracts Delayed Price or Price Later contracts Basis Contracts (often less risk exposure) Delayed Payment contracts

Grain Contracts: Areas of Risk Exposure Price Level Basis Spreads (Intra-and Inter-Year) Options volatility risk Production risk Counter-party or business risk Control risk Tax risk

Refresher on Options Markets Two Types: Puts & Calls (CBOT) Buying Puts: Insure against lower prices Buying Calls: lets you follow market higher after a cash sale No further market expense after buying Cost: premium plus brokerage charge Selling puts: you have an obligation to buy grain at strike price if market goes lower Maximum gain = initial premium (loss no limit)

Options Definitions: Put: Buying the right but not the obligation to sell underlying futures contract at a specific price Call: Buying the right but not the obligation to buy underlying futures contract at a specific price

Options: factors affecting PREMIUM LEVELS A. STRIKE PRICE vs. FUTURES B. TIME REMAINING before expiration C. VOLATILITY OF FUTURES D. INTEREST RATES

Options Summary A. Buy Puts to set floor price --No further financial exposure after initial purchase B. Buy Calls to retain ownership after sale -- No further financial exposure after initial purchase C. Caution: options can expire worthless. Plan exit strategy.

Storage Returns Study Storing corn without pricing on average lost money, esp. off-farm Corn storage & hedging made small profits, with less year-to-year variability Soybean storage: you would have to work hard to make bean storage pay— on average. Iowa exit strategy: Typically in May on farm, Jan-Feb. off farm

New Generation Grain-Marketing Contracts (NGC) 1.Automated pricing (averaging) Cargill ProPricing (A+) 2.Managed hedging Cargill ProPricing Market Pros 3.Combination contracts Decision Commodities (Rally) –Cargill ProPricing (Target Range) Pg. 3

Advisory Service Performance 7-year study period, services for entire period Many services didn’t last entire period For many, performance varied widely from year to year

Crop insurance Importance depends some on location Depends on how much grain you price before harvest Harvest-price revenue insurance: an important companion tool for use with pre-harvest pricing

10 Traits of a Successful Grain Marketer 1.Starts Early (before planting) 2.Knows production, storage costs & risk bearing ability 3.Understands basis & mkt. carry 4.Follows several relevant markets daily 5.Manages yield risk with revenue insurance 6.Has discipline to price when goals are reached 7.Knows various contracts & when to use them 8.Relies on good sources of market information 9.Has an exit plan 10.Keeps marketing records & evaluates results

Key Points Starting point in a mktg plan: financial needs of the business Know your break-even price Know your risk-bearing ability Plan marketing with a goal of at least covering cash-flow needs Look for mktg. & insurance tools to minimize risk of losing the business Start Early