 | Zach Parish is a grain merchandiser at KAMO Grain, Inc., located at 3708 North Free King Hwy in Pittsburg, KS. Zach graduated from the University of Arkansas with a bachelor’s degree in Agricultural Business, specializing in grain marketing and merchandising. KAMO Grain started as a small, family owned, country elevator in 1990, and has now grown to serve producers and elevators all over the four state area with their grain marketing needs. For more information or to reach Zach call 620-232-5800. |
Agriculture
2013-01-02 15:54:41
Risks associated with forward contracting grain
A-This is a great question for a follow up to December’s article. Last month, we discussed the best time to market grain. My simplistic answer was “as soon as you can sell at a profit.” As long as you are making money, you can’t go out of business. But you should always keep in mind there are certain risks involved in selling grain that you don’t physically have.
First you have the risk of non-production. Many weather related catastrophes such as drought, hail, and heavy rains can cause problems for producers. If the weather is too severe and crops don’t produce, farmers may be forced to cancel their forward contracts or buy in the grain from other farmers.
Another risk in forward contracting is the possibility of market rallies. It is possible that grain prices can be higher at delivery time than they are when you forward contract. If you have the physical grain at delivery time, you only have the risk of the price difference between your contract price and the current price. But remember, you should only forward contract a certain percentage of your expected crop. The rest of your crop is now worth that much more. Hopefully, your contracted grain will be the cheapest you sell. If you forward contracted at profitable levels and delivered the rest of the grain at the higher price, you are a very profitable operation.
On the other hand, if you do not produce the grain and prices rally, you could have a liability against your contract. You would be responsible to buy out of the bushels that you can’t deliver. If the current cash price is higher than your contracted price, you would be responsible to pay the difference between the cash prices plus a cancellation fee if applicable.
Those are a few risks that you need to consider before forward contracting. But there are also ways to help protect against those risks. You could buy options. A call option, which gives you the right to buy futures at a specified level, protects you from market rallies. As the market goes up, your option will be worth more. That way if the market does rally after you contract grain, you will be able to capture that rally in the market. If you also fail to produce the grain at delivery, the money you gain from the option would come in handy if you have to buy out of contracts.
Crop insurance is also an important part of protecting your operation. The last couple of years, at least in our area, crop insurance has been essential. It might be best for some producers to wait until their insurance is in force before they forward contract. That way, if there is a non-production, your insurance can cover some of the cost of canceling the contract. There are many pros and cons to forward contracting. But, if producers weigh the options and take actions to protect themselves, it can certainly pay off.
