New Generation Grain Marketing Contracts

By Lewis A. Hagedorn, Scott H. Irwin, Darrel L. Good, Joao Martines-Filho, Bruce J. Sherrick, and Gary D. Schnitkey, Department of Agricultural & Consumer Economics, University of Illinois at Urbana-Champaign

Traditional grain marketing strategies involve discretionary sales by the farmer or sales based on the advice given by a professional market advisory service, or some combination of the two. New generation contracts take a different approach to marketing in that they follow prescribed rules for generating sales.  They can be classified into three basic categories based upon their features:

1. Automated Pricing Contracts Contracts in this category follow predetermined, nondiscretionary pricing rules for marketing a farmer’s grain. These contracts give the farmer the average cash or futures price, depending on the contract, over a set pricing period. If the contract is based on an average of futures prices, the farmer typically has discretion as to establishing the basis.

Companies that offer automated pricing contracts include Cargill, Consolidated Grain and Barge (CGB), Decision Commodities, and E-Markets, as well as many independent grain firms.  Currently, among the large grain firms, only CGB offers a cash averaging contract through its local elevators. Some contracts in this category feature additional provisions for selling only above the loan rate, or have a preset minimum and maximum price levels.

Example of how the contract works: In January, a farmer signs an automated pricing contract to market 5,000 bu. of new crop corn based on the average price of December corn futures over the period February 1 to June 30. The contract carries a
fee of $0.05/bu. Each day between February 1 and June 30, the closing price of the December corn futures contract is recorded by the elevator. The farmer decides to establish the basis on March 1, when the local forward cash price is $0.30 below the price of December futures. At harvest, the farmer delivers 5,000 bu. of corn and receives a final price of $2.15, determined as shown below:

Average Price of December corn futures, Feb. 1 - June 30 = $2.50/bu., - Basis Established on March 1 = -$0.30/bu., - Service Fee for Contract = -$0.05/bu = Final Price Received by Farmer, $2.15/bu.

It should be noted that the idea of an automated “averaging” marketing strategy is not really new. For example, in 1980, (other market experts have discussed) a minimum speculation strategy of making several evenly distributed sales scattered throughout the marketing window.

Such a marketing plan may be relatively easy for a farmer to implement, but  requires the discipline to make systematic sales even during periods of “low” prices. One farmer states the problem this way: “If there’s anything I’ve learned in the past 30 years of studying and marketing grain, it’s this: Even with the right marketing plan and advisories, the critical calls to price grain are often not made.” A systematic selling strategy that has been written into an automated pricing contract removes much of the guesswork for the farmer.

2. Managed Hedging Contracts Managed hedging contracts price a contracted amount of a farmer’s production according to the recommendations of a professional market advisory service, over a set pricing period.

There may be a predetermined minimum price for these contracts, but they offer no guarantee of generating average or above average performance. Furthermore, the marketing strategy of the advisor is not always transparent to the farmer.

Cargill, as well as several other firms, currently offer this type of contract. In addition to a service fee similar to the Automated Pricing contracts, these contracts carry additional performance incentive fees if the market advisory achieves a price above a predetermined level.

3. Combination Contracts

A combination of the first two contract types, these contracts price the contracted amount of grain according to automated pricing rules, but allow the farmer to share in some of the gains, if any, of a professional hedging firm. The results of the discretionary component of these contracts are not always transparent, in real time, to the farmer, and service fees apply. To the best of the authors’ knowledge, Cargill is currently the only company offering this type of contract at this time.