Issue 23
Marketing Guide
1999

Prairie Grains is the official publication of the Minnesota Association of Wheat Growers, North Dakota Grain Growers Association, South Dakota Wheat, Inc. and the Minnesota Barley Growers Assocation.

Copyright Prairie
Grains Marketing Guide
Summer 1999

Develop and implement a selling plan for 1999 grain

By George Flaskerud
NDSU Extension Crops Economist

Take time to develop a marketing plan for each crop that you produce. Doing so could mean the difference between profit and loss for the farm. It could even mean the difference between survival and bankruptcy. Developing a marketing plan is probably the single most important management activity on the farm: A marketing plan for each crop is essential to overall farm financial planning.

In financial planning, it is necessary to combine crop production costs and government farm program payments with a marketing plan. This permits costs and returns to be estimated for the farm. Then it can be determined if the farm's cash will flow and if production will be profitable. If cash flow or profit problems appear, costs may need to be reduced or alternative enterprises considered.

It is best to keep the marketing plan for a crop fairly simple. Key elements include price objectives and time deadlines.

Price objectives are matched with time deadlines. About five objectives and corresponding deadlines are usually specified in a marketing plan. A percentage of the crop is sold when either the first price objective or time deadline is reached. Another percentage of the crop is sold when either the second price objective or second time deadline is reached, and so on. The largest percentage is sold in the middle of the price range.

Time deadlines for selling a crop can be derived from the seasonal price pattern for that crop. Those times of the year when cash prices are usually the highest would be picked as selling deadlines, recognizing that they may need to be modified to meet cash flow needs and storage limitations. Seasonal price patterns for many of the crops produced in North Dakota are presented in NDSU Extension Service Bulletin EB-61.

Set price objectives

Price objectives are set relative to a goal. A goal could be to sell in the upper one­third of the price range for the marketing year. A more modest goal would be to sell the crop for a price above the state seasonal average farm price. Although seemingly modest, this goal is difficult to achieve, according to marketing publications.

The seasonal average farm price expected for a crop can be derived from several sources of information. Sources include current cash prices, cash forward contract prices, the futures market, USDA's price projections, and estimates by marketing advisory services.

If the goal is to sell above the state seasonal average, the lowest price objective would be set at about that level. The other price objectives could be evenly spaced so that the highest is about 115­120% of the lowest. Price charts can also be used as a guide in setting these other price objectives.

An example marketing plan for 14 % protein hard red spring wheat produced in 1999 is as follows:

Marketing plans need to be reviewed and adjusted as new information becomes available. USDA reports generally provide the basic information for updating. This information can be supplemented by news reports of crop conditions throughout the world, weather reports, and so on.

Using the right marketing tools

A marketing plan can be implemented using a number of marketing tools. The best tool to use depends on the situation. The use of elevator contracts as part of your marketing strategy makes farm management sense, especially on that portion of production that can be produced with near certainty, probably the first one-third in the case of preharvest sales.

Cash forward contracts, hedge-to-arrive contracts (sometimes called futures fixed contracts), and minimum price contracts are contract alternatives that should be looked at for making preharvest sales. The best contract for a producer to use largely depends on current and expected futures prices, basis and cash prices.

The put option is an attractive marketing tool because it leaves upside price potential open and does not require delivery. But, that flexibility costs something which must be paid for at the time of purchase. Consider using put options where uncertainty is the greatest. In effect, this would be when uncertainty involves not only price but production, probably the second one-third of production sold prior to harvest.

Generally, selling one-third of anticipated production using a cash forward contract or a futures fixed contract, and one-third using put options, manages an enormous amount of price risk. A floor price is established on two-thirds of anticipated production but the price is still open to the upside on two-thirds.

For 1999 wheat about to be harvested or in the bin, a more specific strategy can be initiated.  Be mindful of a number of price-influencing factors.

The LDP factor

Be sure to check on the availability of a loan deficiency payment (LDP) even if the local elevator price for 14% protein wheat is above loan.  A LDP may be available because of substantial discounts for low protein wheat.  See your local Farm Service Agency for rates and regulations.

A large one-day move in the Minneapolis spring wheat futures price of 15 to 20 cents could be a good time to take the LDP, if available.  Producers should take the LDP that day — before the posted county price (PCP) is raised the next morning.  For grain already under loan, this would be a good opportunity to lock in the PCP.

When producers take an LDP, they should also initiate a storage hedge by selling a wheat futures contract to minimize downside price risk.  The December Minneapolis spring wheat futures contract may be the most appropriate futures contract for wheat protein levels of 14% or greater.  In contrast, the May contract may be best for lower protein wheat since more time may be needed for protein discounts to diminish.  The hedge-to-arrive (HTA) elevator contract would be an alternative to the futures hedge.

The HTA elevator contract or futures hedge is preferred to a cash sale or cash forward contract because the current basis is very weak and because the distant futures contracts offer better pricing opportunities than the nearby contract.

The HTA and futures hedge fix the futures price but not the basis.  This feature allows producers to wait for the basis to improve before fixing that component of the price.  The basis in a HTA can usually be fixed any time up to delivery.  In the case of the futures hedge, the basis is usually established when the grain is sold in the cash market.

How much is the basis likely to improve in the months ahead? Achieving at least the basis levels that occurred last year should be possible.  Although weak, the Minneapolis to-arrive basis last year did improve about 15 cents into November, fluctuated sideways through February, weakened in March, and recovered during April.

Will storage be profitable?

When using either the HTA or the futures hedge, remember that storage involves costs. In an analysis assuming basis improvement similar to last year, an in-out charge of 10 cents per bushel and monthly storage costs of 2.1 cents to 2.3 cents per bushel, storage should generate a return above costs of about 15 cents a bushel by November.  However, any cash price increases during the November-April period are likely to be offset by storage costs

If storage looks profitable, why use the futures hedge or HTA elevator contract? If a storage hedge is not initiated, there is risk that the price may deteriorate.  The prospect of seeing falling prices after taking the LDP may be more risk than many producers want to face.

Storage of wheat, with at least 14% protein, into November would be consistent with the pattern for protein premiums, which tend to peak during the September-November period.  Because premiums and discounts tend to decrease with time, storage of lower protein wheat into April may be profitable.

What are the chances that prices will increase enough so an unhedged storage strategy will be more profitable than a storage hedge strategy? To answer that question, price behavior back to 1974 was reviewed.  And to reflect the current situation, only those years that met two criteria were considered: the Minneapolis cash price in the to-arrive market was less than $3.50 in August, on average, and the stocks-to-use ratio was down from the previous year.

Five years met the criteria for the search.  During those five years, the Minneapolis to-arrive cash price increased an average of 33 cents between August and November and 54 cents between August and April.

The five years were 1977-78, 1978-79, 1986-87, 1987-88, and 1991-92.  The increases ranged from 17 cents to 62 cents between August and November and from 17 cents to $1.13 between August and April.  Monthly averages were used in the analysis.  For example, the August price was the average price during the month of August.

The average increases of 33 cents and 54 cents are close to the expected cash prices (futures adjusted for the basis) used in the storage analysis.  In effect, if price increases exceed these averages, an unhedged storage strategy would be more profitable than a storage hedge strategy.  But risk is the key factor in deciding whether or not to initiate a storage hedge.  The risk-averse producer is likely to initiate a storage hedge.

       "Will Storage Be Profitable?"

Hard red spring wheat protein premiums and discounts are strongly influenced by hard red winter wheat quality.  In effect, the less amount of high-protein wheat, the greater the protein premium potential.  Protein premiums tend to peak in September-November.  Discounts for low-protein tend to peak in the fall as well,
and dissipate into the following spring. (NDSU graphic).