When the grain markets are in a tough pricing environment, it’s important to give yourself every marketing advantage you can. In this blog post, we outline the advantages of an Independent Hedge-to-Arrive Contract (iHTA).
Farmers Business Network recently introduced the Independent Hedge-to-Arrive Contract, or iHTA. Like a traditional HTA, an iHTA allows a farmer to lock-in a futures reference price, but an iHTA has the added benefit of allowing a farmer to deliver to any buyer and shop around for the best basis price.
The iHTA is particularly valuable in the market conditions we’re seeing during the 2017 Harvest.
Times Are Tough
As harvest gets underway, farmers face a really tough pricing environment. Corn futures are hovering around the $3.50 mark, a far cry from mid-summer highs of $4.20. Also, basis markets are compressing quickly as farmers push out the last of old-crop corn sales and new-crop supplies start to hit the market.
The overall price outlook doesn’t seem likely to improve much over the next 3 months with a long list of negatives ready to stymie the market’s upside potential: ample US and global supplies, weak export demand and stiff competition in world markets, and the NAFTA trade deal hanging precariously close to the chopping block which, if dismantled, would sink beef and corn sales to Mexico.
Leveraging the following three strategies, all backed by data, may help you improve your bottom line without placing risky bets on the market going higher.
Conditions favor a Store & Hedge Strategy
A Forward Contract that locks price and basis is typically a bad deal for farmers
The added freedom of an iHTA allows the opportunity for additional premiums
#1 – Store That Grain - Capture Basis Improvement
Big crops are meant to be stored. This year in particular has the double-whammy of ample old-crop stocks and another big crop on top of it. Supply-side economics will be in full force over the next month, pressuring you to store any unpriced corn coming off the combine by making the basis severely low.
At the same time the market is giving other clear signals to store as the carry in futures/forward prices is attractive for earning better returns for deferred delivery.
We built a historical comparison to try & find patterns in history that match current circumstances.
- We examined 10 years of historical corn pricing for several of the top corn producing states and compared the average basis prices for the 5 years with the best basis prices (Green lines in charts below) at harvest to the 5 years with the worst basis prices at harvest (Red lines in charts below).
- We then graphed basis prices in today’s market (Blue lines in charts below).
As you can see, the basis prices in today’s market aligns with some of the worst years of the past decade. Further, in the years with low basis prices at harvest basis tends to improve significantly in the months after harvest.
The data clearly shows in market conditions like the ones we’re seeing today, a store and hedge strategy often provides farmers with strong opportunities to get more for their crops through improving basis prices.
#2 – Let the Basis Float - A Forward Contract that locks-in price and basis is typically a bad deal for farmers
Ok, so if I’m going to store grain, should I lock in basis levels for a post-harvest delivery period and guarantee that return? Why not forward contract with a grain buyer for say January delivery and lock it in?
Unfortunately, what we find from the data that locking in the basis on a forward contract seldom if ever is as good as delivering grain and getting the spot basis. This is a bold statement, so we want to make sure you understand its significance.
You are likely placing a losing bet every time you lock in basis ahead of delivery.
The table below shows the difference in basis you would have received (expressed as cents/bu) if you signed a January forward contract in October instead of simply delivering on spot basis in January.
If you see a negative value (which nearly all the values in the table are), then that implies you would have lost that many cents a bushel by locking in a January forward contract in October versus simply delivering on spot basis in January.
January Forward Basis Bias for Corn (in cents per bushel)
The bias is the average difference across all corn buyers between the spot basis in January and the basis for the January contract forward basis in mid-October. Negative (red) values in the table indicate you would have been better off getting the spot basis in January as compared to locking in the basis for January delivery in October.
The take-away? It's rarely a good idea for farmers to lock-in basis through forward contract at harvest.
#3 – Shop for the best basis - The added freedom of an iHTA allows the opportunity for additional premiums
One of the best things about an HTA is that it gives you certainty about a major risk factor - the futures price. Unfortunately, with a traditional HTA you tether yourself to one grain buyer and give up the ability to market to other grain buyers. Doing so not only restricts your ability to go to other buyers, but that buyer you contract with has all of the power in setting basis. You and every other farmer who has done an HTA contract with the buyer are captive suppliers. No longer does the grain buyer have to “win your grain” in the marketplace by working basis higher.
How important is this freedom? In short, it depends on where you farm and how many grain buyers you have around your farm. For key Midwest states that flexibility can be very important, especially where you have ethanol plants competing against shuttle facilities competing against livestock feeders for the same bushels of grain. In Iowa, it is not unusual to see farmers have the potential to market to 4 to 6 different premium buyers over the season as each will jockey to win farmers grain on the basis of cash price.
Based on a 5-year analysis of a farmer in Iowa, the chart below shows the basis opportunities missed by locking in with one buyer on Oct 1 thru the end of Dec. On average over a 5-year period that freedom value was around 20 cents a bushel.
In other words, if you picked the best buyer for your grain in early October and did a conventional HTA with them, then on average you gave up 20-cents in basis opportunities from other buyers that later in the season had a better basis.
Putting it all Together
This year will be a tough price environment with ample stocks and stiff world competition in the grain complex. Setting realistic expectations on how to improve your bottom line will be important. The chance of 50-cent or more price gains in corn seem unlikely especially by the end of the year.
The iHTA will allow you to capture the improvement in the basis over time, it will keep you from locking in a forward basis that is systematically discounted relative to spot delivery, and allow you to hit any basis opportunities that arise in your local area. All of these combined benefits could help improve your bottom line by 30 to 40 cents just by effectively changing how you market your grain.