Risky business

THE PERIOD BETWEEN 2021 AND 2023 MIGHT GO DOWN IN HISTORY AS SOMETHING OF A DARK PERIOD in the business of grain farming. But not because of the prices. Cash grain prices enjoyed record highs between a drought in North America, two consecutive droughts in South America, and a war breaking out when Russia invaded Ukraine. The dark spot is that those really hot markets taught us some bad habits about marketing and allowed us to slide away from the tools and discipline which had made us successful in the years before.

When the world market believes it is short of grain, it behaves a lot like a motorist who believes that they are about to run out of gas. They find the nearest place to get some and pay whatever the price is because the fear of running out is overwhelming. That’s essentially where the world grain markets were between 2021 and 2023 when there were legitimate concerns about grain supply and potential interruptions to the market. End users around the world wanted to own their supply needs, and commercial grain companies wanted to own inventory because it was a good investment. Like the motorist running out of fuel, we had a very motivated market with enthusiastic buyers whose principal motivation was simply not to run out.

The grain business has changed a lot since then. We have enjoyed two near-record North American harvests, and South America has had one massive crop and may be on its way to a second. The net result of these great production numbers is that ending stocks have become burdensomely large. Going back to our motorist analogy, if you’re going to be able to do all of the running around that you need to do and still get home with a quarter tank of gas, how cheap would it need to be before you chose to pull up to the pumps and fill up?

A ’CARRY’ MARKET

In these times when commodities are well supplied relative to demand, the futures markets shift into what is known as a “carry,” meaning that supplies are large enough that the market will pay holders to carry the inventory forward. It is the historically normal situation for the grain markets. Statistically, five of every six years is a carry market in the corn futures, so we’ve all had plenty of practice operating in this scenario.

In a futures “carry,” the nearby contract is the lowest price, and the values rise as the market moves out into the forward months. In the corn futures, we might see the carry present itself like this: December $4.00. March $4.15. May $4.25. July $4.37. There’s a tendency to think that this shows strength in the markets because the crop is worth more later, but the truth is actually the opposite. In a carry market, the nearby prices are always the lowest because there is a discount if you need the money or the movement now.

The big strategic shift that farmers need to make when we find ourselves in a period of surplus grain supplies is to plan out our marketing in such a way that we don’t get trapped into ever having to accept the spot cash prices.

WHEN TO FORWARD CONTRACT?

The optimal time window for forward contracting grain is six to 12 months before the actual delivery window when the crop is going to move to market. Working inside of that particular time period creates an opportunity to lock in the higher futures prices in the deferred futures, but also is close enough to the actual delivery period that there’s greater accuracy in the basis bids because the crop supply and grain demand modelling is becoming fairly well developed six to 12 months out. It’s certainly possible to sell futures for a grain delivery in 2027, but since so little is known about what the crop supplies or world markets might look like three years from now, there would be a lot of protection taken in the basis portion of the bid.

However, if you contract corn in December of 2024 for delivery in June of 2025 (six months out), the basis portion of the price is pretty accurate because the supply and demand picture for next summer is already pretty well understood at this point in time.

Picking the right day to make forward sales is not without a certain amount of risk, but there are fairly reliable seasonal patterns which can at least get us to focus on locking in prices at the right time of year. During spring seeding and the emergence of the newly seeded crop (April, May, and June), it seems that futures markets experience a great deal of anxiety over new crop supply, and prices are both high and volatile.

In eight out of every 10 years, if a producer forward contracted new crop corn or soybeans during May or June, they would lock in a higher price than the spot bid at harvest. Even this past spring we saw new crop soybeans as high as $15.35/bushel in May, and new crop corn reached $5.85/bushel before the first of June. There are two reliable seasonal cycles in the wheat market, too. One in the fall when the market is trying to buy acres and one in the spring when the crop is breaking dormancy and frost, floods, and snow are worrisome to the crop.

This is where discipline is critical to a successful marketing plan. Sellers of crop need to have realistic expectations for their pricing targets and be decisive enough to book before the opportunity gets away. Some combination of target pricing orders and calendar deadlines (such as booking 10 per cent of the crop each week for the six-week spring season) are good tools to help keep the marketing plan on track.

RISK JUNKIES

I chuckle a little bit at grain producers who aren’t comfortable forward contracting because they “don’t want to take on the risk.” When you look at the business dynamics of grain farming, it’s pretty clear that anyone who makes their living in this line of work is an absolute risk junkie. Who else would invest millions of dollars in land, equipment, and crop inputs and then use it in a way that is vulnerable to local weather, weather in other parts of the world, and a whole host of geopolitical issues, including wars and embargos and then say that they are uncomfortable with risk?

Commodity markets are certainly volatile by nature, but constructing a marketing plan that lets us lock in prices at appropriate times is one of the few tools we have to mitigate risk.

A farm business has something of a risk balance sheet. On the one side are all of the areas where our grain farming operations take on risk. We are committed to expenses on items like land, equipment, crop inputs, and labour, and on the other side, we need to off-set the risk by locking in certainty on the revenue side using tools like crop insurance to create certainty about yield, and forward contracted sales to create certainty about price and cash flow.

Steve Kell is a delegate in District 11 (Dufferin, Simcoe, Halton, Peel, York). He farms in Simcoe County and is the grain merchandiser for Kell Grain Elevators. •