Basis Fallout: Cash Contracts and Crop Insurance Issues

August 27, 2010 03:17 AM

Unusually wide basis and the lack of convergence between cash prices and futures prices has caused distress along the marketing chain by introducing increased risk. At the same time, farmers are frustrated they are unable to capture the widely quoted futures prices, leading to perceptions they are faring better than they actually are.

"Farmers may have to buy puts or sell the Board if they wish to forward price next year’s crop, because the lack of convergence is causing lenders to reduce their credit lines to elevators," says Art Barnaby, Kansas State University agricultural economist. "A reduction in credit line limits elevator’s ability to meet margin calls." As a result, he says, protecting price via futures or options and storing for better basis may be the answer.

Another fallout of the divergence in cash and futures is its effects on crop insurance coverage and indemnity payments. Coverage is based on futures prices, as is "revenue to count" in calculating whether you are entitled to an indemnity. However, if your actual sales price is as much as $1 less than crop insurance calculation assume, you may find yourself with a revenue gap.

However, farmers and policy makers who say crop insurance calculations should be based on the cash prices farmers actually receive should be careful what they ask for, he says. "A CRC contract based on cash prices will always generate a smaller payment with a crop failure and the higher prices [that generally go along with it] than the current contract. The only time a cash-based CRC contract would generate a larger payment is if the basis widens between planting and harvest, requiring market prices to decline below the below the base price, and then it requires yields to be near the Adjusted Production History."

Click here for Barnaby’s complete analysis

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