Drought Makes It Tough to Fulfill Contracts

September 5, 2012 08:17 PM
Drought Makes It Tough to Fulfill Contracts

One of the worst droughts in half a century could make it tough for growers to fulfill forward contracts. There is no good data on how many producers are in this predicament and how large a problem it will be nationwide, in part because no one knows how corn and soybean yields will end up. In a typical year, 30% to 35% of corn and soybean production is pre-sold. The issue is of less concern to those with federal crop insurance to equal what they owe merchandisers, says Chad Hart, an economist at Iowa State University.

The key for producers who can’t deliver on contracts is communication, Hart says. "Talk to merchandisers. Find out what it costs to get out of the contract." Read the fine print; some contracts require the going price plus a 10¢ to 15¢ premium. It’s also important to read the fine print of crop insurance policies. "Don’t do anything to mess up coverage," Hart says. For example, payments could be limited if you chopped corn before the agent made a yield determination.

Merchandisers might have their own problems in fulfilling contracts. What merchandisers want more than money is the grain, Hart says. Talk with other farmers about what they would charge per bushel.

Even those with adequate crop insurance can have a cash flow problem. A contract might require settlement in October, but the crop insurance check might not come until December. Producers might need a loan to fill the gap.

Crop prices could go even higher between now and harvest, making it more expensive to buy out a contract. One strategy that Hart does not recommend is to buy an in-the-money $8 per bushel call option that costs 50¢ to 60¢ per bushel. While offering upside price protection, it could be pricey if it expires worthless.

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