Plan It Forward

November 11, 2015 02:42 AM
 
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Consider forward contracts to meet your marketing targets

You have a lot of tools in your marketing toolbox. They vary in complexity and cost, but all can earn a place in a marketing plan. 

One such tool is forward contracting, which locks in a specific price, quantity, delivery date and place of delivery for grain. Chances are you’ve used this tool before, but with volatile markets and tighter margins, forward contracts can be a relatively simple way to proactively price grain. 

“We need to put our management, producer and marketing hats back on together,” says Stephen Nicholson, vice president for food and agricultural research at Rabo AgriFinance in St. Louis. “Forward contracts add a discipline that can be lacking in all of us.” 

Advantages include removing the risks of prices declining and being able to price any quantity of grain. As a result, you might also negotiate premiums for large-volume contracts or special qualities or quantities. 

Capture Profits. Forward contract profitably by first knowing the cost of production for your crops.

“Take all of your costs, divided by average yields, to come up with your dollar-per-bushel breakeven,” says Chip Nellinger, president of Blue Reef Agri-Marketing, Inc. in Morton, Ill. “When prices are well above that, it makes sense to forward contact.”

Be aggressive in locking in sales when prices exceed your costs. “A good rule of thumb is if you’re well above your breakeven, have up to half of your grain forward contracted ahead of pollination,” Nellinger says. “That puts you in control instead of waiting until harvest, when all the price opportunity may be gone.”

Forward contracts allow for multiple sales during the year. “You don’t have to sell the whole farm,” Nicholson says. “They give you the flexibility to make decisions along the way during the growing season.”

When you are unsure of price movements, focus on a small sale, advises Scott Field, farmer and owner of Promark Grain, a brokerage and market advisory firm located in Stephen, Minn.

“Sometimes the hardest thing is making that first sale,” he says. “Nothing is wrong with making just a 1,000-bu. or 5,000-bu. sale.”

He suggests breaking down your expected production into small and manageable amounts you feel comfortable pricing. 

Since you are securing a price, aim to use forward contracts when you are bearish on the market. 

Market View. Although you don’t want to see prices drop, Nicholson says, forward contracts compel you to be educated on the price outlook. 

“They force you to have an opinion in the market—right, wrong or indifferent,” he says. “That helps take the emotion out of it because you can take the price risk off the table and quit worrying about it.”

Forward contracts also let you do multi-year planning. “If I can look out ahead and know I can project a profit for the farm, I don’t mind marketing two or three years out,” Field says. “If I’m 100% sold on this year and prices go higher, that doesn’t bother me. I start focusing on next year and view it as an opportunity to lock in future profits.”

For many farmers, two years might be the top of their comfort level for forward contracting, Nicholson notes. “If you get too far out, the market may be a little ill-defined,” he points out. 

As with any marketing tool, forward contracts do have disadvantages. They remove your flexibility in where and when you deliver grain. Since forward contracts create a long-term relationship between you and your buyer, communicate openly. “Stay in contact because that buyer may see you as a good customer and come to you first when they need grain,” Nicholson says.

Understand Risks. When selecting a delivery time frame, be sure you choose a date and location that fits your schedule, both from a logistical and cash-flow standpoint. If your contract date requires you to store grain, factor in that cost.

Forward contracts also inhibit you from capturing value if prices increase. “You may get seller’s remorse if you lock in a contract and prices go higher,” Nicholson says. 

What Does It Mean To Me?
  • Forward contracts are a proactive tool for pricing grain, often years early.
  • Know your cost of production and consider making sales in increments.
  • You must deliver on promised bushels and risk missing some price increases.

Because a forward contract names a specific quantity of grain, you are responsible for that amount, even if weather depletes your yields. Nicholson suggests reviewing production history and only forward contracting up to your smallest crop until you know production is set. 

Lower-than-expected yields drive up your cost per bushel, Nellinger notes, so be sure to factor in that risk as you make sales. Use crop insurance or options to reduce risk.

Forward contacts can also be used in conjunction with other marketing tools, such as futures and options. “There is a time and place for each tool, depending on market conditions,” Field says. “Make sure the tool fits within your individual risk parameters and comfort level. Just because a certain tool didn’t perform for you well one year doesn’t mean you should abandon it.”  

Understand the Types of Forward Contracts
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You can choose from three types of forward contracts to meet your marketing goals. “There are pros and cons to each,” says Scott Field, farmer and owner of Promark Grain, a brokerage and market advisory firm. In the following chart, he provides an overview of each of the available options. 

 

For more Business Drivers coverage including original reporting from “AgriTalk,” “Market Rally,” “Top Producer Podcast” and “U.S. Farm Report,” visit agweb.com/business-drivers.

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