As planting begins, it is an excellent time to review the various cash grain contracts available for producers to incorporate into their crop marketing plan. When considering contracts, the producer must understand the special features of each contract and the type of risk it is managing. Producers must also consider the effects of market movement on the contract outcome. This article outlines some common types of grain contracts and how the market can affect the contract results. Producers should speak with their local grain purchaser about the availability of the following contracts and associated fees.
Cash Market Sales – A cash market sale is simply selling grain at the prevailing market price. A producer may choose to sell in the cash market if they deem it appropriate to sell at the market price or if they need to move old crop grain from storage to create space for the new crop. Cash market sales are risky as a marketing strategy because the market price might not be acceptable when the producer is forced to sell, especially if no other strategy is in place.
Forward Contract – A grain farmer may enter into a forward contract with a grain buyer, requiring the producer to deliver a specific quantity and quality of grain at a certain time, place, and price. This type of agreement can be made before planting or anytime during the growing season.
Minimum Price Contract – A minimum price contract is an agreement between the producer and elevator in which a producer is guaranteed either a minimum agreed upon price or the current cash price. Under this contract, a producer must pay a premium, which is relatively high in volatile markets, and any transaction charges. A minimum price establishes a price floor and allows for upside price potential without the direct use of futures and options. Additionally, the contract can provide some leverage in obtaining credit.
Basis Contract – Basis is defined as the local cash price minus the futures price. A basis contract is an agreement in which a producer and elevator establish a basis but not the futures price. The producer can select the day on which the futures price is set. A basis contract is useful when the basis is stronger than normal or when one thinks the basis will weaken before a sale is made. Since a basis contract does not set a price, this contract does not provide price upside potential and exposes a seller to downside price risk since futures prices may move lower. A delivery obligation is established, so a producer is exposed to the production risk of fulfilling the contract.
Hedge-to-Arrive Contract – A hedge-to-arrive contract is the opposite of a basis contract and is an agreement that allows the producer to set the futures price but leaves the basis to be set at a later date and prior to delivery. Once the basis is established, the producer will receive the futures price less the basis.
Price Later (Delayed Pricing) Contract – A price later contract allows the producer to deliver grain and establish the sale price at a later date. Upon delivery, the title of the grain passes to the buyer. The price a producer receives will be the elevator cash price on the day the producer decides to establish the price minus any service charges. This contract allows the producer to move grain despite a relatively low price environment, but the producer is still open to downward price risk if the market moves against them since the grain is unpriced.
Which tool should a producer use?
Figure 1 provides a guide on when to consider using the different types of contracts. The top right quadrant of Figure 1 represents ideal market conditions. In this quadrant, futures prices are expected to rise, and basis is expected to strengthen. Contracts that provide upside price potential are attractive in this scenario. These include minimum price contracts or price later contracts. The bottom left quadrant of Figure 1 represents the worst-case scenario for market conditions. Futures prices are expected to decrease, and the basis is expected to weaken. This scenario suggests that current market conditions are better than expected. Producers will want to consider selling at current price levels with either cash sales or a forward contract.
The top left and bottom right quadrants represent market conditions that are somewhere in between the best- and worst-case scenarios. The top left quadrant represents expected higher futures prices but with the risk of the basis weakening. A basis contract would allow producers to limit basis risk in this scenario by locking in a basis and providing upside potential for the price. The bottom right quadrant represents the expectation of increasing basis but a lower futures price. A hedge-to-arrive contract would allow producers to lock in a futures price and limit price risk but still be able to take advantage of a strengthening basis.
Figure 1. Best Fit Alternatives for Grain Contracts by Market Conditions*
Maples, William E. “Cash Grain Contracts and When to Use Them.” Southern Ag Today 4(18.1). April 29, 2024. Permalink
