Grain Marketing in the BioFuels Era: Session 4: Marketing Strategies: February 12

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Grain Marketing in the BioFuels EraSession 4
Marketing Strategies February 12
Ethanol
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Characteristics of price patterns in the BioFuels
Era
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• Market Opportunity-Bull Strategy
• Price later (wait for a big event)
• No government programs
• Consider selling at harvest-replace with long
  futures/calls
• Smaller returns for storage

Opportunity
Government Support Line
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How BioFuels Era Impacts Prices and Marketing

• Level of crop prices rise
• Relationship of crop prices change
• Volatility of crop prices increases
• Government programs Limited importance
• Risk Exposure-- of Exposure grow
• Cyclical Uncertainties as Boom/Bust Odds Grow
• Coordination of linkage between growers and end
  users

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Opportunity
Exposure
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Ethanols Growth?
Vulnerable
Unlimited

• Lower Energy Prices
• Policy
• Federal Subsidy
• State
• MTBE Restrictions
• State RFS
• Much Higher Corn Prices
• Higher food prices
• Technology-cheaper energy sources

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U.S. Gasoline use is about 140 billion gallons
per year. Ethanol has about 70 of the energy of
gasoline.
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Predicting Price Direction
Everyone is interested, but the success rate is
not encouraging
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Random Walk Model

• What? Successive price changes in futures are
  independent and thus past prices are not a
  reliable indicator of future prices
• And Information tends to flow to the market in a
  random nature. Thus the odds of prices being up
  or down tomorrow are equally likely.

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Efficient Market Hypothesis

• At any given point in time, the marketplace
  incorporates all of the information available,
  and quickly and accurately formulates price.
• Assumes
• A large number of market participants
• Participants who are well informed
• Participants are profit maximizers

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Conclusions From Random Walk and Efficient Market
Hypothesis

• Futures Prices are not predictable
• Futures Markets should not have predictable
  trends
• Futures Markets should not have seasonality
• A trader should not be able to profit from trend
  following or seasonality of price movement
• It is difficult to make speculative profits in
  futures trading from price prediction

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Hurt Hog Price Forecast Errors
T1 T2 T3 T4
Average Price Error 3.56/cwt. 5.72 6.12 7.37
Percent Error 8.1 13.0 13.9 16.8
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USDA Average Miss on Crop Size 1981 to 2005
Crops
May July Sept
Corn Crop 10.2 7.8 3.9
Soybeans 7.6 6.1 4.9
For May 2007 This is Plus or Minus 1.2 billion
bushels
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Support for these Theories

• Past studies show in any given year for small
  speculators about 75 lose money, ie. There are 3
  times more losers than winners
• This means that over 90 of small specs would be
  net losers after 2 years
• AgMas Project tracks corn and soybean
  recommendations from Ag advisories show little
  net gain from advisory information in totalsee
  examples

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Rejection of these Theories

• Empirical evidence suggest there is seasonality
  of futures when the last 10-15 years are observed
  on average--Maybe
• Some people do make money speculating in
  futuresDoes not reject Theories
• Some advisory firms did substantially exceed the
  average in pricing corn and soybeans (AgMas)Does
  not reject Theories

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Some Relaxation of Theories

• While information is random, that information
  sometimes has a trending nature to it. For
  example
• Weather trends
• USDA supply and demand reports
• Economic trends (Favorable economic trends)
• News trends (Asian Financial Crisis)
• Livestock production cycles

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• Risk premiums may have to be paid, giving rise to
  seasonality
• Buyer of futures perceive greater risk in the
  spring and early summer for crops therefore will
  pay greater futures prices to
• Shift risk of upside from themselves to a
  speculator
• At harvest, short hedge pressure tends to drive
  futures to their lowest seasonal price.
• At harvest, buyer feels little need to pay risk
  premium

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Purdue Conclusions on Speculation

• Beating futures markets at price speculation is
  difficult.
• At any trading price, the odds of prices going
  higher or lower is about 50/50.
• Limit your speculative positions to acceptable
  levels.
• Always look for the best pricing strategy, but
  also diversify them.
• If you have a speculative objective also have a
  speculative Ouch point.
• Markets have NO concern for you or your family,
  they can destroy your business if allowed.
• The returns to non-speculative types of marketing
  knowledge have higher odds of success than
  speculation.
• Stick to your knitting. Returns for your time
  in other farm management decisions are generally
  more profitable over time than market speculation

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Optimum Pricing Strategies
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Overview

• What drives the pricing decision (criteria)?
• Conceptual framework to consider in establishing
  your strategies.
• Pricing clues from the past
• Pre-harvest pricing
• Harvest-pricing
• Post-harvest pricing (storage returns)

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Decisions In Pricing

• What drives the pricing decision?
• Timing based decisions.
• Outlook
• Fundamental indicators
• Technical indicators
• Use an analyst, or marketing service
• Cost of production thresholds
• Cash flow needs
• Emotion--- Not Generally Recommended

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Strategy Concepts

• Routine strategy, or discretionary decisions
• Portfolio approach to marketing
• Portion that is passive marketing
• Portion that is active
• Decision weighting
• Concentrate marketing strategies
• Diversify marketing strategies.

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Pricing Clues From Past Patterns

• For Pre-harvest pricing
• Do new crop futures tend to have a seasonal
  pattern?
• Do new crop cash bids tend to follow this
  pattern?
• For Post-harvest prices
• Do they tend to follow a pattern?
• Do they increase enough to cover storage costs?
• On-farm
• Off-farm (commercial).

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About a 20 cent historic premium for pricing in
the mid-Feb to early-June period versus harvest
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About a 35 cent historic advantage for pricing in
the mid-March to late-June time period versus
harvest
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New Crop Forward Pricing Window
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Pre-Harvest Pricing
1. Research on pricing strategies on both corn
and soybeans shows that pre-harvest pricing tends
to help increase the mean returns versus selling
at harvest and also reduces the variability of
prices received over time. 2. The reason is new
crop futures for both corn and beans have tended
to be higher in mid-February to early-June period
than at harvest. Thus, on average, pricing some
new crop in this time period has given higher
average prices in the past. 3. The price
variability of new crop futures also tends to be
less in the mid-February to early-June time
period than at harvest.
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Pre-Harvest Pricing

• Pricing strategies that tend to work well in the
  Pre-harvest period include
• Forward cash contracting
• Selling futures to hedge
• Buying put options, and
• Selling cash on a forward contract and also
  buying new crop call options (this is called a
  synthetic put)

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Hurt/Weitrich Study SoybeansHarvest Price
6.04
May 15 June 15 July 15
Sell Futures Futures hedge 6.09 6.18 6.17
Buy Puts No forward pricing and buy puts. Min price 6.22 6.29 6.06
Synthetic Put Forward Price and Buy Calls. Min price 6.13 6.17 6.05
Sell Calls No forward pricing and sell call. Max price 5.99 6.03 6.15
This study was for 1975 to 1988. The spring highs
tend to come earlier in more recent years.
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Further Guidelines Related to Storage
Without Storage
With On-farm Storage

• Be more aggressive at pre-harvest pricing
• Have a stronger tendency to use forward cash
  contracting
• Still need to follow the volume guidelines
  outlined next

• Want to leave open the storage decision until
  later in the summer/fall
• Tend to avoid forward cash contracting for
  harvest delivery, but
• May forward cash contract for delivery out of
  storage, or
• In the spring, sell futures or buy puts which
  allow you to make the storage decision later in
  the summer/fall
• May tend to sell Nov/Dec futures in the spring
  and then roll to March after futures spreads
  widen in the summer or fall.

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Pre-Harvest Pricing Volumes

• Generally pricing too large of volume in
  pre-harvest is considered risky until yields are
  known.
• The first 25 can often be priced with a forward
  cash contract, generally without concern for
  ultimate yields.
• The portion from 25 to 50 of expected
  conservative yields might be priced
• Once yields are more certain into the late spring
  or summer
• With options
• Or forward priced after buying out-of-the money
  calls to protect against upside price movements

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Pre-Harvest Pricing

• Above 50 of the expected conservative yield
• Should not be done until yields are more certain
• Should be done with options only
• Remain unpriced and buy puts
• Puts establish a futures floor price, but
• Do not establish a final price, in the case of
  rising futures
• Do not commit bushels to be delivered in case of
  short crop yields
• Forward cash contract, and also buy
  out-of-the-money call options to cover potential
  futures price increases

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Pre-Harvest Pricing

• Should be more aggressive and start pricing new
  crop earlier in years following a short
  production year.
• In 1995 there was a short corn crop due to low
  yields
• Begin to price the 1996 crop as early as the fall
  of 1995 and into the spring of 1996.
• Generally you also want to be more aggressive at
  pricing larger volumes, although still use
  options once you are moving above the 25 to 50
  of conservative production estimates.

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Pricing At Harvest

• Should generally be avoided with some exceptions
• When futures price spreads are inverted and the
  market carry is small or negative.
• When prices are viewed as high.
• When income tax management favors selling in the
  harvest calendar year.
• When storage is not available, or commercial
  storage costs exceed the estimated price gains
  (carry) offered by the market.
• When a landlord or tenant is not willing to
  consider other alternatives.
• When cash flow needs demand pricing at harvest

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Pricing at Harvest

• Even if you price at harvest
• Consider bids for later time delivery
• Calculate the storage costs
• Evaluate whether a positive return can be gained
  from storing and pricing for a later delivery
  period.
• Also, always look for any premiums for early
  harvest delivery that you may be able to earn.

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Post Harvest Pricing

• Basis normally appreciates sharply at the
  conclusion of harvest.
• Expect to see 15 to 20 cents per bushel gain, or
  more, in the three or four weeks immediately
  after harvest.
• Beans
• Cash prices of beans tend to rise until
  early-December, but tend to be flat to slightly
  downward into March.
• Then beans tend to have final increase into
  spring
• The best pricing window for beans is often the 30
  to 60 days after harvest or into March to
  mid-May.
• Those who want to continue to speculate on beans
  might then consider doing so with futures or
  options.

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Post Harvest Pricing

• Corn
• Corn prices have a tendency to continue to rise
  into the spring period because there is no major
  Southern Hemisphere competitive crops.
• The odds of receiving a positive net return to
  corn storage into the spring are higher for corn
  than beans, especially on-farm storage.
• Commercial, off-farm storage over time has been
  about a breakeven situation
• Storage into the late spring and summer generally
  does not cover storage costs, so
• Either sell the cash grain and buy call options
  for potential upside gain, or
• Store with the grain priced for summer delivery.

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Review

• There are many aspects to establishing a pricing
  decision.
• Pre-harvest pricing somewhat before or during
  planting has tended to increase average prices
  versus harvest pricing.
• Post-harvest pricing has tended to provide
  positive storage returns for
• Short term storage on beans either on-farm or in
  off-farm storage, and for
• Storage into the spring for on-farm corn storage
  only.
• There is much variation from year to year, thus
• There is a need to read the market signals each
  year, and
• Make some adjustment in pricing strategy.
• Diversification in a marketing program has its
  merits

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In the End

1. When all the research is concluded, remember no
   one knows for sure what the optimum pricing
   strategy will be for next year.
2. The odds of most producers beating the market
   at price speculation are relatively low.
3. Always know for sure how much risk you can and
   are willing to take in the market.
4. Stick to your knitting. Do your best job of
   pricing, but remember returns can often be higher
   for time spent in production and general farm
   management.
5. Diversify, because no one does know for sure what
   will happen.

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The Ten Step Marketing Plan
(CMS Disk 2, Unit 7)
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What Is a Marketing Plan?
An orderly procedure to attempt to achieve
specific pricing objectives that meet the farms
overall goals.
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The First Step

• 1. Define Your Pricing Objectives
• Highest price?
• Sell above average yearly price?
• Net price above yearly average price?
• Price above the midpoint of the price range?
• Price in the highest 1/3 of the price range?
• Price at a profit?
• Price to meet cash flow?
• Reduce or minimize price uncertaintyrisk?

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Suggested Objectives

• Use a strategy that allows you to increase prices
  2 to 5 above the average yearly price received
  by farmers in your area, adjusted for storage
  costs.
• Implement a strategy that will allow you to
  generate prices 5 to 10 above the average
  harvest cash prices after you net out all costs
  of marketing including storage cost, commissions,
  options premiums, etc. (Except in short
  production years, or when futures price spreads
  are inverted at harvest).

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The Second Step

• 2. Evaluate Your Personality
• What is your basic business
• A professional price speculator, or
• A business person attempting to generate a
  positive margin.

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More on Personality

• Do you make decisions on the basis of
• Emotions...GREEDHOPEand FEAR, or
• Rational, information based decision making
• Good decision making involves looking at
  alternatives
• Collecting information about alternatives
• Listing advantages and disadvantages
• Calculating potential costs/returns Evaluating
  the risks in each alternative
• Making a decision and implementing
• Learning from your decisions.reviewing

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The Third Step

• 3. Integrate Budgets and Financial Position into
  Marketing Plan
• Examine enterprise profit loss. Does what
  youre producing
• Have reasonable chance of being profitable?
• Is it the best economic use of the resources?
• Look at cash flow needs implications for the
  timing of pricing and general cash needs
• How is your net worth?
• What are the implications for taking risk?

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Whats Required?
Enterprise Profit and Loss Estimates Cash
Flow Statement Net Worth Statement
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The Fourth Step

• 4. Understanding Government Programs
• Pre-planting
• An understanding of Government commodity programs
  and
• Crop insurance alternatives
• Harvest and post-harvest
• How do government loans work?
• How do LDPs work and what are the implications
  for pricing alternatives
• Know all relevant government programs and details

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The Fifth Step

• 5. Evaluating Your Production Plan
• How much will be produced
• When will it be available to be delivered
• What grades or special premiums might be
  available
• When can these products be priced?
• What is the pricing window?
• Generally at least 10 months before harvest until
  10 months after harvest.

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The Sixth Step

• 6. Evaluate Physical Handling and Delivery
  Alternatives
• Transportation costs to various elevators
• Storage costs and economics
• Premiums/discounts for grade-quality-volume
• Grain grades and discounts
• For livestock
• Carcass premium systems
• Optimum selling weights

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The Seventh Step

• 7. Evaluating Pricing Alternatives
• Futures and their use
• Options and their use
• Cash forward contracting
• Basis contracts
• Futures only contracts, or Hedge-to-Arrive
• Delayed pricing
• Average pricing programs at the elevator

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The Eighth Step

• 8. Evaluate the Outlook
• Examine and study historical price patterns of
• Futures, basis, and cash prices
• Be aware of the USDA balance sheets and basic
  price outlook they provide, as well as other
  fundamental information.
• Spend some time each week studying price charts
  and technical indicators.
• Read, or talk with analyst who provide outlook
  information.

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The Eighth StepRevisited

• 8. Re-Examine the Risks Faced Once More
• How much risk can you take?
• How much risk are you willing to take?
• Remember the two largest risk in agricultural
  production are
• Price uncertainty, and
• Yield uncertainty
• Keep price risks to a moderately acceptable level
• Remember markets do not care about you as an
  individual. Prices can move sharply in an adverse
  direction. The financial damage is compounded
  when an individual has a large market position.

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The Ninth Step

• 9. Develop a Written Plan of Market Action
• Writing down the plan will help you to formulate
  it in the first place.
• Update the plan quarterly.
• Keep all past copies of your plans.
• It will give you a benchmark to see how your
  marketing thoughts progress from period to
  period, and
• Provide a better basis for evaluating needed
  changes in the plans over time.

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The Tenth Step

• 10. Implement Your Plan and Continue to Learn
• Put your plan into action. Follow through on the
  plan, even if pricing opportunities look more
  promising than you had thought. Remember market
  prices always reach a peak on a bullish day.
• Monitor results and compare performance to your
  objective
• Evaluate your plan.
• Learn from it, and
• Modify as needed.

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Course Evaluation

• Please fill it out
• Let us know what programs you would like to see
  in the future
• Thank you!!!

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Questions

• To email in questions, either give them to your
  host or send them to Corinne Alexander
• cealexan_at_purdue.edu