UK Grain Marketing Series January 19, Todd D. Davis Assistant Extension Professor. Economics

Transcription

1 Introduction to Basis, Cash Forward Contracts, HTA Contracts and Basis Contracts UK Grain Marketing Series January 19, 2016 Todd D. Davis Assistant Extension Professor

2 Outline What is basis and how can we use basis in marketing decisions? Using Cash Forward Contracts (CFC), basis contracts and Hedge-to-Arrive (HTA) contracts Update on January WASDE reports Commodity Challenge update

3 Nuts and Bolts of Commodity Futures Futures Cash $3.00 $2.90 $2.80 $2.70 $2.60 $2.50 $2.40 $2.30 $2.20 $2.10 $2.00 $1.90 $1.80 $1.70 $1.60 $ Apr 2-May 2-Jun 2-Jul 2-Aug 2-Sep 2-Oct 2-Nov Two markets that tend to move together Futures like a national price. Impacted by US and World Supply/Demand Conditions Cash local price impacted by local factors Basis = Cash - Futures

4 Hedging - Review Sell futures when you have commodity to sell in the future Sell contract month nearest when you intend to deliver or the next one after Offset (buy) futures position when you sell commodity If prices fall, we gain on futures If prices rise, we gain in cash market

5 Put Options Motivation Dec Futures $9.00 $8.75 $8.50 $8.25 $8.00 $7.75 $7.50 $7.25 $7.00 $6.75 $6.50 $6.25 $6.00 $5.75 $5.50 $5.25 $5.00 $4.75 $ Jan 3-Feb 3-Mar 3-Apr 3-May 3-Jun 3-Jul 3-Aug 3-Sep 3-Oct 3-Nov Hedging locks in a price ($5.50). Put Options create a price floor to benefit from higher prices ($7.50)

6 Put Option Put Options Overview Gives the buyer the right to sell a contract at a predetermined strike price You only sell if the market moves down and it benefits you to do so Buy the right to sell Dec Corn futures at $4.10 If the market moves down, your put becomes more valuable You pay a premium for this flexibility

7 What price floor can you set? Strike Price - Premium - Basis Futures price for contract month in which you plan to sell Cost of the option Local basis for the month in which you plan to sell Price Floor

8 Graphically $ / bu Put Option Straight Hedge No Protection Overall Market

9 What is basis? The difference between local cash prices and the futures price cash price futures price = BASIS Cash price is local price Futures is a national price Basis localizes the Futures price Negative basis sometimes expressed as under New crop corn bids are $0.30 under the December board

10 What Impacts Grain Basis? Transportation costs Distance from market Storage and handling costs Interest costs Local supply / demand conditions Short crop vs. record large crop Local weather / logistical challenges Local markets?

11 Strengthening / Weakening Basis $0.40 $0.30 $0.20 $0.10 $0.00 ($0.10) ($0.20) ($0.30) ($0.40) Narrowing or Strengthening Widening or Weakening Strengthening basis = becoming more positive or less negative Beneficial for short hedger Market wants cash sales Weakening basis = becoming less positive or more negative Bad for short hedger Market wants storage

12 Basis Tends to be Seasonal Basis tends to show seasonal patterns. Usually widest at harvest Then strengthening throughout winter and spring

13 Using Basis to Forecast Price Basis = Cash Futures If you know expected basis (Average of 3-5 years), you can use that with current futures price to forecast a cash price EX: If harvest averages -$0.25 / DEC in October, Current DEC Futures = $3.75. Expected cash is $3.50

14 Tools to Manage Price Risk Hedging Locks in futures price. Still have basis risk. Subject to margin calls Put Options Creates a price floor. Still have basis risk. Total cost is known and no margin calls. Cash Forward Contracts Locks in the cash price Futures and Options are in 5000 bushel units. Cash Forward Contracts are in customizable units.

15 A contract that fixes the cash price. Farmer agrees to sell a fixed quantity at an agreed upon price at a specific date and location Advantages: Ability to price before harvest Eliminates futures price risk / basis risk; Easy to understand Not tied to 5000 bushel units Disadvantages: Cash Forward Contracts Production risk not able to fulfill contract Locked into price. Don t benefit if prices increase

16 Using Cash Forward Contracts to Lock in a Price Dec. Date Cash Futures Basis Mar. 3 $4.00 $4.10 -$0.10 Actual Cash Forward Contract bid is $4.00 bushel. Contract 1000 bu for harvest delivery Nov. 3 $3.80 $3.90 -$0.10 Actual Sell 5,000 bushels of corn in cash market at $4.00 a bushel. Change in Price -$0.20 Cash Price $4.00 You've locked in a price.

17 Using Cash Forward Contracts to Lock in a Price Dec. Date Cash Futures Basis Mar. 3 $4.00 $4.10 -$0.10 Actual Cash Forward Contract bid is $4.00 bushel. Contract 1000 bu for harvest delivery Nov. 3 $4.40 $4.50 -$0.10 Actual Sell 5,000 bushels of corn in cash market at $4.00 a bushel. Change in Price +$0.40 Cash Price $4.00 You've locked in a price.

18 Western Kentucky October Corn CFC Price (Index October) Jan Feb Mar Apr May June Jul Aug Sep Oct Source: Kentucky Farm Bureau Federation

19 $2.50 $2.00 $1.50 Change in October CFC Corn Price from April to October $1.53 $2.18 $1.00 $0.50 $0.00 -$0.50 -$1.00 -$1.50 -$0.22 $0.51 -$0.02 -$1.24 -$0.48 $0.44 -$0.02 -$0.31 $0.05 -$1.05 -$0.15 -$2.00 -$2.50 -$1.93 -$ Western Kentucky Spot price in October is lower 67% of the years. The average decrease is $0.73 / bushel.

20 Western Kentucky October Soybean CFC Price (Index October) Jan Feb Mar Apr May June July Aug Sep Oct Source: Kentucky Farm Bureau Federation

21 $3.00 $2.00 $1.00 $0.00 -$1.00 -$2.00 Change in October CFC Soybean Price from July to October -$0.63 $0.32 $2.05 -$1.02 -$1.48 -$0.02 $1.42 $0.49 $1.85 -$1.25 -$0.15 $0.23 -$1.56 -$0.74 -$3.00 -$4.00 -$5.00 -$6.00 -$ Western Kentucky Spot price in October is lower 64% of the years. The average decrease is $0.86 / bushel (excluding 2008).

22 Hedging vs. Cash Forward Contracting (CFC) Both lock in price: Hedging locks in Futures / CFC locks in cash Hedging allow flexibility to select final delivery point Hedging allows easier flexibility to reverse decision. CFC s may not be easy to change your mind without penalty payments Hedging allows for basis speculation (hope of strengthening vs. fear of weakening). Hedging allows for longer marketing as Futures contracts are available 18 to 24 months in advance.

23 Advantages of CFC Forward contracting know the final price with certainty Forward contracting is simpler as don t need broker or understanding futures Forward contracting doesn t require margin accounts or margin calls for cash flow problems Forward contracting isn t in 5000 bu lots. Can customize to meet needs.

24 Basis Contracts Allows to lock in basis for grain when basis is acceptable but futures price is unacceptable and believe there will be higher future prices Have deadline to fix the futures price. At decision-time, can fix futures price or roll into another contract month (after paying a fee) Advantages: Basis is locked and can t widen (weaken) Can benefit from rallies in the futures market Disadvantages Can t benefit from strengthening (narrowing) basis Exposed to future price risk If roll the contract, subject to market spreads and fees to roll between contract months.

25 Examples: Basis Contracts Sell 5000 bu new crop corn for October delivery at basis of -$0.25 DEC futures. At harvest, decides to price at DEC Futures $6.05. Net cash price is: $ $0.25 = $5.80 bushel Currently have a basis contract for DEC Futures. DEC Futures = $2.60; May = $2.75 DEC May Spread = ( ) Original basis = -$ spread = new basis of $-0.45

26 Examples: Rolling a Basis Contracts In July, sign a basis contract for DEC Futures. In November, DEC Futures = $3.60; May = $3.70. Decide to roll basis contract to May DEC May Spread = ( ) Original basis = -$ spread = new basis of -$0.20 In April, May Futures at $3.85. Fix futures price for cash price of $3.85 $0.20 = $3.65

27 Hedge-to-Arrive (HTA) Contracts A contract where fix the futures contract price but not the basis Like a short hedge except elevator manages the futures account and margin calls Can choose to roll contract within the same marketing-year (September to August) A non-roll HTA: Requires a specific quantity and quality of grain to sell at a predetermined date and place Basis risk is the main risk for non-roll HTA s Non-roll HTA s prevent producer from benefiting from higher prices.

28 Non-Rolling HTA Contract On July 1: DEC corn futures are at $3.75 with an expected harvest basis of -$0.30. The CFC is $3.30. Decides to use a non-roll HTA contract to establish a better price. The Non-Roll HTA fixes DEC Futures at $3.75. Expected price is $3.75+-$0.30 = $3.45. At Harvest, producer delivers corn to elevator to fulfill HTA. Cash price is $3.35 and DEC contract is at $3.65. Basis is actually -$0.30 Producer s price is: $3.35 (cash) plus Futures gain ($ $3.65 = $0.10) Net price is $ $0.10 = $3.45 as expected o Like hedging, a stronger basis benefits farmers o A weaker basis is detrimental to farmers.

29 Intra-Year Rolling HTA Similar to the non-roll HTA EXCEPT that the delivery date can be changed to another time within the same crop marketing year (September August for Corn/Soybeans) This can create intra-year spread risk between different contract month s prices Potential price gains are from basis strengthening or rolling the price up to a later delivery contract month. Both are risky and could result in lower prices. More complicated as producer has to decide when to set the basis and when to roll the contract.

30 Example: Intra-Year Rolling HTA June 1 HTA DEC Corn at $3.90 for harvest delivery Harvest, basis is $0.35 under DEC. You could A. Lock in the basis and take the $3.65 cash price OR B: Roll HTA to July and capture a $0.20 carry in DEC-July Spread. July: Basis is $0.10 under the July futures. Cash Price is: $3.90 (original futures) + $0.20 (spread) - $0.10 basis = $4.00

31 Advantages of HTA Contracts Allows the seller to lock in what he/she perceives to be a favorable futures market price. Provides time during which the seller can price the basis portion of the contract. If the seller of grain feels the basis market will improve, this alternative provides the seller to price the basis portion of the contract at a later date. Allows the seller to lock in favorable futures market carry when available. Allows the seller the flexibility to roll the contract to a desired shipment date within the same crop year (October through September).

32 Disadvantages of HTA Contracts Does not allow the seller to benefit if the futures market rally after the futures portion of the contract is priced. Does not lock in the basis portion of the trade. The seller is exposed to a potential basis decline. May expose the seller to quality deterioration if the seller has to store grain until a later delivery date.

33 F u t u r e s Which Risk Management Contract is Preferred? Acceptable Unacceptable Acceptable Forward Contract Basis Contract BASIS Unacceptable Hedge Do Nothing

34 Decision Matrix - Continued If futures price and basis are acceptable, then forward contracting is best for you. What is acceptable depends on: o Production costs (what price do you need to be profitable) o Financial resources (ability to absorb loss; ability to make margin call cash flow) o Attitude towards risk o Comparing the basis to history / futures to history provides perspective If Futures Contract are acceptable but basis isn t, hedge and hope for basis strengthening If basis is acceptable but futures isn t, consider a basis contract

35 Considerations for Contracting Know and understand everything in the contract If you don t understand, don t sign contract Know how the net price you receive will be determined Know what happens if you have a production problem and can t fulfill the contract Evaluate the contract under various and extreme price and yield risk to know the potential outcome

36 Table 1. U.S. Corn Supply and Use Change from Estimated Projected Projected Planted Area (million) Harvested Area (million) million from Yield (bushels/acre) nd Largest Yield after last year's record Million Bushels Beginning Stocks ,232 1, Largest Carry-in since Production 10,755 13,829 14,216 13, rd largest crop on record Imports Total Supply 11,904 14,686 15,479 15, nd largest supply on record Plt. Acres down 9.3 million and Harv. Acres down Feed and Residual 4,315 5,036 5,315 5, Food, Seed & Industrial 6,038 6,501 6,568 6, FSI hitting blending wall and substittuion of Ethanol and by-products 4,641 5,134 5,209 5, sorghum for corn in ethanol (-75 mil bu in Nov) Exports 730 1,917 1,864 1, Strong dollar and cheap Brazilian corn Total Use 11,083 13,454 13,748 13, Ending Stocks 821 1,232 1,731 1, Largest ending stocks since Stocks/Use 7.4% 9.2% 12.6% 13.3% +0.7% Days of Stocks U.S. Marketing-Year Average $6.89 $4.46 $3.70 $3.60 $0.10 Price ($/bu) Potential $0.10 PLC payment Source: January 2016 WASDE - USDA: WAOB. Source: USDA-WAOB

37 Strong dollar makes US exports less competitive Strongest Dollar since January 2003 Source: St. Louis Federal Reserve Bank

38 Ending Stocks (MMT) US & World Ending Stocks -- Corn US ROW China % % 54% 52% 50% 48% 46% 44% 42% China Share (%) Source: WAOB

39 $4.00 $3.90 $3.80 $3.70 $3.60 $3.50 $3.40 $3.30 $3.20 $3.10 $3.00 USDA s Marketing-Year Price Projections (December 2015) $3.70 $3.65 $3.68 $3.65 $3.70 $3.70 $3.70 $3.70 $3.70 $3.70 $3.75 $3.75 Source: USDA-ERS

40 Table 2. U.S. Soybean Supply and Use Change from Estimated Projected Projected Planted Area (million) Harvested Area (million) Yield (bushels/acre) Record Soybean Yield, if Realized Million Bushels Beginning Stocks Largest Carry-in Since Production 3,042 3,358 3,927 3, Larvest Crop on Record, if realized Imports Total Supply 3,252 3,570 4,052 4, Largest Supply on Record 2nd largest Planted and Harvested Area on record Crushings 1,689 1,734 1,873 1, Largest crushing demand on record Exports 1,317 1,647 1,843 1, Strong Dollar and South American Competition Seed Residual Total Use 3,111 3,478 3,862 3, Ending Stocks Largest Ending-Stocks since Stocks/Use 4.5% 2.6% 4.9% 11.9% +6.9% Days of Stocks U.S. Marketing-Year Average Price ($/bu) $14.40 $13.00 $10.10 $8.80 -$1.30 Source: January 2016 WASDE - USDA: WAOB. Source: USDA-WAOB Bad recipe of declining demand in the face of increasing supply

41 Ending Stocks (MMT) US & World Ending Stocks -- Soybeans US ARG BRZ ROW China % % 22% 22% 21% 21% 20% 20% 19% 19% 18% 18% China Share (%) Source; WAOB

42 $10.60 $10.40 $10.20 $10.00 $9.80 $9.60 $9.40 $9.20 $9.00 $8.80 $8.60 $8.40 $8.20 USDA s Baseline Marketing-Year Price Projections (December 2015) $10.10 $8.90 $9.10 $8.80 $8.95 $9.00 $9.10 $9.20 $9.20 $9.20 $9.30 $9.35 Source: USDA-ERS

43 Summary World and U.S. rebuilt corn, soybean and wheat stocks China holds a large percentage of corn (of questionable quality). Import needs? South American economic uncertainty, currency strength, export tax policy

44 Thank you! Any questions?