Minimum Price Contracts

[TOM4CWB]

Charlie and Lee;

Do you folks know of any minimum price contracts, other than for specialty Canola and special Crops?

Why don't more grain marketers offer minimum price forward production contracts like the OWPMB Wheat and CanAmera $10/bu HEAR contracts?

[melvill]

tom4cwb, you ask all the hard questions. I'd rather enjoy watching the moisture fall outside my window than answer them but . . . .

Minimum price contracts have a way of coming and going as a way to attract product when producers are reluctant deliverers. Most of the ones I've seen are offered by crushers or line companies for canola deliveries. I've seen them for all kinds of canola, not just specialty kinds. I've never seen any for special crops.

A minimum price contract is a deferred delivery contract (or flat price contract) plus a call option. Some companies use WCE traded canola options or CBOT soyoil options to cover the canola call options premium. Some access the risk and cover the call option internally but use exchange traded options as a guideline.

The Canamera HEAR contracts are kinda unique but they're not a minimum price contract. They're a flat price contract for all the high High Eurisic Acid Canola (industrial type) that a grower can produce. The contracts are full now - Canamera limited them to a certain number of acres. Canamera can offer that kind of price because they have a guaranteed sale for the oil at a specific, guaranteed price.

However, in the special crop business there are no options traded anywhere to act as a guideline. I suppose special crop buyers could use a company like FIMAT Derivatives to lay off the risk if their volume was big enough. However, I doubt the volume would be large enough. Chaffmeister you have any ideas on this?

I don't know what the OWPMB offers but I'll find out.

[melvill]

Found out about the OWPMP minimum price contracts. Basically they're a wheat call option based on CBOT July 03 wheat futures. Of course, any call (or put) option is price insurance. Like any insurance the OWPMP minimum price contract costs the producers a premium to participate. Details are at http://www.ontariowheatboard.com/Basis.html .

I suppose any crusher or grainco could offer minimum price contracts if enough producers asked for them and IF the company thought it was worth their while in terms of cost, effort and hassle. Companies tell me that very few producers use them and most of the producers that do don't understand them very well. Many producers expect a guaranteed return for the money they kick in. Unfortunately, they don't understand that it's insurance not a guaranteed investment. It ends up being a frustration for the seller and the company.

[TOM4CWB]

Lee;

Last year was a perfect example why we need minimum price contracts, whether or not they include the option to select a higher price in the future or not.

Many farmers paid out big dollars to buy back canola in 2002

A production contract that specifies a specific price, without an obligation to buy out the contract in the case of a production failure... is a very important risk management tool.

Last spring we said that $8.00/bu canola was a fair price, is this still not the case today, especially if there was no risk from a production failure?

[melvill]

Ah, tom4cwb, maybe you and I have a different idea of what a minimum price contract is. My experience with minimum price contracts is a DDC (or flat price contract) with a call option attached to it. It can also be a cash price for spot delivery with the price reduced by the cost of the call option premium. In either case it means the grain must be delivered or has been delivered but the seller has the right to lock in a higher price, if the market rallies, before some deadline date. A producer, who had used a minimum price contract before delivery of the product might still have to buy back the contract if he/she couldn't deliver, depending on the fine print in the contract.

I have never seen a minimum price contract where the producer didn't have to buy out the contract if there was no delivery. That doesn't mean they don't exist, though.

Let's suppose that a company were to offer a minimum price production contract with no buyout if there was no delivery. The price side of that could be managed with a call option (if an option existed for that commodity) but there would be a company cost for the call option premiums. The premium cost would have to be passed on to the producer as a lower contract price. The problem is a production contract usually doesn't specify a number of tonnes so how would the buyer know how many options to buy to cover his possible loss if there was no delivery? If the buyer has additional uncertainty, you can bet he's going to charge the seller for it somehow. Last year special crops buyers were charging 2 cents/pound for an "Act of God" clause in their contracts. In canola terms that's $1.00/bu. How would canola growers feel about a buck a bushel charge so they wouldn't have to deliver in case of a production failure?

In my mind the better alternative is for producers to know how to use call and put options and to have those tools in their marketing tool boxes for whenever they need them. Options are going to cost the producer regardless of whether a company offers them or the producer buys them from a commodity broker.

Incidently old-crop canola futures were hammered again today. New-crop got whacked, too. $8.00 for new-crop might look pretty good shortly. Then take a buck off that for non-delivery insurance . . . .