CWB Fixed Price Contracts

[bbrindle]

Any experiences with the first round of the CWB Fixed Price Contracts that ran from April 27- May 3??. The next series will be come out May 25th. I've posted an article in the Specialist's Corner on Agri-ville here: http://www.agri-ville.com/newspaper/spcorner/sc131.html

[melvill]

I had two calls (wow, TWO whole calls!) from producers who were thinking about signing up for small tonnages. They were thinking about doing it as a trial run. In the end they decided not to commit any tonnage at this point. They both intend to consider the next round in late May.

[rsomer]

Brenda: I am presuming that CWB FPCs are for new crop wheat, not for wheat already in the bin. If so, what happens if I experience a crop disaster and am not able to fill my contract next fall? I think this points out an important advantage of the CWB, that the farmer can enjoy protection from being forced to sell grain in the fall (for cash flow reasons) at below average prices without having to commit production for delivery before it is grown. Any of us who wish to speculate in US wheat futures are free to do so even without this new program. Sure we can't deliver against the futures position but this seldom happens in any event.

[bbrindle]

Yes, CWB contracts are for new crop. However I don't think there is any thing stopping someone who might want to hold some old crop to cover the contract. It is similar to canola -- you would likely price an amount that you are comfortable with, based on your conservative yields. If you had a full and complete crop disaster, then there would be liquidated damages, just like with canola, barley or anything else. But if you have a crop disaster and prices move down, you don't have much of a problem. To really get into a problem two things have to happen: 1)a disaster that leaves you with less than you contracted and 2) prices move up above your contracted price. For example, lets say you contacted 100t out of a 500t crop and ended up with a total crop of 50t. In general, if the market moved down from your contrated price you don't have a problem because the 50t you are short can be replaced by cheaper grain. If the market moved up $20/t from where you priced, you would likely owe 50t X $20/t = $1000 and you would have locked in revenue for the other 50t -- for which you would receive complete payment on delivery. That's the theory. I'll leave it to Tom to address the details of how the CWB will handle liquidated damages. That's not clear unless the CWB is going to come up with a 'price of the day'. Anything you don't forward contract will be pooled . So doing a contract does not stop you from still participating in th pool account - its just a matter of the percentage of crop you do that with.

[bbrindle]

To answer the question about what happens if you have a crop failure and can't deliver, refer to the terms and conditions that were in the little booklet mailed out to you. (if you don't have this booklet overview, call 1-800-275-4292 and the CWB will send you the information). The CWB will have a 'buy-out price' in effect that will represent a pre-estimate of the actual costs the CWB will incur as a result of the default. There is an element of production risk that you assume with these products, and only #3CWRS and higher grades can be delivered. However, it is rare that there is a total crop failure on the farm (hail perhaps). These tools allow you to lock in the price for the deliveries. In making the delivery commitment and locking in some tonnes, you initiate a hedge process at the CWB. These programs are intended to be revenue neutral over time, hence the buy-out recovery of the position. The programs offer you the choice to use any or all of the pricing opportunities, the Fixed price option, the basis option or traditional price pooling. Of course the new options aren't for everyone, but they shouldn't impact on non-participants.

[bbrindle]

I seem to forget to reference the CWB's own website! You can get the info booklet in a pdf file from www.cwb.ca. There is a link on the home page for the FPC booklet. Tom

[melvill]

The message above points out a very interesting belief held by most, (but a slowly shrinking number of) producers. I have been working teaching marketing to producers since 1986 and one of the things that continues to surprise me is how many producers believe that production risk is much greater than price or market risk. That belief shows up by how far producers will go to cover production risk using crop and hail insurance but at the same time they often aren't willing to put as much time or resources into covering price risk or market risk. The reason we worry about production, I believe, is that as farmers, most of us grew up on farms and saw the anxiety that drought or hail or frost caused to our parents and/or grandparents many of whom saw the absolute crop desolation of the '30s. I remember the intense anxiety on the faces of my parents when crops were threatened by drought, in particular. However, we were much less likely to have seen 'price stress' on the faces of our parents/grandparents. In that era, producers who grew either Board or non-Board crops believed that 'prices were prices', you took what you got and there was nothing that could be done about it. Many producers in that era didn't pay any attention to pre-harvest prices. Post-harvest prices were the only ones they watched. I don't ever remember hearing my parents discuss crop prices before or during the growing season. Now our industry has changed. When was the last time that anyone has had zero yield (except perhaps when we planted something we hadn't grown before and really made big mistakes)? When was the last time that anyone's crop yield was below 50% of THEIR previous five-year average yield? In fact, it's not often that production drops below 70% of a producer's previous five-year average. Even if it were to happen, crop/hail insurance protects to some degree. However, in prices it's a different matter. This year in canola alone, high prices for the marketing year were about $8.40/bu. in southern Albera and the lows were around $5.70. The lows are 30% below the highs. That's significant price risk, certainly on a par with production risk. Lee

[rsomer]

In my area, we do get zero yields. And production risk is a real concern. We have had at least one crop yield below 70% of average every year for the last ten years, yes even last year when we lost all of our Extra Strong Wheat because it was too wet in the spring. If you ain't got no crop, it don't matter what the price is. Prices are prices and there really is nothing we can do about them unless as a producer we change where we fit into the supply chain. In your work teaching marketing you are merely pointing out other alternatives for pricing. But in reality this just provides the producer with more options for obtaining an average price (given that over enough time and with enough trades everyone will make as many pricing mistakes as pricing successes). If you realize that over time the price you accept for your production will tend to fit a bell curve with some highs and lows but with most prices tending towards the average then you see how the CWB pool accounts achieve the same result but with fewer marketing costs for the producer. And without the risk of having to commit production for sale before it is grown.

[bbrindle]

I do not agree with the statement 'Prices are prices and there really is nothing we can do about them'. That's basically saying, 'why bother'. Striving for average is good enough. No business gets anywhere that way. As long as there are individual farmers who strive, and get better than average on a consistent basis (and I can assure you, some do) then they will be in a better position to pay for the land rent, hire the best people, or whatever. They will be more competitive, whether in their local area or in world markets. Those that strive for average will stay there, just average, at best. I will agree individual farmers can not influence the overall level of prices and trends in the market. However as individual decision makers, in open markets, they can choose when to lock in profitable prices during the time period which very much influences individual returns. It boils down to price times quantity minus costs. Focusing all the attention on one, or even two factors, doesn't work consistently over the long term. It takes total balanced management, which includes marketing. The statement was also made, '...unless as a producer we change where we fit into the supply chain.' I'd be interested to hear what should be changed, to fit in the supply chain, particularly with wheat.

[melvill]

My heavens. An almost lively debate on Agri-ville! I've always contended that we learn the most in a good (well-informed) debate. I still stand by my contention that most producers see production risk as more threatening to their businesses than price risk but, in my opinion, the reality is that price risk can create just as much damage. Let me give you two examples of why I believe (actually I know) producers can improve their incomes by doing a good job of managing price risk. 1) I was in the Peace for nearly 8 years (and I'd love to go back). For two years an elevator manager up there kept track of how and when all the canola delivered to his elevator was priced. During those two years just slightly less than 65% of the canola coming to his elevator was priced (priced, not delivered) when prices were in the bottom third of the price range for each year. Just imagine the difference to those farm's net incomes if pricing that canola had taken place in the middle third of the price range for each year! 2)In the 1998-99 crop year when everyone was trying to guess the peak in canola prices, I was getting a lot of calls from producers each day. Most of them weren't asking about strategies to deal with the high prices. They were either asking if prices were going to go higher or, after prices started to slide, they were asking why they were going down and would they go back up again. Those calls gave me an idea. I had an idea that many of the callers didn't have good market information to help them make decisions so I started asking each one what kind of info they were receiving. I wasn't totally surprised to learn that many (in fact, most) were getting little or no quality market info. Most were depending on their elevator manager or their crusher rep or the Country Guide or the Western Producer and the radio for their market info and analysis. It is not those sources roles to provide the ongoing, detailed info needed to make good, informed decisions. The producers that were phoning me were trying to make incredibly important decisions without adequate information. Your are right. Prices are prices and I agree that we can't do anything about the actual prices levels but we CAN do something about where and when in the annual price cycle we price our crops. In other words we can manage the price risk rather than letting it manage us which, in my experience, is what often what happens. I agree that over time none of us can consistently price in the top third of the annual price range - we each have our own proverbial bell curve. But my experience working with marketing clubs here in the south where the members are very invensive marketers and my contacts with marketing clubs south of the 49th says that those producers believe that they have moved your bell curve (your words, not theirs) to a higher point in the price range. Finally, my comments aren't at all related to the pro-CWB/anti-CWB debate. In my experience, that debate is like debating politics - only historians will be able to draw the final conclusion. However, my grandfather used to say 'be prepared for the unexpected.' That means Canadian producers who grow Board crops must thoroughly understand marketing and price risk management in case some years down the road the negotiators at the WTO decide that state trading organizations should not exist. That probably won't happen tomorrow or next year but it is a possibility that we need to prepare for.

[rsomer]

Re supply chains. I tend to be of the opinion that producers can benefit more by moving down the supply chain than they can by skillful use of pricing tools. For instance many producers choose to market their wheat as seed and expect to realize greater margins as a result. The organic growers are aiming at a different market but I see them as more involved in the marketing of their produce often with closer relationships to the eventual user of the product. Another example is the durum producers who wish to build a pasta plant, effectively adding value to their grain while moving down the supply chain closer to the end user (I realize there are CWB related issues with this example). Dealing with non-board grains, many producers feel they benefit by selling their grain through their hogs or feeder cattle, adding value to their produce while moving the effective selling point of their grain further down the supply chain.

[bbrindle]

Good points. Organic is a fascinating area from a marketing perspective -- whether you buy or produce organic or not. In many ways it is an example of identity preservation and the 'value chain' concept that everyone talks about now. Traditional commodity producers might learn something by looking at those case study examples across the fence. Do you think farmers need to be owners (e.g. hogs and cattle) to move up the supply chain, or is it more of a relationship? By doing this, are you reducing marketing costs? (Perhaps we should be starting a new topic on 'supply Chains'?)

[rsomer]

Interesting comments. I was intrigued by the percentage of Peace farmers selling in the bottom third. The best explanation I can give is that normal supply/demand fundamentals would suggest that when the majority of farmers are selling their grain the price should decline so we would not expect to see otherwise. Human nature, competitive forces, financial pressures compel us to at least consider if the commodity market is going to be higher or lower at some future point whenever we make a grain pricing or risk management decision. Higher or lower, a 50/50 choice. If anyone wants to test their commodity marketing skills, take a coin and say heads is higher and tails is lower. Make your best market assessment as to which way the next coin toss is going to go, record your guess and flip the coin. Record the result. Repeat this test a large number of times. If anyone out there can assess the market correctly significantly higher than the mean value of 50% contact me and you can help me with my risk management. We might even do a little speculating together. Now many would say that risk management is not pure chance rather the skill of the player influences the outcome of the game. If a knowledgeable person listens to the right market information they should increase their odds of winning. But it is possible, even probable, that the market information is merely historical data that offers little certainty about the future direction of anything. My opinion. I thought your comments re the WTO and state trading agencies to be very astute. I don’t wish to debate the pros and cons of the two systems either but will make the following observation. At the beginning of this thread Brenda Brindle compared the new pricing contract based on U.S futures to the CWB pool. The U.S. producer is very used to the 'American' system of pricing grain. We would expect them to be very adept at using the various pricing and risk management tools that are available and as such would expect to see their farm profitability increased as a result. Yet I see the U.S. farmer needing to be constantly propped up by massive federal government subsidies. If a Canadian producer intends to price his wheat doing things the American way he is likely to fail unless he can persuade our government to offer us the same level of subsidy support. If anyone is interested I might suggest reading a very interesting book on risk. Against the Gods, The Remarkable Story of Risk, Peter L. Berstein documents man’s efforts to understand risk and probability. Very enlightening.

[rockpile]

rsomer, you are so right, No disrespect Lee, but in your years of teaching, and not farming, you have missed the point of why farmers worry about production decimation. It is because that is final. No hedges, no basis, no options. As for crop insurance - that's an insult. It is completely out of sinc with the times. rsomer has pinned down the essence of risk management - pooling your marketing. Your risk is obviously higher if you do it as an individual than if you are part of a larger group. That is not to downplay the importance of knowing marketing oportunities, but is a much larger issue of strategic industrial planning. Has anyone given thought to the fact that this spring, Western farmers will be investing 3 billion dollars in trying to produce a crop? This investment rivals any recent mega-project undertaken. Isn't it time we realize that our farms are just part of one big factory and that their is zero that the individual can do to influence price? I know, I have 1500 bus. of barley that I grew in 1997 and I 'want' 7 dollars a bus. Any takers?

[charliep]

Just to contribute to the discussion, I have a couple of questions. 1) Should farm managers apply the same principles to debt (operating, equipment and land) as you do to pricing? If you applied the same principles around concerns around yield risk on early pre-harvest pricing decisions, would most farm managers try to operate debt free? Is this realistic? 2) Two neighbors farm across the road from each other. One only uses the cash market when he has crop in the bin. His pricing decisions are based on his market forecasts or failing that, forced sales to meet cash flow commitments. The neighbor plans his sales/pricing in advance based on profit targets/breakeven analysis and cashflow needs during critical times of the year. The way he gets around the yield side is staging sales in as he feels comfortable with yield prospects. Which farmer will have more net income after 10 years? If you were a banker, which one would you loan money to? 3) One of the key issues in the new world the grain idustry is the ability to provide the type and quantity of product when our customer needs it. I am going to make the bold statement that it will be one of the prime requirements in the future to meet customers needs/achieve at least some price premium. Can we as an industry achieve this objective without some type of effective forward contracting programs based as much on logistics/optimizing the grain handling/transportation system as on pricing?