Class started two weeks ago. The course is titled “Agricultural Futures and Options Markets.” I have 51 students, including 46 undergraduates (this is a popular elective for Juniors and Seniors), 2 graduate students and 3 Mast students (a special foreign exchange program at the University). I like to start slow, lecturing on the evolution of futures trading and getting students comfortable with the terms used in futures trading (types of orders and traders, margins, etc.) and the standardized terms of a futures contract. Nobody has fallen asleep.

Tomorrow I start getting serious when I discuss carrying charges. I tell my students that if they want to understand grain futures markets, they must understand carrying charges – what they are and what they tell us about the bullish or bearish nature of the market. After carrying charges, I’ll talk about basis – the difference between cash and futures prices. Anybody with a firm handle on carrying charges and basis is ready to discuss hedging.

Too many people see hedging as a risk avoidance ploy, but the risk avoidance angle is overemphasized. In reality, hedgers trade flat price risk (and opportunity) with basis risk (and opportunity). Here are two stories that illustrate basis risk and opportunity.

In 1990, I managed commodity operations for the Flour Milling Division of the Pillsbury Company. We operated eight flour mills including one in Enid, Oklahoma (still going today as part of ADM). It was late spring/early summer and harvest was still several weeks away. In any grain processing business, it usually a good idea to minimize ownership of stocks at the end of the crop year because you are anticipating oodles of cheap new crop bushels on the market. We were doing just that in early June of 1990 – drawing down our ownership to minimum levels. At the same time, we were making a lot of flour sales for the third and fourth quarters. What motivates flour buyers? I’m not sure, but I do know that when one or two large players decide it’s time to price flour and lock down costs, every buyer jumps on board. The net result of this activity was that we were “short” the basis in a large way – over one million bushels. To say we were short the basis simply means that we had made many cash flour sales (sold the cash market) and we covered these sales with purchases in the futures market (buy the futures market). Even though the position was large, we were not particularly concerned because, as I noted, harvest was just weeks away and the HRW wheat crop in the Enid area looked very good.

Then the railroads decided – without a hint of warning to anyone in the industry – that the time was right to substantially lower unit train freight rates to the Gulf of Mexico. Lower freight rates means a higher basis. Overnight we had to raise our bid for new crop wheat by nearly 20 cents per bushels to stay competitive with the export market. Overnight, one flour mill lost about a quarter million dollars.

That’s what we call basis risk.

My story of basis opportunity comes Toledo, Ohio in 1983. A good friend of mine is in his second or third year with Cargill. He is still in training and they have him trading corn and serving the feed needs of large poutry producers in Pennsylvania and other eastern states (a fairly quiet and safe market for a beginner). In the first half of 1983, corn prices are dirt cheap and the big players in poultry are aggressively purchasing corn for delivery through the balance of the year. My friend is selling one heck of a lot of corn and getting “short” the basis (selling cash corn, buying futures). He is not too concerned about finding the corn to fulfill his contracts because of delivery economics.  You see, Cargill’s elevator is located in Toledo (an alternative delivery point) and he figures his worst case scenario is to take delivery of corn in the futures market and ship the corn to Pennsylvania. In this scenario, Cargill will make just a penny or two per bushel but the risk is minimal. Going into early summer, my friend had accumulated a very large “book” of corn sales (i.e. a very large short basis position).

Then August came with dry weather and the drought of 1983. Corn prices soared and the poultry producers were very happy they had locked-in corn costs early. Corn prices soared and the farmers with grain in the bin from 1982 (or 1980 and 1981!) started selling because they finally saw good prices. My friend (and Cargill) was happy because the basis crashed. Heavy sales led to the crashing basis. No worst-case scenario here – he was covering sales at basis levels he could not have dreamed of several months earlier. This junior trader with Cargill made over a million dollars trading a “quiet and safe” market.

That is basis opportunity.

We never got there. In early September, the Nov’12 contract peaked at $13.99½/bu. That is correct: for lack of a lousy ½ cent/bu., I passed on a great pricing opportunity. The Nov’12 contract proceeded to trade all the way down to $11.20/bu. in late November and again in mid-December. I grumbled the whole way down.

Well, the new year is here and I think it is time to turn my attention – serious attention – to pricing new crop soybeans. I start by telling myself to “forget last year” (and nearly $14 soybeans) and to thank goodness for an end-of-year rally that put $1 back on the lows set last month. I took action on the market closes of January 3 ($12.29 Nov’12 futures). It is not nearly as good as the $14 available in early September but it is, by most measures, a profitable price for soybeans.

You can find my 2012 pre-harvest marketing plan for soybeans here.

The holidays are here and it’s time (if you haven’t already done so)  to turn our attention to 2012. My pre-harvest marketing plan for 2012 spring wheat is here. I first published it last August and the initial sales were made at very good levels. Which leaves me, of course, with that “I should’a sold more” feeling.

Grain prices are searching for direction. The bull market died during the collapse last September, but it doesn’t feel like a bear market today. We are searching for direction. I’d like to see a bull market resume but, until then, I want to be ready to sell rallies.

LULU.com says this is their last sale before the holidays – one more chance to buy Grain Marketing is Simple for a friend or family member. Go to the website here and type in Grain Marketing is Simple in the “find” bar.

Enter coupon code COUNTDOWN305 at checkout and receive 25% off your order. The maximum savings for this offer is $150.  Sorry, but this offer is only valid in US Dollars and cannot be applied to previous orders. You can only use this code once per account, and unfortunately you can’t use this coupon in combination with other coupon codes. This great offer expires on December 14, 2011 at 11:59 PM PST, so don’t miss out!

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Several weeks ago, I asked a colleague at the Center for Farm Financial Management to update his projections for production costs in Southern Minnesota. Estimated production costs are a very important number in my approach to pre-harvest marketing. They represent my minimum pricing objective – a number, under which, I am unwilling to price grain before harvest. The update was needed because costs do change. Fertilizer prices, for example, are much higher today than when we put together a quick projection for 2012 costs last spring.

Hmm, the updated projections were surprising, and much higher than the quick projections from last spring. These higher projections have prompted me to revise my 2012 pre-harvest marketing plan for corn. The new minimum pricing objective is $4.60 cash corn, or 35 cents/bu. higher than the original figure. In terms of a new crop futures price, the minimum pricing objective is $5.10 Dec’12 futures (currently near the $5.40/bu. mark). That’s 45 cents/bu. higher than the original figure (yes, I widened my expectations for a new crop basis to 50 cents under the Dec’12 contract). In addition to raising the minimum price, all other price targets have been revised upward.

All of my marketing plans, including my revised corn plan for 2012, can be found here.

Forget last year. I’m staying conservative and selling the carry.

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Have a wonderful Thanksgiving.

Buy 1 book get the second 50% off when you use coupon code SECRET305 at checkout. Maximum savings with this promotion is $50. Print and tax amounts are excluded. You can only use the code once per account, and you can’t use this coupon in combination with other coupon codes. This great offer ends on November 18, 2011 at 11:59 PM so try not to procrastinate!  You must have at least two books in your cart for this promotion to work.  This promotion works for self-purchases (i.e., buying your own book) or purchasing someone else’s book.

Commodity Challenge

Most of the games on Commodity Challenge are closed to participants outside of a particular marketing group or classroom. To say they are closed simply means that these games are password protected. However, I also have a number of open games where no password is needed to play. I put the open games out there for you adventurous types who would like to explore Commodity Challenge. You can place orders, check account actions and just develop a feel for how the game works. Remember that Commodity Challenge is an educational game. Use it to explore new pricing tools or practice executing a marketing plan. You might have a little fun and be inspired to have a game set-up for a group in your area.

Virtually all of the games played on Commodity Challenge are old crop games where the game assumes that your harvested grain is held in storage. All cash price quotes are spot prices, or the price for grain delivered today. Storage costs accrue. Old crop open games include the Iowa Corn Open 2011, the MN Soybean Open 2011 and the Montana open 2011.

Today I established three more open games which feature 2012 new crop pricing. These games include the Preharvest Corn Open, the Preharvest Soy Open and the Preharvest HRW Open. What makes these pre-harvest games different from other games is the price quote for each site. Quotes are not spot quotes but new crop quotes. By quoting prices for delivery at harvest, the competition becomes one where you are trying for the best price before harvest.

If you would like to compete in an open game, go to the Commodity Challenge website. You must register to play, and registration is free. Once signed in, look for an open game. You can participate in as many games as you wish.

If you would like to set up a game for your own small group, please contact me at usset001@umn.edu.