NEWS for North Dakotans
Agriculture Communication, North Dakota State University
7 Morrill Hall, Fargo, ND 58105-5665
August 5, 1999
Wheat prices have improved in recent weeks, but price movement is volatile. An agricultural economist with the North Dakota State University Extension Service expects a short-term continuation of both price strength and volatility, which he says can be marketing opportunities. At the same time, he urges wheat producers with grain to sell to be mindful of a number of price-influencing factors.
"Be sure to check on the availability of a loan deficiency payment (LDP) even if the local elevator price for 14 percent protein wheat is above loan," says George Flaskerud, extension crops economist at NDSU. "An LDP may be available because of substantial discounts for low protein wheat. See your local Farm Service Agency for rates and regulations."
A large one-day move in the Minneapolis spring wheat futures price of 15 to 20 cents could be a good time to take the LDP, if available. Flaskerud says producers should take the LDP that day--before the posted county price (PCP) is raised the next morning. He says, "For grain already under loan, this would be a good opportunity to lock in the PCP."
When producers take an LDP, they should also initiate a storage hedge by selling a wheat futures contract to minimize downside price risk. The December Minneapolis spring wheat futures contract may be the most appropriate futures contract for wheat protein levels of 14 percent or greater. In contrast, the May contract may be best for lower protein wheats since more time may be needed for protein discounts to diminish, Flaskerud explains. The hedge-to-arrive (HTA) elevator contract would be an alternative to the futures hedge.
"The HTA elevator contract or futures hedge is preferred to a cash sale or cash forward contract because the current basis is very weak and because the distant futures contracts offer better pricing opportunities than the nearby contract," Flaskerud says.
The HTA and futures hedge fix the futures price but not the basis. This feature allows producers to wait for the basis to improve before fixing that component of the price. The basis in a HTA can usually be fixed any time up to delivery, Flaskerud says. In the case of the futures hedge, the basis is usually established when the grain is sold in the cash market.
How much is the basis likely to improve in the months ahead? Achieving at least the basis levels that occurred last year should be possible, Flaskerud says. Although weak, the Minneapolis to-arrive basis last year did improve about 15 cents into November, fluctuated sideways through February, weakened in March, and recovered during April.
"When using either the HTA or the futures hedge, remember that storage involves costs," Flaskerud says.
In an analysis assuming basis improvement similar to last year, an in-out charge of 10 cents per bushel and monthly storage costs of 2.1 cents to 2.3 cents per bushel, storage should generate a return above costs of about 15 cents a bushel by November, Flaskerud says. However any cash price increases during the November-April period are likely to be offset by storage costs.
If storage looks profitable, why use the futures hedge or HTA elevator contract? If a storage hedge is not initiated, there is risk that the price may deteriorate, Flaskerud explains. The prospect of seeing falling prices after taking the LDP may be more risk than many producers want to face.
"Storage of wheat, with at least 14 percent protein, into November would be consistent with the pattern for protein premiums, which tend to peak during the September-November period," Flaskerud says. "Because premiums and discounts tend to decrease with time, storage of lower protein wheat into April may be profitable."
What are the chances that prices will increase enough so an unhedged storage strategy will be more profitable than a storage hedge strategy? To answer that question, Flaskerud reviewed price behavior back to 1974. And to reflect the current situation, he considered only those years that met two criteria: the Minneapolis cash price in the to-arrive market was less than $3.50 in August, on average, and the stocks-to-use ratio was down from the previous year.
"Five years met the criteria for the search," Flaskerud says. "During those five years, the Minneapolis to-arrive cash price increased an average of 33 cents between August and November and 54 cents between August and April."
The five years were 1977-78, 1978-79, 1986-87, 1987-88, and 1991-92. The increases ranged from 17 cents to 62 cents between August and November and from 17 cents to $1.13 between August and April. Flaskerud used monthly averages in his analysis. For example, the August price was the average price during the month of August.
"The average increases of 33 cents and 54 cents are close to the expected cash prices (futures adjusted for the basis) that I used in my storage analysis," Flaskerud says. "In effect, if price increases exceed these averages, an unhedged storage strategy would be more profitable than a storage hedge strategy. But risk is the key factor in deciding whether or not to initiate a storage hedge. The risk-averse producer is likely to initiate a storage hedge."
###
Source: George Flaskerud (701) 231-7377
Editor: Dean Hulse (701) 231-6136