Market Advisor: Canola Marketing Publication Available

by George Flaskerud, Crops Economist
NDSU Extension Service

Development of a marketing plan for canola is critical for producers, as shown by a new North Dakota State University study of price risk management for that crop.

Goals must first be evaluated. Producers must also evaluate the economic fundamentals of canola, the price needed to break even on production costs, the technical characteristics of the corresponding futures market, the establishment of price objectives and a contingency plan, the study indicates. The study, Price Risk Management for Canola Producers in the Northern Plains, offers historical guidance for making those evaluations.

The study was recently completed by a team that included Extension crops economist George Flaskerud, research scientist Bruce Dahl and professor William Wilson. The team members are all in the Department of Agribusiness and Applied Economics. Results of the study are presented in Extension Bulletin EB-75, available from your local NDSU Extension Service agent and from the Northern Canola Growers Association, which provided financial support for the publication.

The following are highlights of the publication.

Canola production has grown rapidly in North Dakota since the mid-1990s because it has been more profitable than many other crops. Even though canola often competes well economically with other crops, canola producers confront substantial price risk.

Canola is not traded on a U.S. futures market but it is on the Winnipeg Commodity Exchange. The contract price is for a par region, which is an area around Saskatoon, Saskatchewan. Canola futures prices, which are in Canadian dollars per metric ton, are converted to U.S. dollars per hundredweight ($US/cwt.) in the publication. For an exchange rate of .674 , a price quotation of $254 per metric ton would convert to $7.77 in U.S. dollars per hundredweight ($254 times .674 divided by 22.046 = $7.77).

The expected price from hedging canola is the Winnipeg Commodity Exchange canola converted futures price adjusted by a typical basis, less brokerage fees and interest cost on the margin money held by the brokerage firm on the futures hedge. The transaction (fees and interest) cost may total 7 cents per hundredweight for canola. For a price quotation of $7.77 in U.S. dollars per hundredweight and a basis of $1, the expected hedge price would be $6.70 ($7.77 less $1 and $.07).

Using the canola futures market to establish a hedge in a distant futures contract means that the hedge is subject to uncertainty about changes in the exchange rate. Analysis indicated that exchange rate variability is low over the usual life of a hedge, making the exchange rate inconsequential.

On-farm storage may be profitable. The profitability of storage is determined by selecting the month with the highest expected net price. This net price is derived by subtracting variable storage costs from an expected price for each month. The month with the highest net expected price is the month during which sales should be planned.

Prices and marketing strategies were analyzed using data gathered from several sources. The availability of price data for cash canola prices at Velva, N.D., limited the analysis to the 1993-2000 period.

Seasonal patterns for canola prices were examined for the marketing year, August to July. The pattern for Velva cash prices, on average, is to decline to lows in September and October and then increase to peaks in January and April. The pattern for nearby canola futures prices was similar. The history of the November contract indicates highs occurring in May with lows occurring in August, on average. In contrast, the May contract exhibits a pattern where highs occur in November and the lows in February, on average.

The Velva cash basis was derived relative to canola futures converted to $US/cwt. The basis for the 1996-99 marketing years is summarized since a change in basing points for canola futures occurred in 1996 from Vancouver to the Saskatoon area. The cash basis after the change has a marketing year low that occurs in October and then increases throughout the remainder of the marketing year. The range of the basis is narrowest from January to April and is widest from May to October. The Velva cash basis was also derived relative to soybean futures and soybean oil futures.

Hedging of commodities relies on the relationship or correlation between futures and cash prices. The results strongly indicate that canola futures should be used to manage price risk rather than futures for soybeans, soybean oil or soybean meal.

A hedge ratio is the proportion of the futures position required to minimize risk associated with a cash position. Although traditionally hedges are 1:1, risk could be reduced further by using a hedge ratio of about .8 to .9. Risks could also be reduced further by adding positions in other contracts including foreign exchange and soybean oil. However, the added risk reduction potential of these is relatively small and would most likely be offset by the additional transaction costs required for the additional futures positions.

Preharvest and harvest/postharvest marketing strategies were analyzed. Caution must be exercised in generalizing about what might happen in the future based on the study since relatively few years were analyzed. A hedge ratio of 1:1 was used.

The preharvest futures hedging strategy was superior to the other preharvest marketing strategies. Not only was the highest average price achieved but it was achieved with considerably less variability than from the cash sales at harvest strategy. The futures hedge also achieved the highest minimum and maximum prices of all the strategies.

Selective storage was the most profitable harvest/postharvest strategy. Storage was profitable during three of the six years analyzed. The challenge with selective storage is to determine which years to store and then when to sell. The net selling price must be calculated whenever futures prices and basis expectations significantly change until a sell signal is given. Even then, judgement must be exercised since the table of calculations is only a guide.

Development of a marketing plan is critical. Goals must first be evaluated. Other steps include evaluating the economic fundamentals of canola, the price needed to breakeven on production costs, the technical characteristics of the corresponding futures market, the establishment of price objectives and a contingency plan. Marketing plans need to be reviewed and adjusted as new information becomes available. Ag Canada reports and USDA reports generally provide the basic information for updating the canola marketing plan. A marketing plan can be implemented using cash sales, elevator contracts, futures hedges and options. Making marketing decisions based on a marketing plan should improve marketing performance since farm management and marketing concepts will be the guide instead of emotions.

###

Source: George Flaskerud, (701) 231-7377, gflasker@ndsuext.nodak.edu
Editor: Tom Jirik, (701) 231-9629, tjirik@ndsuext.nodak.edu